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…
-KD

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