It is popular right now to blame banks for the financial crisis – that is, the current recession in the US. The banking system in the US is not working, people say. Banks are not lending, not passing the government billions on to hungry borrowers. And so on.
The hidden premises behind these lines of reasoning are two. One is that banks ought to be lending more money to borrowers than they do (especially since they have received government bailouts). The other is that the economic system is not working because banks are not lending as they are supposed to. Both premises are seriously flawed.
Banks in the US are currently doing exactly what they should be doing. Look at it this way: You are a banker. For the last several quarters you have had huge losses. So have other banks. Furthermore, the economy is bad. You think housing prices may fall another 20 percent, that GDP may drop another 10 percent, that 5 million more may become unemployed. As well, you expect Dow to drop to 5500. And as lots of other banks are losing money big time, you want to be cautious about borrowing to them as well. Also you read every day about businesses losing money or making considerably less money than before. As well, you know the same thing is happening in Latin America, Europe and the Far East. And commercial real estate is in a decline, and default on credit card debt is rising.
Who would you lend money to? Or – more generally – is this a climate where you would want to lend at all? I think maybe not. I certainly would not if it was my money.
So, in a situation where the economy is still on the way down – and pretty fast as well – the banks are doing the right thing! They are behaving in a rational fashion as far as lending is concerned.
So, if you want to blame anybody – blame the financial institutions for the crisis, and the Bush-administration for giving away money to the financial industry without imposing sufficiently strict terms. But not the banks for not lending right now!
The second premise is equally flawed. Why it is, should be apparent. Simply because the problem is the economy itself, not the banks. It is not that the economy is dropping deeper into recession because banks are not lending, but rather (or more correctly “more”) that banks are not lending because the crisis is still expanding, spreading and deepening. Thus there are few solid, good borrowers around.
Thus the primary task right now is to shore up the economy and make it work again. Forcing banks to lend would be wrong – it would lead to even greater future losses, as the risks currently are simply huge! This is probably true not only for the US, but many other countries as well.