Thursday, January 15, 2009

Bank Bailouts and Losses

Representative Barney Frank and many others complain that recipients of TARP funds have hoarded funds rather than issue new loans. I find this argument perplexing. If there was a huge demand for credit that is going unfulfilled, perhaps it makes sense. But as we spiral into a Keynesian recession the demand for credit, at least by able borrowers, has fallen significantly. De-leveraging is taking place because banks are not sure if anybody else is credit-worthy. Since the banks got in trouble by lending too much it is not surprising that they hold reserves to maintain some semblance of solvency.

And then we read, in today's Post for example, that unexpectedly large bank losses are complicating the federal government's rescue plans. As they note:
The problems are intensifying the pressure on the incoming Obama administration to allocate more of the $700 billion rescue program to financial firms even as Democratic leaders have urged more help for distressed homeowners, small businesses and municipalities. Senior Federal Reserve officials said this week that the bulk of the money should go to banks.
This should hardly be a surprise. Given the massive de-leveraging we are experiencing, and the fact that a new wave of foreclosures are coming. Moreover, it is not clear that all of the troubled banks have recognized their losses yet. Under these conditions would you lend?

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