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The prospects for credit market revitalization
Today you get more Felix Salmon, who nails it:
America's banks -- and the world's, for that matter -- have had de facto unlimited access to very cheap Fed liquidity for many months now. That hasn't induced them to lend. Will this latest recapitalization do the trick? I'm far from convinced. And what's more, the demand for loans is drying up fast: do you really feel like buying a bigger house right now, or taking out a car loan? Well, businesses are in the same boat. In a recession, their ROI falls, so they borrow less.
I am, however, a little worried about Felix's proposal to make banks lend the money. It's not that I have a better idea, but I suspect any scheme of compulsion will bring either higher risk or ways to game the scheme or both. And if bank shareholders and CEOs do not wish those loans to be made, our current system of corporate governance quickly becomes unworkable.
Posted by Tyler Cowen on October 15, 2008 at 08:05 AM in Economics | Permalink
Comments
Tyler, with debt loads at all levels of society so high, why do we want people to borrow more money? This is a serious question, not a rhetorical one. Is it just to avoid the recession that would come along with paying down debt?
Posted by: K T Cat at Oct 15, 2008 8:16:21 AM
Maybe a better idea would be something that would increase firms' ROI. A corporate income tax rate cut anyone?
Posted by: Anon at Oct 15, 2008 8:21:07 AM
Didn't the great depression happen because both banks and customers horded money, ie the mattress became the nation's greatest savings bank?
How about this, what if we let the banking sector go where it may and the Fed instead printed money by indiscriminately giving checks to everybody in America? If deflation is the big enemy, that seems to be best, if unseemly, way to fight it. Just throwing that out there by the way; it's not like I'm a huge supporter of it.
Posted by: mw at Oct 15, 2008 8:38:25 AM
How far would $700B get us toward a nation railway system?
Posted by: David J at Oct 15, 2008 8:48:38 AM
How far would $700B get us toward a nation railway system?
Posted by: David J at Oct 15, 2008 8:49:16 AM
mw, doesn't this all seem like following path of the Zimbabwe Economic Miracle? First, we trash the people who produce. Second, we hand out wads of cash to people who don't. Lather, rinse, repeat!
:-)
Posted by: K T Cat at Oct 15, 2008 8:50:21 AM
From reading this post and your last one on too many sentences to ponder, I get the impression that you have started to realize how wrong you have been about the crisis. Even ignoring your wrong ideas about a liquidity trap and the differences between banks and other financial firms, you have failed to apply the insights from Hayek, Hurwicz and many others about information and incentives (remember how many posts you wrote last year about them) as well as the lessons one can draw from public choice theory on how to deal with a crisis.
Posted by: E. Barandiaran at Oct 15, 2008 9:17:53 AM
Wasn't making (re: encouraging) the banks to lend money one of the reasons why we got in this message to begin with?
Posted by: Jack C. at Oct 15, 2008 9:24:12 AM
err... I meant MESS, not message
Posted by: Jack C. at Oct 15, 2008 9:25:31 AM
The ease of making fun of the helicopter analogy has obscured the basic truth that the helicopter or it's real world equivalent (Gov buybacks of long term Treasuries, fixed assets, tax rebates etc.) is the only way to unclog a liquidity trap. That's what we are in now, and it's time for economists (and bloggers) to drop the helicopter jokes and get serious about the best methods for remonetizing the economy. A liquidity trap is an absolute catastrophe, and we are facing that now.
Posted by: maynardGkeynes at Oct 15, 2008 9:28:32 AM
I'm pretty sure the pendulum has swung the other way at this point. Incenting higher risk, at least in the short term, is a good thing.
Posted by: dWj at Oct 15, 2008 9:32:48 AM
There's a problem of bad debt and overpriced assets. Treasury stepped in to save the banking system, now let the asset prices find the bottom. And let companies like GM die. There are several electric car manufacturers who'd be happy to purchase the production capacity.
Posted by: 8 at Oct 15, 2008 10:06:02 AM
Well, there you have it. Prof. Tabarrok says in September that there is no credit crunch "despite all the talk"; today Prof. Cowen tells that we are, basically, in a liquidity trap where nothing will make the banks lend. But I'm sure both of them sit around the department office complaining that policymakers don't listen to economists.
Posted by: y81 at Oct 15, 2008 10:25:11 AM
America's banks -- and the world's, for that matter -- have had de facto unlimited access to very cheap Fed liquidity for many months now.
======
This conflates the large, money-center banks with "Americas Banks".
It used to be that small banks were net _providers_ of funds to the Fed Funds market (not sure if that is still true).
To some extent, I suspect that loan officers, even credit-card companies, are fighting the last battle, so to speak. It's human nature, right? Unfortunately, making this year's vintage of loans the super best ever, may, paradoxically, raise the probability that the existing vintages get ... worse.
We should jawbone bank managements and shareholders, to make sure they don't get too panic-y, so I agree with Paulson saying something (he just doesn't know how to talk bank-speak).
More:
Supposing there is unmet loan demand out there, especially from small businesses (who are growing sales, rather than just using debt to keep from sinking as sales stagnate).
What would you do to induce small banks to switch, to become net borrowers of Fed Funds and leverage them up on their balance sheets?
Well, you'd waive capital requirements. God knows, they don't mean too much (one could argue), since our pandering politicians have passed out a free-wheeling FDIC insurance to $250,000 on the lion's share of their liabilities (deposits), anyway. What are we doing instead? Encouraging people to raise capital and stick to the highest standards ... ? Maybe (I don't know, for sure).
Last, we should pressure small banks, as a group, to stop paying dividends, as a matter of prudence, for a year. Publicly doing so can only help the system and help them with ... unruly shareholders, who ... are short-term oriented.
Posted by: Amicus at Oct 15, 2008 10:37:31 AM
How far would $700B get us toward a nation railway system?
We have a nationwide railway system. Your question, I assume, is more, how much would $700B be able to upgrade our railway system?
One question would be how long it would take to spend that much. The National Environmental Policy Act of 1970 and its requirements for Environmental Impact Statements come into play. If you're asking about true Japanese-style high speed rail, that would require all-new tracks and in that case a tiered EIS process. There is zero chance that anything could built until ten years in the future. Check out the history of the Southeast High Speed Rail project to see how long EISes take.
If you're talking about incremental improvements, there's a large number of service improvements that could bring various corridors up to 110 mph speeds for that much money. However, concentrating on a "nationwide" system is a bad idea; rail will not be competitive for transcontinental trips. The proper area of focus is on 100-500 mile corridor trips. Amtrak could actually be profitable over such trips. The long-distance trains are so inefficient (low loads, sleeper cars, filling up on short segments but being empty on long stretches across empty land) that Amtrak actually loses more money on them when oil goes up, as the increased passengers don't outweigh increased fuel costs.
Posted by: John Thacker at Oct 15, 2008 11:00:47 AM
Great minds think alike. Here is a comment I posted last night on Krugman's blog:
Funny, I thought there was pretty widespread agreement that the financial services industry has gotten too large and needs to shrink. All the capital injections will do is delay that while losses from overcapacity grow. Too many lenders chasing too few profitable loans leads to more risk, not less.Look at AIG. It took them only 3 weeks to lose the first $85 billion the Fed loaned them, largely due to continuing losses on the approx. $440 billion of credit default swaps they wrote. The longer AIG stays in business, the more they’ll lose. And AIG is less than one percent of the CDS market.
There is no way all the swaps can be paid off. Bankruptcy for the big CDS sellers is inevitable, and delaying it via equity injections is just shoveling good money after bad.
Having the FDIC guarantee new bank debt is another really bad idea. It encourages shaky banks to borrow a ton of money and risk it all on one throw of the dice. This is what happened with the S&L’s twenty years ago, and the incentives created by this plan are pretty much the same now as they were then.
By the way, the Fed's commercial paper release and bank credit tables (the H.8) are still showing, as they have all along, that nonfinancial firms are getting plenty of credit. The only things endangered by this "crisis" continue to be Wall Street salaries and bonuses.
Posted by: Jeff at Oct 15, 2008 11:18:02 AM
Isn't compelling banks to make risky loans part of the reason we are in this mess?
Posted by: Paul at Oct 15, 2008 11:18:54 AM
700B = ~13.5 million jobs at $50k. not great jobs, but jobs.
That sops up a lot of unemployment.
Posted by: dieselm at Oct 15, 2008 11:38:03 AM
Tyler,
The key is to lower lending standards back to where they were for subprime borrowers. Even in good times, there are literally thousands of money-losing businesses that die for lack of funding, but whose owners, managers, and employees would glady borrow any amount of money you want to lend them as long as you never actually make them pay it back.
Here is what is going to happen- sometime next year, after the inaugeration, and when the recession is at its deepest, money will begin be lent to these dying companies (already happening for the automakers) to keep them afloat, and the government will guarantee these loans on a continuing basis. As the numbers of these state supported firms increases, their competitors, previously sound money-making operations, begin to lose money, too, and they also get on the gravy train of government supplied inco....er...loans (via the banking system). Losses never need be declared. The government balance sheet doesn't really exist anyway.
Posted by: Yancey Ward at Oct 15, 2008 11:47:31 AM
Tyler, Felix and Friends,
Cast your minds back to a year ago. We knew then that the banks were short of $400-600 billion capital. What did being short of capital mean? It meant that the banks would not be creditworthy, would not be lent to by other banks who distrusted their ability to repay in all circumstances. OK?
The banks raised about half of the capital needed.
So giving banks plenty of funds to lend to one another did not produce much lending. Any surprise?
Now the banks have been forced to accept adequate recapitalisation, and incidentally given even more funds to lend to one another, might credit markets settle down to normal, profitable trading? Or is that unthinkable?
Posted by: David Heigham at Oct 15, 2008 12:07:35 PM
People are forgetting that the government is getting something back for the 700 billion. The eventual balance sheet hit will be far less than if, say, the government gave 13.5 million people 50k jobs for one year.
Posted by: mw at Oct 15, 2008 12:34:47 PM
"mw, doesn't this all seem like following path of the Zimbabwe Economic Miracle? First, we trash the people who produce. Second, we hand out wads of cash to people who don't. Lather, rinse, repeat!"
Unfortunately, you're describing much of what the government does already.
Posted by: mw at Oct 15, 2008 12:37:30 PM
I hardly need to take jabs at Tyler at this point, since others have done an adequate job already in this thread. But let me be constructive (for a change!) and address this statement:
I am, however, a little worried about Felix's proposal to make banks lend the money. It's not that I have a better idea...
C'mon Tyler, relax the constraints of what is "politically feasible." First shake off what other "responsible" people are talking about, and imagine the president comes to you for advice. Do you really not have a better idea than the government forcing banks to make loans?! I can't believe you mean that.
How about, the government pulls half its troops home and disbands them (maybe with 6 months' pay to avoid riots from trained killers), it auctions off all of the oil and natural gas deposits in OCS lands (using Vernon Smith to arrange revenue-sharing with the coastal states who fear oil spills), it cancels the Paulson bailout, and then it eliminates the income tax. All IRS employees are laid off, again with 6 months' pay to avoid riots from trained thieves.
I'm thinking the above would be pretty sweet, and it probably would only increase the federal budget deficit for a year or two, tops. After that, supply-side effects would more than pay for it (in conjunction with the revenues from auctions and lower military spending).
If you want to say, "C'mon, stop being ridiculous, Ron Paul didn't win the election," fair enough. But then you should be blogging, "I can't come up with a better idea that wouldn't get me laughed off of Fox News." But you can certainly come up with a better idea than forcing banks to lend money that the government forced them to take.
Posted by: Bob Murphy at Oct 15, 2008 12:46:30 PM
People are forgetting that the government is getting something back for the 700 billion. The eventual balance sheet hit will be far less than if, say, the government gave 13.5 million people 50k jobs for one year.
Is that really true though?
The government is going to invest in non-performing loans on real-estate assets that provide no real capital gain for the overall economy (the people paying those loans are already cash strapped, so having the government hold their loan isn't going to make them become rabid consumers again, it's just going to free the bank from short-term burden of missed payments).
The question is really whether or not the government taking over those assets allows the banks to reallocate capital towards more productive investments. But in a market downturn it is already being shown that they have nowhere to put the money.
What if the government puts that $700B into lots of $50K jobs that are part of capital improvement projects such as the building of more efficient/secure ports, oil refineries that are less subject to interruption by hurricanes, investment in alternative fuel infrastructure to help us reduce the reliance on foreign oil?
I'm not promoting one approach or the other, I'm really just questioning whether your argument is perhaps a little overly simplistic.
Posted by: Sam Wilson at Oct 15, 2008 12:57:49 PM
The government has enough land to give everyone, in the 300 million population, 7 acres each. I'd take 7 acres. They could even give the returning soldiers we can't afford anymore 20 acres each and take that out of our share. This would be a nice addition to Bob Murphy's plan IMO.
Posted by: Gabe at Oct 15, 2008 1:48:47 PM
