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.

Credit and the Bankers

President Obama called the big Bankers to DC today to tell them to make more loans. See here and this article from Bloomberg. The purpose of the meeting was to "to ratchet up pressure on banks to extend more credit to small businesses and ease opposition to his regulatory overhaul."

Meanwhile,

Federal Deposit Insurance Corp. Chairman Sheila Bair said she’s “concerned” that U.S. banks are making only the safest loans. “There needs to be well-managed risk-taking to get the economy going again,” Bair said today in a Bloomberg Television interview at the White House.

Now it seems clear that credit for small business is a problem. But does it really make sense for regulators to call on banks to make more risky loans when the financial crisis arose because of excessive lending and an asset bubble?

Moreover, the whole process seems backwards to me. It was only six months ago that the Treasury was assessing the health of individual banks because we were worried about their solvency. In the wake of the financial crisis prudence would suggest that they should be worried about the quality of their balance sheets.

But the questions arise why the banks don't lend given that we bailed them out. We helped them, why don't they help Main Street? Well, one problem might be the restrictions put on those banks that took TARP money. They are paying a large price to get out of TARP, as this article in the NYTimes about Citibank suggests.

The moves will result in a $10.1 billion hit to Citigroup’s fourth quarter results, because of accounting charges taken on the value of the repaid preferred shares and the cancellation of loss-sharing agreement. The new stock offering, meanwhile, will severely dilute the value of existing Citigroup shares.

Why do it then? Clearly to get out from under the Pay Czar. It is better for the big banks to raise capital costly and pay back Uncle Sam than to be subject to the restrictions mandated by Congress. And if you are raising money to pay back Uncle Sam it must be harder to lend to Aunt Main Street. Nobody wants to mention that connection, however.

Addendum: Wells Fargo has announced that it too will repay TARP funds.