Banks - Useless At Best

Policy initiatives in place have eased the credit crisis. As Fed Governor Kevin Warsh pointed out last week: "We have had a forceful response from monetary, fiscal and financial policymakers. There are some notable signs of improvement. Short-term funding spreads are retreating from extremely elevated levels. Funding maturities are being extended beyond the very near term. Money market funds and commercial paper markets are showing signs of stabilization. And credit default swap spread of banking institutions are narrowing significantly."

Translation - the liquidity crisis, inter-bank, is over. Fine. Great. What’s it mean for us? Next to nothing. Banks won’t lend. Banks are essential but they refuse to act. As Willem Buiter puts it, "After years of excess and anything goes, the bean counters and risk controllers now rule supreme in the banking world. There is little upside to lending and taking a risk, but a lot of downside. Rolling over an old loan or extending a new one won’t help your bonus and it may cost you your job."

This is critical folks. Unless the banks start lending in normal volumes very soon, this recession could indeed become another great depression. We did not label our sketch of Oct/9 - "1929?", on a whim.

It’s not just US banks. In the UK, legal curbs may be imposed on banks if they fail to abide by a new code of practice on lending. They will also be compelled to open their books to the government so that their lending can be monitored. Whoa! But good businesses and consumers are starved of credit so why not. "I am in no doubt that the single most pressing challenge to domestic economic policy is to get the banking system to begin lending in any normal sense. That is more important than anything else at present," Bk of Eng gov Mervyn King said this week. King (the very best of all central bank gov’s, our view) also held the threat of wholesale nationalization over these banking clowns!

From Buiter, "We have no longer just a crisis in the financial system. We have gone even beyond the stage where there is a crisis of the financial system."

Getting banks to lend again is even more essential than establishing primary and secondary markets for garbage assets. In the US as elsewhere, small and medium enterprises rely overwhelmingly on banks for external finance. We all know that. Without access to bank loans, credit lines and overdraft facilities, countless small and intermediate sized businesses that would be perfectly viable with a functional financial and banking system, that are great credits, are threatened with bankruptcy. They’re innocent for goodness sake!!

What is to be done? 1) The US may have to set aggregate lending targets to the domestic non-financial business sector for each bank (last year’s total plus 7 percent, say). The banks themselves can decide who to lend to and on what terms. Any shortfall of actual lending from the target is translated dollar for dollar into some kind of tax. Since not meeting the target amounts to throwing money away, the banks will probably lend. Or, 2) nationalize those that don’t (paying as little as possible to the existing shareholders), fire the existing management and board of directors, and have the government appoint a new executive and a new board that are serious about meeting lending targets.

This is nonsense.

Robert Craven