To Lend or Not To Lend, Fed Edition

This is so brilliant I’m going to just copy Mark Thoma’s entire post right here:

Tim Duy emails:

Discordant headlines in Bloomberg:

Fed’s Kohn Says Regulators Should Encourage More Bank Lending Amid Turmoil: U.S. regulators should rise to the “challenge” of encouraging an expansion in bank lending amid a weakening economy and continuing financial-market turmoil, Federal Reserve Vice Chairman Donald Kohn said.

Fed’s Kroszner Urges Banks to Increase Capital Reserves to Buffer Losses: Federal Reserve Governor Randall Kroszner urged banks to hold more reserve capital to protect themselves from future “cascading losses,” as potential market fixes are “no guarantee” against another credit crisis.

It’s nice to see the Fed getting its communication problems under control.

This is the inconsistency I pointed out in the goals of the financial sector bailout. Banks need new capital to protect themselves against falling values of their existing assets. But if they use the new capital to make new loans, you defeat the purpose of the new capital, because that new capital is no longer helping support the existing assets. These are two separate and somewhat contradictory goals. Note that, according to Bloomberg (see the second link above), financial institutions have taken $978 billion in writedowns – so far – and raised only $872 billion in new capital. So while politicians rail against banks that took TARP money but haven’t expanded lending, the banks at least have logic on their side. I’ve been surprised that no one in Washington that I’m aware of has been willing to point this out.

(And do visit Mark’s blog – it’s a great place to get a variety of perspectives, updated throughout the day.)

5 thoughts on “To Lend or Not To Lend, Fed Edition

  1. Not contradictory — they can be reconciled by cutting dividends (to zero, for a while)! Part of the (not paid) dividends go to capital boosting, part to lending. Ta dah!

  2. Banks are holding onto inflated assets and loans, what they are forgetting is that if they don’t provide new loans those asset values will go down even further and they have to write off more losses. Credit was holding up the prices…So much for leveraging.

    Current situation and questions: How many more bailouts and stimuli? Nothing seems to be working so far (it started since March with Bear). Everyday you hear more bad news and new government intervention or spending programmes. This is going to kill consumer confidence and will cause more hunkering down tendencies.
    Why are these troubled Banks still paying dividends? They should be giving same money in new loans to consumers and businesses.
    Citi’s shareholders got bailed out at taxpayers expense, those $309Bn assets are probably worth less than $200bn today, who know? Where is transparency? And confidence that was created using this deal is fading away again. Banks are still not lending each other, they are using central banks.
    I think now we have too many Moral Issues and Hazards in this crisis and a back clash is sure to come. Risks are just growing.

    Probably government should have just opened few nationalized banks for few years rather than giving money to people who brought up this mess on us in the first place.

    Luckily, we sold half of those bad securities to Europe (and other countries as well, well they were greedy too)…we were doomed otherwise.

  3. I think the credit expansion could be referring to the new credit policy, which is not reckless and therefore far less risky. Such low risk lending can be possible, in small amounts, while the bank recapitalizes. They can go hand in hand. Expansion is probably the wrong word here. Replace that with “cautious start” and statements would make sense.

  4. Self preservation is priority one in the animal kingdom and in the business world. Can’t say I blame the banks for wanting to hold on to the capital. One simply can’t say for sure at this point how bad the recession will ultimately be. Assets that still look good could become toxic. Eventually a brighter outlook will bring renewed confidence and loosen up the credit.

    The reluctance to lend suggests that more capital needs to be injected into the system. Maybe a second TARP round is needed (we still have $350 billion not tapped). When banks feel confident they have adequate reserves along with surplus capital, they will start lending the surplus capital. There is simply too much potential interest income out there for them not to lend when they feel confident they have adequate reserves.

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