Framing the Geithner Bank Plan

What are your expectations for the impending Geithner Bank Plan?  Listening carefully to the messaging from the top, you are probably hoping for an increase in bank lending.  In fact, over the past few weeks, Congressional leaders (e.g., at the Senate Budget Committee hearing last week) and the President (e.g., see the penultimate paragraph of last week’s TV address) have repeatedly insisted that, going forward, banks that receive government support should increase their lending.

And you’ve probably seen matching statements from the banks recently, either (a) explaining why the fall in lending was not their fault, or (b) celebrating the fact that, against all odds, they did manage to increase loans in the last quarter. 

So the perception has been created that the new Bank Plan will succeed if it raises bank lending, and that it can be judged by this metric.

But this is the wrong framing of the problem.  Or, perhaps it was the right framing for last October, when credit supply was severely disrupted, but it is an out-of-date and perhaps dangerous way to think about what is now needed.

If many creditworthy consumers and firms currently want to borrow less (i.e. increase their savings/strengthen their balance sheets), the amount of outstanding credit in the economy should fall. 

Banks have definitely tightened lending standards (subscription link, but the point is in the free part) – there might be some overreaction here, but everyone agrees that overly loose standards were a major cause of the crisis, so what else would you want them to do?  Certainly there are some creditworthy borrowers who cannot currently get loans at the prevailing interest rate, but how many? 

If you think there was overlending in the boom (and who doesn’t?), then you should expect a contraction in total credit now – this is the simple and compelling idea behind the fancy term “deleveraging”.

The task is not so much to force lending to increase now, but rather to clean up the banking system so that, when the recovery begins in earnest, credit will be available on reasonable terms and subject to sensible lending standards. 

This difference matters because the real danger is that either the executive or legislative branch will see the need to mandate that lending must increase – or that loans must be made to particular categories of borrowers, such as small business or housing.  This would be a recipe for more bad loans and further damage to the banking system (and more costs for you, the taxpayer.)  It would also lead to corruption, scandal, and reform fatigue.

The Geithner plan may work – let’s see the details before we take a more definite view on that.  But if the wrong expectations are set, it could even work well and still be judged a failure.

8 responses to “Framing the Geithner Bank Plan

  1. You need to see Yves Smith’s highly critical comments on WaPo reports on the “bad bank” at Naked Capitalism. Here’s the link: http://www.nakedcapitalism.com/2009/02/bad-bank-assets-proposal-worse-than-you.html

  2. Strongly agree re: Yves’s piece.

    Regarding lending, Team Obama’s plan is a simple two-step process. Step 1: Buy (or insure) the banks’ bad loans. Step 2: Force them to make new bad loans.

    Are Obama’s advisers really so totally captive to the big banking interests? Or do they simply know something I do not?

  3. Really enjoyed the Planet Money live chat, thanks!

    Would like to get a real economist’s perspective on an extremely charitable view of Geithner’s plan: are there risks in taking the shortest path to stabilizing the financial system (temp nationalizing money center banks) vs. avoiding those by protracting the current period of market/financial uncertainty? That is, could fixing the problem quickly be worse than letting it drag on?

    For example is the threat of, say, hyper-inflation greater if the financial system stabilizes sooner rather than later? If not hyper-inflation (and ignoring market turmoil/loss of shareholder value), what could be some bad things about fixing the problem quickly?

  4. Pingback: Credit banking | Financial Articles

  5. I want to propose a different idea, in hopes of sparking a different conversation.

    1. Let’s stop giving money to the banks, to car companies, to thieves, to idiots, to lobbyists, to anyone who has so far lined up with hand out begging taxpayers to save the Lards of the Universe who failed us into this mess. Just. Stop. The. Insanity. Period.

    2. According to some web site I googled, approximately 140 million PERSONAL/JOINT tax returns were filed in 2007. Let’s say 145 million in 2008. Now eliminate any personal/joint return reporting gross income greater than $250,000 — Obama’s cutoff for any tax cut. Then, eliminate any personal/joint return reporting gross income less than whatever number it is under which the US permits you to pay no taxes — let’s say this is $15,000 per year. Let’s say this leaves 100 million qualifying tax returns for step 3.

    3. Take $1 trillion. Divide by 100 million. You get $10,000. Presuming the MS calculator in Windows XP is operating correctly. Now distribute $10,000 US checks to 100 million US taxpayers. Direct. No middleman. No damn banker whining about having to earn just 500,000 a year with no bonus until he’s paid us back for 350 million he can’t and won’t itemize.

    4. I’m going to take my 10K and pay off mortgage principal in advance. I’ll bet several million more US citizens do the same. Some us might buy new cars. Some of us might put solar cells on the roof. Some of us might send a kid to college. WE KNOW WHAT TO DO WITH THE MONEY. And every time we pay off a loan or buy a car or send a kid to college, that money goes back into the system, pumping it, priming it, moving it up the food chain. Hell, some of it might even reach a bank.

    5. You want to see the US economy recover in less than two years? I’ll bet this approach takes us to Mars.

    6. And the beauty is, it also creates an incentive for every tax cheat who can’t read the rule book he helped to write to damn well want to file a tax return just to get his 10K.

  6. Can Simon Johnson/ James Kwak comment on the Safehaven analysis of Feb 1 2009 ?

    http://www.safehaven.com/showarticle.cfm?id=12483

    Quoting from “We’ve only just begun” …. the deleveraging of the three decade credit boom in the US

    “…actual deleveraging has been occurring in the financial sector during 2008. THE poster child example for this phenomenon is the asset backed securities markets. The following chart is self-explanatory. Since the dawn of the asset backed markets in the mid-1980’s, there had never been a quarter over quarter decline in asset backed securities market leverage until 4Q of 2007. We already know that it’s the non-bank credit creation arena (the shadow banking system necessarily inclusive of Wall Street) that has been ground zero for broader credit cycle reconciliation in the current period. Have the markets already priced in contraction/deleveraging in the non-bank financial sector? To a large extent, you bet. Yet confidence in the sector will never be restored until investors can truly assess balance sheet risk. Given the revelations of companies like Citi, State Street and BofA lately, it’s clearly what we don’t know that’s the issue. And we’re miles away from confidence restoration. Miles.”

  7. To see the Chart of the Asset backed Securities Debt – Quarter to Quarter Growth Rate from 1985 to 2008 click here

    http://www.safehaven.com/images/contrary/12483_c.png

  8. The Biggest Propoganda Piece in most people’s understanding of the Plan is that is will “finally establish” the Correct MKT price…….because private investors will be offering to buy these assets at certain prices (obviously).

    The Problem is that the “MKT” price will be ARTIFICIALLY HIGH because the private investors will be borrowing up to 90% of the capital used to purchase the assets and the FED GOV’T is providing this LEVERAGE without the accompanying risk…(the private investors only have to pay back their own capital put down…..not the majority (they used to purchase it) because the gov’t says they won’t need to pay back the loans should they investors lose money on th deal. *This Added reward and reduced risk …when factored in will have a big upward price revision….than the current value (where investors would be on the hook for all they borrow and all they put down)…like in a normal transcation that would fairly determine price.