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[randomness]

Lately there's been much talk about how Treasury's attempts to get the banks lending again have failed. Today's NYTimes has a piece that discusses this:

Bailout Monitor Sees Lack of a Coherent Plan

The head of a new Congressional panel set up to monitor the gigantic federal bailout says the government still does not seem to have a coherent strategy for easing the financial crisis, despite the billions it has already spent in that effort.

Elizabeth Warren, the chairwoman of the oversight panel, said in an interview Monday that the government instead seemed to be lurching from one tactic to the next without clarifying how each step fits into an overall plan.

“You can’t just say, ‘Credit isn’t moving through the system,’ ” she said in her first public comments since being named to the panel. “You have to ask why.”

If the answer is that banks do not have money to lend, it would make sense to push capital into their hands, as the Treasury has been doing over the last two months, she continued. But if the answer is that their potential borrowers are getting less creditworthy with each passing day, “pouring money into banks isn’t going to fix that problem,” she said.

Prof. Michael Pettis talked about this problem in greater detail a month ago, in an analysis focused on China. (Both countries face similar policy questions.)
From http://mpettis.com/2008/11/can-china-adjust-to-the-us-adjustment/:

The discussion of the health and stability of the banking system leads easily into the second much-discussed option – really sort of a variation on the first. The government can force credit expansion by requiring the banks to lend more. Although there has been a process over the last decade of freeing the banks and allowing them more discretion in lending as a way of improving China’s dismal capital allocation process, there is no reason why policy-makers cannot reverse course and force banks to lend more.

Certainly they are trying. Last week, after weeks of rumors that loan caps were being relaxed, the PBoC announced that they were junking the credit restrictions they had previously imposed on banks (interestingly enough they have always denied that they had imposed constraints). But instead of gleefully exploiting their newfound liberty banks have refused to party, and loan growth has been very low.

This is hardly surprising. In such dire economic circumstances with global credit markets and liquidity seizing up, with domestic bankruptcies rising, with inventories and receivables also rising, it takes both brave banks and brave borrowers to accommodate credit expansion. Most good companies seem reluctant to borrow and anyway banks are reluctant to lend.

So what if policy-makers simply announce minimum loan growth targets for every bank? That should certainly cause an expansion in banks’ balance sheets.

I think, however, that there are two problems with such a policy (although administrative measures of this sort hold a dangerous allure to policy makers). First, I don’t think it will be effective in net credit creation for the country. This argument is simply the flip side of my previous arguments as to why I did not believe the loan caps that were in place until this summer actually restricted credit creation.

In those days I argued that if monetary conditions are consistent with rapid credit creation, we will see credit creation. Any attempts to restrict credit creation will simply meet with some or all of the following responses:

1. Banks will innovate around the restrictions.
2. Credit creation will occur outside the restricted areas.
3. Banks will lie.

In China’s case we have definitely seen innovation (securitizations and transactions that took loans off the balance sheets of banks) and outside growth (rapid increases in dollar loans and policy bank loans and, most importantly, growth in the informal banking sector). If there is a sharp contraction we will know if there have also been many cases of lying.

The same thing can happen in reverse. If banks don’t want to lend but are forced to, we will see off-balance sheet transactions placed back on balance sheet and a much more rapid decline in loans from informal banks. That means that real credit expansion can still be negative even with minimum loan growth target enforced onto the banking system.

The second problem is likely to be the quality of the loans. It is always possible to find borrowers, even in a sharp economic contraction and an overinvestment crisis. The problem is that many of these borrowers are not the ones that any prudent bank should be dealing with, and to the extent that the forced loan expansion is successful, it will probably do little more than ease the credit crisis in the immediate near term and make it much worse in the medium term.

Comments

[drwex]

What I didn't see addressed here is the hypothesis that the creditworthiness of the potential borrowers is itself a self-fulfilling prophecy. That is, nobody wants to be the FIRST lender, but once someone has secured credit it's much easier to secure more. This has always been true - it's the bane of more than one start-up I've seen - but moreso now.

By the fact of banks refusing to lend to all kinds of entities, they are declaring those entities un-credit-worthy and thus encouraging everyone else not to lend, either.

At base I agree that the Treasury really has a serious lack of ideas on how to deal with this and the ones they're trying out aren't particularly appealing to me as an observer.

[r-ness.livejournal.com]

I think part of the problem is that large numbers of entities which appeared creditworthy have suddenly stopped being so, and this has led lenders to question whether anyone is creditworthy. "If GM can be on the edge of bankruptcy, who's a good credit risk?" goes the thought.

Obviously, this kind of thinking is overdone. But if you are a bank officer in charge of lending, you're feeling that landmines abound right now, so why stick your neck out, particularly when no one else is lending either?

Classic herding behavior in the East African Plains Ape.

[st-rev.livejournal.com]

Wasn't government-encouraged extension of credit part of how we got into this mess in the first place?

[r-ness.livejournal.com]

Wasn't it, though?

[r-ness.livejournal.com]

Note that I think by far the greatest share of that government encouragement was in the lack of oversight in the creation and use of vehicles to facilitate massive leverage by financial institutions.

I grant that conditions have now changed, and that the resulting deleveraging has sucked a huge amount of capital out of the economy. The current attempts to address that issue appear to be very reactive.

Someone needs to take a step back and look carefully at what they want to achieve, and how it can best be done.

[madbodger.livejournal.com]

That, and the unregulated secondary and tertiary markets, which move (much) more money than the primary market.
Yeah, I quite agree. The economic (housing) bubble was caused by people buying more than they can afford. The fact remains that they borrowed money they can't repay. There simply aren't any pretty ways to fix that.