Monday, December 14, 2009

Damned If You Do, Damned If You Don't

We had a major financial crisis because banks made bad loans with high leverage.  We yelled at the banks for causing all these problems, and we yelled at them for not exercising sound risk management.  Now, they're trying to be prudent and not lend money to people who won't be able to easily pay it back, but the American economy is like a crack addict in need of a fix - so we're yelling at the banks for not lending enough - for being TOO prudent.

We've become addicted to easy credit - but people forget that the current, tighter credit situation is not abnormal - it's the reversion to the mean!  The orgy of credit and appetite for risk that fueled the growth of the last 10 years is what was abnormal.  This is the single most important realization for policymakers to wake up to.  It shouldn't be a shocking epiphany, when you consider the paragraph above  -   the people who can most readily payback loans are, by definition, the ones who don't need the loans.

Today, President Obama "Pressured the heads of the nation’s biggest banks on Monday to take “extraordinary” steps to revive lending for small businesses and homeowners, drawing a firm commitment from one large bank to make more loans and vaguer assurances from others," according to the NY Times.  Remember, this is a day after he blamed the same "fat cats" for causing the crisis. 

Let's consider a few more soundbites from today:

“America’s banks received extraordinary assistance from American taxpayers to rebuild their industry,” Mr. Obama said in remarks after a midday meeting with bankers at the White House."

That is indubitably true. And then:

“Now that they’re back on their feet we expect an extraordinary commitment from them to help rebuild our economy.”

But what does that mean?  From the start of the bank bailouts, one theme from critics of the policies enacted was that they would result in us ending up with a bunch of zombie banks, like Japan did in the 1980's.  The problem, when you fix damaged banks with duct tape, is that they can't resume normal lending - they become zombies, holding onto their capital and trying to earn enough to cover future writedowns, but unable to take new risk because they are still in a fragile state!  Remarkably, this problem was made even WORSE this week, when C, BAC, and now WFC were allowed to pay back TARP funds.  

US Bancorp CEO Richard David responded:

"Mr. Davis said financial institutions would re-examine small business loans that had been denied, but he cautioned that banks had a responsibility to carefully evaluate the qualifications of each client. “We simply want to assure that we make qualified loans,” he said."

That sums it up. The reason Banks are hoarding money and not making loans is not because they hate America.  They are hoarding money and not making loans because, amongst other reasons,  1) they learned something from their collossal screw ups in risk management 2) the current risk-reward, with consumer purchasing power deflating and a murky economic outlook at best, doesn't favor massive loan origination, and 3) consumers/businesses are unable/unwilling to borrow more - they are maxed out.   Are there small business who want to borrow money?  Of course there are - THERE ALWAYS ARE! That doesn't mean they should be given money though!  Haven't we learned anything?  There are also always people who want to take out mortgages to buy houses - that doesn't mean that writing mortgages to these people is a good risk reward - as we've seen beyond the shadow of a doubt in the last 3 years.

MISH has a piece up today quoting FDIC chair Sheila Bair:

"Federal Deposit Insurance Corp. Chairman Sheila Bair said she’s “concerned” that U.S. banks are making only the safest loans, and encouraged the companies to step up their pace of lending.

“There needs to be well-managed risk-taking to get the economy going again,” Bair said today"

I'm trying to think of proper analogies, and some sports ones are coming to mind.  Imagine a baseball manager telling his cleanup hitter: "I need you to hit more home runs - but don't strike out anymore."  Or perhaps a football coach telling his quarterback: "We need more big plays down the field - big yardage pass plays - but don't throw any interceptions."   Maybe a site-boss tells his construction foreman: "I need this job done today - you have to do it in half the time with the same manpower, but make sure the quality is still perfect and that no one gets hurt."

Or perhaps a politician tells a bank manager "I need you to make more loans - but only good ones that won't default - because we're still trying to recover from the last wave of bad loans you wrote."

Boggles the mind...



Kid Dynamite said...

another thing i forgot to mention in the post is that perhaps a reason banks are not lending is because they are more realistic about the ACTUAL economic situation and they realize how bad it is - despite the never ending stream of optimism spewing from the Financial Powers That Be

Anonymous said...


ruh roh

Anonymous said...

Its not the case where we've told the cleanup hitter to "hit more home runs, but strike out less often".

Rather, since mortgage rates are so low, the case is, "hit more home runs, but when you strike out, we're going to reduce your salary".

The banks would be willing to lend more if the profit margins were better. If the returns on the performing loans did cover the losses on the lost loans.

Why loan for 30 years to a home owner, when you can buy T-bonds that pay nearly the same thing, risk free?

Kid Dynamite said...

yes, Anon - that's a good point - BUT, mortgage rates are so low because the gov't is artificially suppressing rates by buying mortgages - in other words, the banks don't have to hold the mortgages (with low rates) on their books - they offload them to Fannie, Freddie, and the Fed...

EconomicDisconnect said...

Glad I am not the only one confused by the "lend your way out of bad debt" line of thought.

Onlooker said...

Indeed. Those who are creditworthy don't want to borrow. And those who want to borrow, aren't creditworthy.

(generalized, of course)

These people are so bloody stupid it's amazing. If the mainstream economics theories and practices aren't fully and soundly discredited by the time this thing is over there's just no justice.

Of course it all boils down to political expediency and pandering to the shortsighted voters.

They're running through the forest, reacting to the brush 2 feet ahead of them, as they barrel (once again) towards the cliff ahead. Meanwhile those who have climbed up to see the forest for the trees are dismissed as crazy, while we watch these fools self destruct.

It's maddening.

JeffS said...

Banks do have to be more careful when lending, so that it shouldn't end up in a cycle, and become even worse off. However being more careful doesn't necessarily mean to cut off all lending. True most people that are creditworthy don't want to borrow, but there still are small businesses that do have a good business plan, and have a good credit, that need loans due to the crisis. With a good game plan there are ways to be able to avoid defaulting on your loans.