Should We Force Banks to Lend?

January 19, 2009, 1:05 PM
Should We Force Banks to Lend?
Why save banks if they will not lend?

That has become a significant political issue on both sides of the Atlantic as governments confront the reality that preventing the financial system from collapsing is not the same as repairing it.

In Britain, that led the government of Prime Minister Gordon Brown to announce a new round of bailouts, with a twist. “In return to access to any government support, there will have to be an increase in lending, and that will be legally binding,” Mr. Brown told a news conference today.

In the United States, aides to President-elect Barack Obama sounded a similar theme. “The focus isn’t going to be on the needs of banks,” Mr. Obama’s chief economic adviser, Lawrence H. Summers, said. “It’s going to be on the needs of the economy for credit.”

There is little doubt that many in the public are fed up with wealthy bankers who get large salaries and bonuses from banks that would have failed had the government not stepped in.

But there are risks inherent in a “get tough” strategy with the banks, and some of them can be seen today in the London stock market, where bank shares were battered despite — or because of — the latest bailout. A huge loss from the Royal Bank of Scotland revived fears that the banks will be forced into nationalizations that leave shareholders with little or nothing.

Such a result might seem just. Having blown all the capital they had, and lost most of the money put up by their first rescuers — the sovereign wealth funds — the bankers have richly earned opprobrium.

But any successful government bailout must lead eventually to the banks becoming attractive to private capital. The belief that banks are on the road to confiscation by the government will assure that no such capital will be forthcoming anytime soon, and it can create a vicious circle, in which that fear causes investors to dump bank shares, and thus makes them seem even more shaky and unworthy of investment.

There are two lessons from the first bailout rounds.

1. Somehow a way must be found to persuade both the public and the bankers themselves that the banks are now solvent. Hopes that hundreds of billions in capital would accomplish that were dashed by the reality that no one is sure how toxic some securities are — or how toxic they will become if the economy and home prices continue to sink.

That may require more deals in which the risk of toxic assets is shifted to governments, which may have to give up the notion that they are likely to profit from owning them.

2. Once that takes place, the newly risk-averse bankers must be willing to lend money — not to anyone, but to those who are likely to be able to repay the loans. The supply of such borrowers depends in part on getting the economy moving again.

It was foolishly easy credit that got us into this mess. A government-mandated return to such lending is not a viable solution.

Ordering the bankers to make loans is both simple and satisfying. But it will not fix the economy or the financial system.