Should Banks Be Forced to Lend: A Rebuttal

In an interesting column on the New York Times website today, Floyd Norris asks whether banks should be forced to lend. Good question.

His answer, at least, is no.

“It was foolishly easy credit that got us into this mess,” he wrote. “A government-mandated return to such lending is not a viable solution. Ordering the bankers to make loans is both simple and satisfying. But it will not fix the economy or the financial system.”

Norris suggests that to get lending going “somehow a way must be found to persuade both the public and the bankers themselves that the banks are now solvent.” To do that, he maintains that the government should take over more toxic assets.

After that, “the newly risk-averse bankers must be willing to lend money — not to anyone, but to those who are likely to be able to repay the loans.”

His suggestions are a bit Pollyanna. “Convincing” bankers is not exactly a sound strategic plan. Call it the Fingers-Crossed Strategy.

Actually, the comments to Norris’s article are far more compelling. There are several meaningful suggestions there. A read through them is a meander through the wilderness of indecision that our federal regulators must face daily. Nationalize banks, or allow for Citigroup and the like to fail and you’ve got an RTC of epic proportions on the government’s hands. Continue with TARP I bailouts and there’s little result to all the billions invested. Do nothing and the problem persists. We circle around and around, and yet the central reality of the situation is likely to be that until everything shakes out — housing, CDS, SIVs, mortgage finance, de-leveraging, everything — the economy will not rebound and banks won’t lend. It will take time, but it will happen.

Two Interesting Comments to the Norris Article Worth Reading:

1) The Status Quo Argument…

Letting these banks go bust sounds great, but it will not work. Taking over extremely large institutions is nothing like the RTC in the 80’s, when the largest banks in the country had assets of $100 billion, not $2 trillion. It’s far too complicated a world today, far too intertwined – look at what happened after Lehman.

I usually agree with Krugman, but not this time. What the government is doing with AIG will work for an insurance company, not a bank. Citigroup is going through the same process, just without the wipe-out of equity. We can’t have a country where all the largest financial institutions are allowed to fail, or have stocks trading at under $5.

This is partially the government’s fault by allowing all this excess risk to be taken on without proper regulation. We are paying the piper. The solution is to get out of it and fix it so it doesn’t happen again.

The government did the right thing supporting JPM’s take-over of BSC. It did the wrong thing with LEH, and the world economy is suffering. It did the right thing supporting BAC’s takeover of MER and Countrywide, and I assume WFC’s takeover of Wachovia.

Vengeance is not the solution. The solution is setting things right, and making sure it never happens again. Supply-side economics is indeed dead.–bmeisen

2) The Let-Them-Fail Argument…

We, absolutely, should not force banks to lend. At the same time we should not give them any public funds. It is irrational to give somebody money and force them to behave differently then they normally do.

As clearly exposed by The New York Times, bank will continue to do whatever they want to do. But, when given the opportunity, they will put their hand out and get whatever free money is available, anyone would. Banks should not get any public funds and should be left to file for bankruptcy if poorly managed.

The government can and should lend money directly to the needing public. Several government entities are already equipped, capable and experienced at lending money to the public. There is no need for intermediaries like banks, who are poorly managed and greedy, to make profits and add nothing to the process except costs and poor judgment.—Alexander Gray