Yes, But Will Banks Finally Lend?

By Bizbox

The news of the Federal Reserve's latest contribution to the bailout--which includes a pledge to lend up to $200 billion, on favorable terms, against collateral that consists of securities backed by several types of troubled loans, including ones backed by the Small Business Administration--is being greeted as something that's finally going to loosen banks' lending gears. "Small businesses finally are getting their own little piece of the federal government’s ballooning bailout package," writes Independent Street in a typical offering.

The post also quotes Sen. Chuck Schumer (D-N.Y.) offering praise on similar grounds: "This new focus by Treasury and the Fed should help inject some much needed economic life into Main Street and couldn’t come a day sooner."

While we hope for the best, we're not exactly expecting it. We can't get this article from last Sunday's New York Times out of our head. It pointed out that despite receiving the initial injection of billions and billions in government capital on the implicit and explicit grounds that they were expected to lend it back out, the banks aren't offering much credit at all. Not that we didn't already know this: we did. But still, it's disheartening to read each time we have to read it.

"Reports from institutional and individual borrowers across the country indicate this," writes the columnist Gretchen Morgensen. "Nervous lenders are demanding that even healthy loans be paid back. Banks and other financial institutions, meanwhile, are reducing exposures to borrowers and doing whatever they can to discourage the assumption of further debt."

Morgensen doesn't blame the banks, exactly: they're just pursuing their own self-interest, which is another way of saying they're being good capitalists. It is for such reasons, rather, that government exists: to compel action that is not necessarily in economic players' self-interest but that is essential to the common good. Government does this constantly even when those whom it is compelling don't owe it anything. That it did not require (as opposed to encourage) specific behavior from banks that were the beneficiaries of hundreds of billions of dollars in government money is frankly kind of appalling. In other words, either promote a free market or don't--either let the banks die or bail them out. But if you're going to bail them out, at least make sure you get something in return!

And so we're worried about this new step, because once again, there isn't really any compulsion. A bank could now put up its crappy asset-backed securities for Fed cash; and it could in turn lend that cash out to the small businesses that need it. Certainly in good times this would be a no-brainer: after all, in good times, lending out money is a prime way--maybe the prime way--banks make money. (That's what a bank is!) But these are not good times. And who's to say that banks, having borrowed that money, are going in turn to lend it out? Who's to say they're not going instead to take it and use it to buy smaller banks? Or increase dividends to hard-hit shareholders (and executives)? Nothing would stop them from doing that. Come to think of it, what's to stop them from simply not taking the Fed's money in the first place?

Schumer may be praising this new step, which could, via three degrees of separation, increase lending to small businesses. But it's worth remembering that Schumer is also the one who proposed lending directly to small businesses, to the tune of somewhere in the neighborhood of $10 billion.

If such a hypothetical program were to be instituted, there's not an x% chance that x% of the money would be lended to small businesses, as is the case with the Treasury Department's capital injections or with the Fed's new lending program. Rather, there would be a 100% chance that 100% of the allocated money woud be lended to small businesses. Too-big government? Government micromanagement? That ship has long since left the free-market harbor.

Okay, okay. We hope it works--we hope the Fed's neutralizing of the toxicity of these assets ups lending to small businesses. But in case you couldn't tell, count us skeptical.

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November 26, 2008 12:25 PM