Compelling banks to lend

Mike Shedlock has a straightforward post about the government’s decision on Monday to directly invest in banks. First, he quotes these amazing opening paragraphs from a New York Times article.

The chief executives of the nine largest banks in the United States trooped into a gilded conference room at the Treasury Department at 3 p.m. Monday. To their astonishment, they were each handed a one-page document that said they agreed to sell shares to the government, then Treasury Secretary Henry M. Paulson Jr. said they must sign it before they left.

The chairman of JPMorgan Chase, Jamie Dimon, was receptive, saying he thought the deal looked pretty good once he ran the numbers through his head. The chairman of Wells Fargo, Richard M. Kovacevich, protested strongly that, unlike his New York rivals, his bank was not in trouble because of investments in exotic mortgages, and did not need a bailout, according to people briefed on the meeting.

But by 6:30, all nine chief executives had signed — setting in motion the largest government intervention in the American banking system since the Depression and retreating from the rescue plan Mr. Paulson had fought so hard to get through Congress only two weeks earlier.

Will this injection of capital unfreeze the credit market? Maybe not.

Treasury Secretary Henry Paulson persuaded nine major U.S. banks to accept $125 billion in government investment. Getting them to lend it out may prove a tougher sell. […]

“The truth of the matter is, they can’t put a gun to their head and say you have to lend this money,” said Charles Horn, a former official at the Office of the Comptroller of the Currency

Mish goes on to comment.

There seems to be a fine line between …

  1. Illegally forcing supposedly well capitalized banks at bazooka point to take money on questionable terms
  2. And illegally forcing those same banks at bazooka point to lend it
    Self Preservation

I hope that fine dividing line holds and I also hope banks do the responsible thing (nothing) because Paulson is acting like a complete fool. It is in no one’s best interest to lend that much money. We are in this mess because banks lent money to anyone and everyone including those with no possible means of paying the money back.

The US is in a recession, consumers are cutting back discretionary spending, there is rampant overcapacity in every sector but energy, and there is no reason to go on a lending spree. Furthermore, there is no reason for any qualified buyer to want to borrow. Why would any responsible party want to expand in this environment? The only people who want to borrow significant sums of money now are the very people banks should not want to lend to.

Thus the best thing banks can do with that money is sit on it. Yet the penalty for sitting on it is the difference between what the Fed will pay on bank reserves and the 5% interest banks have to pay at bazooka point for borrowing money they did not want in the first place. If banks do start lending like Paulson wants, defaults are guaranteed to increase dramatically.

Is this right? He supports his arguments by quoting from an interview he did with economist Paul Kasriel in December 2006, two years ago.

Most people are not aware of actions the Fed took during the great depression. Bernanke claims that the Fed did not act strong enough during the great depression. This is simply not true. The Fed slashed interest rates and injected huge sums of base money but it did no good. More recently, Japan did the same thing. It also did no good. If default rates get high enough, banks will simply be unwilling to lend which will severely limit money and credit creation. [Emphasis added]

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