Note to Bernanke: Make the Banks Lend

Tuesday, 19 Jan 2010 02:46 PM

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Led by Chairman Ben Bernanke, the Federal Reserve is in the fight of its life.
Congress is considering legislation that would limit the Fed’s authority as chief watchdog over Wall Street. According to The New York Times, Bernanke believes that “being able to monitor the health of banks was crucial to setting sound monetary policy.”

Bernanke’s 11-page report to the U.S. Senate Banking Committee argued that "stripping the Fed of its powers would leave the financial system more vulnerable to collapse." With their powers, the Feds permitted a meltdown to occur, and it was Hank Paulsen, secretary of the Treasury under President George W. Bush, who got the Congress (which first voted down the proposed bailout) to reverse itself and approve the original bailout with more to follow.

Many believe that if the bailouts had not taken place, with billions of dollars being given to the banks, AIG, General Motors, and Chrysler, and if the country had allowed bankruptcies to take place, the U.S. would have come through the crisis in even better shape. The poster boy for this laissez-faire approach is of course, Ford Motors which took no bailout funding and is now leading the automotive industry.

My own questioning of Ben Bernanke’s logic with respect to continuing the Federal Reserve’s enormous sole authority comes from my exchange of correspondence with him, beginning with my letter of Oct. 9, 2008.

My letter stated: “As you have pointed out, the meltdown occurring in the United States is taking place in large part because of a lack of available liquidity, meaning that lenders — commercial banks in the lead — are not lending to applicants seeking to borrow in order to purchase housing, cars and other big ticket items that the economy relies on to flourish, as well as denying loans to small businesses and local governments seeking to borrow to pay their bills with municipal bond markets largely closed to them.

"One of the purposes of the $700 billion recently made available as a result of legislation enacted by the Congress is to give additional liquidity to commercial banking institutions so that they can once again perform their leading raison d’etre — lending money. The major reason for lack of liquidity — availability of loans — is fear, as you have stated, fear that the money will not be repaid either by individuals, governments or institutions, e.g., other banks.

"If I have s accurately stated the facts, why not, by order of the United States Treasury and Federal Reserve, direct the commercial banks to immediately commence loaning money to 'creditworthy' applicants and at a scale comparable to loans individual banks entered into last year?

"If the banks refuse to abide by such order, they would not be eligible among other punitive measures to sell their “toxic” securities to the Treasury. If the banks require a definition of 'creditworthy,' your offices will supply it for the various situations that apply.”

To his credit, Bernanke responded on Oct. 16, 2008. Often government officials at every level of government simply ignore letters that raise annoying issues for them, as I think my letter did

His response, laudatory because he answered, was not satisfactory. He wrote: “But requiring directly that banks extend specified amounts of credit to creditworthy borrowers would entail many complications. For example, bank regulators would need to create an objective definition for determining which borrowers were creditworthy. Moreover, because the volume of banks’ credit activities can fluctuate over time for a variety of reasons, including those over which they have no control (such as the rate of economic growth in their geographical regions), determining appropriate targets for individual banks’ lending activities would be complex and potentially arbitrary.”

I was particularly struck by his statement, “In addition, because of the very large number of banking institutions in the country — more than 8,000 — administering such a program would be extremely resource intensive.”

A federal agency administering to 8,000 or so institutions in today’s economy should consider itself lucky, particularly when it was created to do exactly that.

On Nov. 17, 2009, I attended a luncheon at the Economic Club of New York where Chairman Bernanke spoke. A major part of his speech was devoted to the continuing lack of liquidity available to businesses and individuals, limiting the country’s recovery from the economic debacle we had suffered.


The chairman of the Federal Reserve announced, “The flow of credit remains constrained, economic activity weak, and unemployment much too high,” and “the ultimate purpose of financial stabilization of course was to restore the normal flow of credit which had been severely damaged.”

He also remarked, “The fraction of small businesses reporting difficulties in obtaining credit is near a record high and many of these businesses expect credit conditions to tighten further.”

I wrote to him the day of the lunch, Nov. 17, 2009, asking once again, as I did in my letter of Oct. 9, 2008, a year before: “If I have accurately stated the facts, why not, by order of the United States Treasury and Federal Reserve, direct the commercial banks to immediately commence loaning money to ‘creditworthy’ applicants and at a scale comparable to loans individual banks entered into last year?

"If the banks refuse to abide by such order, they would not be eligible among other punitive measures to sell their ‘toxic’ securities to the Treasury. If the banks require a definition of ‘creditworthy,’ your offices will supply it for the various situations that apply. Apparently, your 'guidance' of November 2008 to the banks has not had the result you had hoped for.

"Shouldn’t there be consequences to the banks for failing to take the measures required to substantially increase liquidity for small businesses which provide more jobs, we are told, than the large businesses of this country and are perhaps unable to perform that function because of the lack of credit?”

The chairman responded by letter dated Nov. 19, 2009, writing: “Finally, I do not think it would be appropriate for bank regulators to substitute their judgments regarding individual loans for those of experienced bank lending officers.

"The lending decisions of banks are directly reflected in their institutions’ profits and losses, riskiness, and growth prospects and thus have a direct effect on the interests of their shareholders. In a market-based economy and financial system, it is more appropriate for bank directors and managers, as representatives of the shareholders, rather than regulators, to make such decisions.”

Surely, the Federal Reserve could use its current authority to work out a reasonable way to deal with this issue. Indeed, that is its job.

That is why it wants to keep its authority, opposes the efforts of those who seek to strip it of some of its authority, and wants Congress to retain some of the regulatory authority.

The response of the chairman gives me pause. I have a high regard for Chairman Bernanke and believe that if he gave this issue of liquidity greater attention, he could come up with the appropriate carrots and sticks that would compel liquidity to emerge, not next year, but next week.

The banks that dominate this country’s business activity had money shoveled to them by the Federal Reserve, U.S. Treasury and the U.S. Congress, with nearly no interest to be paid, and many still owing the U.S. Treasury those TARP monies and are using their current huge profits to pay huge bonuses to their executives and employees, while still not lending to American businesses and individuals.

One way to allow the banks to make the decision on creditworthiness and still spur lending, is to require they make available to the Federal Reserve the reasons they declined to loan on the basis of lack of creditworthiness in individual cases, with the Federal Reserve randomly examining those files to determine good faith.

Mr. Bernanke, use your existing authority to make them lend.

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