The economy is suffering from too much debt and not enough credit, says Treasury Secretary Tim Geithner. While announcing a new “Financial Stability Plan” yesterday, he noted that many firms and households “borrowed beyond their means,” due to a “boom in credit.”
Yet he also complained that many banks (having finally come to their senses) have tightened lax lending standards. He insisted, “We must get credit flowing again to businesses and families.”
Before spending yet another $2 trillion to fix something, it might help to find out what’s broken.
Last October, the Minneapolis Fed published Facts and Myths about the Financial Crisis of 2008 by V.V. Chari, Lawrence Christiano and Patrick J. Kehoe. Bank lending had not declined, they showed, nor had sales of nonfinancial commercial paper. Besides, 80 percent of nonfinancial corporate borrowing is done outside the banking system, they noted, such as selling bonds and commercial paper.
Bank lending was 5.7 percent higher in December than a year earlier, and roughly flat from September to January (surprisingly strong for a falling quarter with rising credit risks). And the areas commonly pointed to for signs of a credit squeeze last fall (such as high interest rates on loans between banks) don’t look troublesome today. On the contrary, healthy companies have been raising billions by selling long‐term bonds at low interest rates.
So why does Geithner suggest that cuts in bank lending caused the recession (rather than, say, the squeeze on profits from too much debt) and that increased bank lending (rather than bond sales) is the cure?
The new Treasury plan continues to put most of the emphasis on pushing banks to make more loans to over‐indebted consumers, homeowners and firms. Unlike last year, however, Geithner now believes, “Our policies must be designed to mobilize and leverage private capital, not to supplant or discourage private capital. When government investment is necessary, it should be replaced with private capital as soon as possible.”
That’s a laudable goal — but contradictory. In reality, government capital replaces (“crowds out”) private capital, leaving taxpayers holding a bigger and bigger bag. Call that nationalization by default.
Under the new and old TARP schemes, the mere threat of incremental nationalization of banks and insurance companies will always “supplant and discourage private capital.” You could watch it happening while Geithner spoke — as investors rudely pushed bank stocks down sharply. (An “ultra short” exchange‐trade fund that bets heavily against financial stocks (SKF) was up 15 percent by the end of his talk and 18 percent at closing.)
This is nothing new. As I observed on this page last fall (“Why Bailouts Scare Stocks,” Sept. 18), Treasury plans to “help” financial institutions always scare away private investors.
In mid‐January, for example, Bank of America stock fell from $10.50 to $5.10 in three days on news that “the bank is close to getting billions in additional aid from the government.” Then President Obama’s inauguration shared The Wall Street Journal’s front page with the headline: “Banks Hit by Nationalization Fears: Financials Plunge as US Considers New Rescue Options.”
Nationalization fears began last September with the virtual expropriation of Fannie Mae, Freddie Mac and AIG. Shareholders were swiftly wiped out, with no vote on the bad deal.
The federal assault on financial stocks escalated in October, when Congress converted TARP by whim into a “Capital Purchase Program” (CPP) — a scheme for incremental nationalization of select banks, via Treasury purchases of preferred stock with warrants. Investors soon realized that CPP is simply a time‐release dose of the same poison deliberately used to punish shareholders in Fannie, Freddie and AIG.
Neel Kashkari, Treasury’s TARP czar, described this plan as “purchasing equity in healthy banks around the country.” But from the perspective of common shareholders, Treasury’s purchase of senior preferred shares is no different from the banks taking on more debt.
TARP‐afflicted firms will have to pay dividends to the Treasury for its preferred shares before any remaining crumbs fall to common shareholders. Treasury will be first to get any dividends or capital gains if the firm does well, and first to get repaid in the event of bankruptcy.
Once a bank or insurance company gets in bed with the government, the property rights of that company’s stockholders become uniquely insecure. When the government jumps into the cockpit, smart stockholders bail out.
And depressed stock prices deflate the banks’ capital cushion, regardless of Treasury investments — making them more likely to fail and therefore less likely to lend. In other words, government “help” achieves the opposite of Geithner’s declared goal.
“Our work will be guided by the lessons of the last few months,” says Geithner. But he never learned those lessons. On the contrary, he continues to emphasize how sternly “conditions placed on banks” will be enforced, while naively expecting private investors to risk money in enterprises under intensely politicized control.
Companies as valuable as Bank of America and AIG need stockholder support, not taxpayer support. If Secretary Geithner really hopes to get stockholders back in, the government will have to get out.