April 19, 2009
Repaying the Government's Loans to the Banks--Posner's Comment
Last fall the federal government lent hundreds of billions of dollars to major banks and other financial intermediaries pursuant to a program called the Troubled Asset Relief Program (TARP). Some of the recipients, notably Goldman Sachs and JPMorgan Chase, want to repay the money. Essentially that means buying back the preferred stock that the government received in exchange for the loans; they thus were loans without a maturity date.
I do not know whether, as a matter of law, the government's consent to repayment is required, although it would not be surprising if it were, since, as I said, the government received preferred stock for the loans rather than just a promise to repay. But maybe there's something in the loan contracts that entitles the banks to repay when they want to; I do not know, but I'll assume that the government's consent is required and consider whether that consent should be given.
The answer depends in part on an understanding of why the loans were made. Last September it appeared that most of the nation's major banks and related financial intermediaries were either insolvent or in danger of becoming so; TARP was designed to save them. Had the banks been allowed to go broke, the depression in which we now find ourselves would be even more severe than it is; think of the chaos that ensued when Lehman Brothers, one of the lesser financial intermediaries, was allowed to fail that month. No private investor was willing to step in and save the tottering banks, so the federal government stepped in instead.
TARP proved highly unpopular with Congress and the general public. The main reason was that the banks were seen to be "hoarding" the money they had received from the government, rather than lending it. TARP had been sold to a public suspicious of "Wall Street" (an echo of age-old hostility to finance as "sterile," rather than "productive" like making a physical product) in part as a way of stimulating economic activity by enabling banks to increase their loans. The idea was that the hundreds of billions of dollars fed the banks by the government would go out as loans to the bank's customers. And loans do stimulate economic activity. Many businesses rely on bank loans to bridge the gap between incurring costs of production or distribution and later receiving revenues from the sale of goods and services; and both businesses and consumers use borrowing to bring production and consumption, respectively, forward--borrowing to spend means consuming more today and less in the future (the eventual repayment of the loan will reduce the amount of money that the borrower has for spending on investment or consumption). A depression is a severe contraction of output, and borrowing is a way of increasing output by increasing the amount of money that people and firms have for immediate spending.
The hoped-for expansion of lending did not take place. Contrary to myth, at no point did banks cease to make loans, although they came close to doing so last September and October. But they did reduce their lending, both by raising interest rates and by increasing credit standards and, in some cases, by refusing to lend to other than their best, established customers. The money that the banks received from the government was mainly either hoarded quite literally, or used to buy bonds or other assets (including in some cases other banks). By literal hoarding I mean keeping the money received from the government in cash or a cash equivalent, such as a bank account in a federal reserve bank. Banks are required to keep a modest percentage of their demand deposits in cash; these are their "required reserves." Any excess cash they have is called "excess reserves," and since cash does not earn interest, banks usually try to minimize their excess reserves. In 2007 their excess reserves amounted to only about $2 billion; today, they are almost $800 billion. When banks are worried,"excess" reserves are not really excess.
Why did the bankers not lend the money they received from the government? There are five reasons: (1) because banks were undercapitalized, as a result of being overinvested in assets that had lost much of their value, such as mortgage loans and interests in mortgage-backed securities; (2) because they anticipated big losses from their outstanding credit card and commercial real estate loans, and perhaps from other loans as well (this is related to the next point); (3) because lending in a depression is highly risky--the default risk is high, and if the lender tries to compensate for the risk by charging a very interest rate this will increase the risk of default, because interest is a fixed cost of the borrower, that is, invariant to his revenues; (4) because as businesses reduced their output their need for borrowing fell and the risk of default (as I just mentioned) rose, making them reluctant to borrow; and (5) because consumer borrowing fell as a result of consumers' being overindebted as a consequence of the fall in house and stock values, the principal source of their savings. Of course failing businesses and unemployed or otherwise necessitous consumers might want desperately to borrow, risky as their borrowing would be. But they are unattractive customers for banks, especially when the banks, because they too are overindebted, are trying to reduce the riskiness of their loan portfolios.
These reasons for the banks' reluctance to use federal money to make loans are perfectly good reasons, and do not invalidate the TARP because without the additional capital that the program contributed the banks would have been even more chary about lending. But the reasons that despite TARP bank lending is continuing to decline were never adequately explained to the Congress or to the public, and as a result the failure of the banks to lend more was and is seen as sinister. And when it turned out that banks were continuing to pay high bonuses and other generous-seeming compensation to their employees, Congress and the public accused the banks of being a conduit between the federal taxpayer and the "stupid, greedy, reckless" bankers who had brought down the banking industry and, with it, the nonfinancial economy.
Again, no one explained that (1) bankers are smart, and the collapse of the industry last fall was due to a combination of dumb Federal Reserve interest-rate policy in the early 2000s and the excessive deregulation of financial intermediation, beginning in the 1970s; (2) bonuses are a more efficient form of compensation than salary, because they are more closely aligned with performance; and (3) the problem of overcompensation is a problem of senior management, because of its de facto control, in a large, publicly trade corporation, of the board of directors; most recipients of bonuses in financial intermediaries are not part of senior management. Somehow Congress and much of the public got into its head that the banks had hired dopes and deliberately overpaid them, which would make no sense from the standpoint of senior management.
The uproar over the banking industry has led to legal restrictions on compensation, proposals for other highly intrusive forms of regulation, even threats to "nationalize" major banks (that is, confiscate them), congressional witch hunts, interference with banks' use of private aircraft and with promotional activity at resorts, adverse publicity, and other inroads into the autonomy and efficiency of financial intermediation. So naturally the banks are scrambling to repay the TARP money as fast as they can, in the hope of getting the government, the public, the politicians, and the media out of their hair.
I can't see a good reason not to allow them to repay the loans. Repayment will go some distance toward reducing the astronomically mounting federal deficit and will allay, to some extent at any rate, the public and legislative hostility to banks and bankers. That hostility is counterproductive. By increasing the uncertainty of the banks' business environment, the attacks on the banks increase their incentive to hoard cash or to make safe investments rather than to make loans. (So who is being stupid and reckless?) There is I suppose a danger that some banks would repay prematurely, that is, before the risk of insolvency has been dispelled, but that is unlikely. As Becker points out, a bank would be reluctant to repay its government loans if it anticipated a significant probability of having to return soon to the government, hat in hand, for a further loan because it has gotten into more financial difficulties.
Posted by Richard Posner at 5:02 PM | Comments (20) | TrackBack (0)
Trackback Pings
TrackBack URL for this entry:
http://www.becker-posner-blog.com/mt/mt-tb.cgi/1807
Comments
Excess reserves DO receive interest now.....please do research before you blog
Posted by Marriner Eccles at April 19, 2009 5:53 PM | direct link
Great site and I am really pleased to see you have what I am actually looking for here and this post is exactly what I am interested in. I shall be pleased to become a regular visitor
Posted by air jordan shoes at April 20, 2009 12:47 AM | direct link
If you think it is relevant, would you please comment on the significance you see, if any, in the fact that TARP funds were disbursed to bank holding companies, rather than the actual banks? Opinions have been expressed that this is one of the main reasons TARP failed to stimulate lending. Do you agree? Would it have been wise for Treasury to insist that the banks receive the money directly? Was stimulating lending really a goal of the program (as opposed to merely a stated goal), or was it more to improve the balance sheets so no bank failed or endured a run? If you think any of these questions are pertinent, thank you for commenting on them!
Posted by Lewis at April 20, 2009 10:56 AM | direct link
Our current troubles are also related to the Fed reaction to yet another price shock from oil prices. Plus higher oil prices, combined with troubles in the financial sector, combined to finally topple the domestic auto industry.
Michigan, Ohio, and Indiana are suffering from the collapse of the auto industry. Florida, Nevada, and Arizona are suffering from the housing sector. The Carolinas are suffering from the collapse of the banking sector. California is a huge political failure of high taxes, excessive regulation, and questionable social programs.
Combine this with a new administration in Washington that wants to impose wage and price controls on the health care system, increase energy taxes, and uses the Social Democrats in Europe as a role model.
What do we get? We have an economy suffering from systemic failure.
Next, I disagree that we had excessive deregulation. We had bad regulations that socialized the losses and privatized the profits. Plus, for reasons I don't fully understand, private rating agencies failed to maintain transparency in the system.
Lastly the form of compensation in the financial sector was a disaster. The compensation system was not connected to the long term health of the firm.
Financial institutions created a game that workers quickly learned to exploit. Workers could become very rich, very quickly if they were aggressive. But this created a moral hazard were workers took far greater risks then was optimal for the firm. Workers were overpaid in that their compensation became disconnected from the long term interests of their firms.
Bad government regulations socialize losses and privatize gains which encourages excessive risk taking. The compensation system at these firms created a system were workers could become extremely rich if they took risks and then seemed shocked that excessive risks were taken
Posted by DanC at April 21, 2009 7:38 AM | direct link
Excellent post,thanks for sharing!
Posted by runescape gold at April 21, 2009 7:41 PM | direct link
It occurred to me that there is actually a correlation between recessionary pro-cyclical lending practices and long-term bank health, and a trade-off between that and the general state of the overall real economy.
The fact of the matter is that the banks which most quickly reduced their lending and limited themselves to their most trustworthy customers would be in the greatest financial health. Trying to lend expansively in a recessionary environment is foolish; no amount of government stimuli will correct the added risk, as a large part of it derives from eroding personal equity. Thus, those whose lending practices are most in line with anti-recessionary goals will actually suffer the most, whereas the most conservative banks will be stronger and will wait out the recession as such time the economy has recovered enough for them to re-expend.
The recession itself cannot be correct permanently unless the banks are returned to full health; it's a chicken-and-egg problem, but methinks its the overall economy that's the chicken and bank lending the egg.
Posted by Myles SG at April 23, 2009 6:32 PM | direct link
Можно и подискутировать по этому поводу …
Posted by piellthostet at April 26, 2009 10:53 AM | direct link
Давайте подискусируем...
EarthDesk 3.5
Posted by upach87 at May 4, 2009 3:52 AM | direct link
Давайте подискусируем...
Posted by upach87 at May 4, 2009 3:53 AM | direct link
In this recession time everything is down.
Posted by Apostille at May 8, 2009 2:15 AM | direct link
Nice post from you on this topic.
Posted by Apostille at May 8, 2009 2:17 AM | direct link
Why did the bankers not lend the money they received from the government? the answer is perfect.make me stounding.
Posted by nfl football clothing at May 16, 2009 12:50 AM | direct link
I am glad that I can comment here, I hope everything will be good.
Posted by Anonymous at June 3, 2009 9:50 PM | direct link
I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog.
Posted by Anonymous at June 5, 2009 3:54 AM | direct link
good
Posted by Anonymous at June 5, 2009 3:55 AM | direct link
googlegooglegooglegooglegooglegooglegooglegooglegooglegoogle
Posted by Anonymous at June 5, 2009 4:06 AM | direct link
When you play games, you really thought about the Department of your equipment well enough, your account than others, your gold enough ... There are better! What you want to have here.come on..Let's go!
Posted by Anonymous at June 5, 2009 4:15 AM | direct link
I am glad to talk with you and you give me great help! Thanks for that,I am wonderring if I can contact you via email when I meet problems.
Posted by Anonymous at June 6, 2009 4:10 AM | direct link
It is a wonderful article,i like it,thank you very much!
Posted by Anonymous at June 6, 2009 10:00 AM | direct link
I tried to think so, but I found it was not as the same in the actual process. As you mentioned, I still have doubts, but really thank you for sharing!
Posted by Anonymous at June 11, 2009 9:59 PM | direct link