President Barack Obama called in leading bankers to the White House on Monday to lecture them on their responsibility to lend. The bankers say they are doing all they can. Who is right?
In the president’s view, U.S. taxpayers saved the collective hash of bank owners and managers with sundry bailout measures. Now there is a dearth of lending, especially to small- and medium-sized businesses. Banks, the president admonished, need to step up and do their duty by lending more rather than sitting on piles of money while good businesses wither for lack of funding and the general economy remains stalled as a result.
The bankers were wise enough not to remonstrate. Indeed, their least plutocratic-appearing representatives stood up before TV cameras to piously assure the world that they understood their responsibilities. All the while, however, their PR flacks assured the media that banks were, in fact, lending to every creditworthy potential borrower who walked in the door. I heard one argue that with 8,000 banks and 50,000 nonbank lenders competing for business, it was impossible that anyone with good credit could not get a loan.
Both sides are partly right.
Obama is right that many banks would have gone down the tubes and the economy would be in another Great Depression if not for the financial bailouts engineered by the Fed and the Bush administration. He also is correct that lending to small- and medium-sized businesses is down from historic levels.
Bankers are right that there are many potential lenders and that market competition should make money available to worthy borrowers. But take this with several grains of salt.
First, business lending is fragmented, and for most businesses, the total number of banks in the country is irrelevant. In practical terms, any individual business has only a handful of possible sources for a loan.
Second, bankers are like teenagers. They are highly influenced by what everyone else seems to be doing. When others are lending freely, they lend freely, and when others fear lending, they fear it too. Moreover, when business conditions are bad, the very act of approaching a new lender sends a message that your existing lender doesn’t want to give you any money.
On the other hand, the idea that bankers are unpatriotic misers truculently sitting on pots of money while great business opportunities wither on the vine is a red herring. Banks have cut back lending because the business outlook for many of their customers remains bleak. This is the classic catch-22 described by John Maynard Keynes. As long as the economy is bad, banks are unwilling to lend much and as long as banks are unwilling to lend much, the economy stays bad.
Yes, if every bank stuck its neck out a little further, the economy might improve. But a lot of banks are financially vulnerable. And the ones that stick out their necks the most are likely to get their heads chopped off. More than 100 banks have failed so far this year, and Federal Deposit Insurance Corp. head Sheila Bair thinks the number will be higher in 2010. Banks with a lot of bad loans already on the books are scared of incurring more.
In eras of optimism, bankers look at competitors and say, “If I don’t make this loan, they will and I’ll lose the business.” When pessimism prevails, the logic often is, “If I make this loan and it goes bad, I’ll be in trouble while their caution will keep them afloat and in a stronger position relative to us.”
Uncertainty always suppresses willingness to lend. Despite stock price gains over the past nine months, somewhat less bleak labor markets and marginally improved business profitability, tremendous uncertainty still looms over the economy like a thunderhead cloud.
Bankers themselves know only too well how many bad-credit shoes still have to drop. They know how difficult a task the Fed faces in draining away the vast liquidity it created. It must do this to avoid inflation but doing so without slowing the economy is difficult. And, much rhetoric to the contrary, neither party has a believable plan for restoring the long-term fiscal stability of the federal government.
If you were a banker, would you be taking on any extra risk right now? I wouldn’t.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.