More on Credit

The President told the bankers they have to start lending to help us get out of the recession, and that they owe us this:

“America’s banks received extraordinary assistance from American taxpayers to rebuild their industry,” Mr. Obama said. “Now that they’re back on their feet, we expect an extraordinary commitment from them to help rebuild our economy.”

The President argues that credit difficulties are hurting small business:

President Obama reiterated his call Monday for the nation's banks to increase lending, saying that he was getting too many letters from small businesses unable to borrow money.

The story seems to be that the recovery is now held back because of a lack of credit. It is hard to understand what model might suggest this. The normal story is that we suffer from a lack of demand. Many observers, like Paul Krugman, have been arguing that we need more stimulus to fuel the recovery. That seems like what we need is more demand. In a recession the demand for loans declines. That is why the yield curve steepens. The quantity of credit extended depends on supply and demand. Given how low interest rates are, it is hard to believe that the recovery is really being stifled by a lack of credit supply.

Sure, we hear a lot about the troubles small businessmen are having obtaining credit. And surely banks are busy improving their balance sheets. But it must primarily be a lack of demand which hinders credit from flowing. Banking is a competitive industry. If there were companies with good collateral that were trying to borrow it is hard to believe they could not get credit.

More likely, the problem is that the quality of collateral is quite poor right now. Banks don't need more real assets. What kind of paper can companies pledge in a recession? Given that bank regulators want banks to improve their balance sheets this pressure must be what is limiting loans.