Twofish's Blog

January 18, 2009

Missing the problem

Filed under: finance — twofish @ 9:11 pm

http://www.nytimes.com/2009/01/18/opinion/18friedman.html

http://chinesepolitics.blogspot.com/

I think that Friedman misses the problem.  It’s not just banks with bad balance sheets that aren’t lending.  It’s banks with *good* balance sheets that are reluctant to lend.  The problem is that people are scared and uncertain about the future, and when that happens, people hoard cash.  If you are an debt, you hoard cash.  If you aren’t in debt, you hoard cash.  If you have lots of cash, you want more cash.

One problem is “who do you lend to?”  Obviously, you lend to people with good credit risks.  The trouble right now is that *NO ONE* (except maybe the US government) is a good credit risk.  Raise your hand if you are sure you are going to have your job next year? Point to any company large or small that you know is not going to be bailed out by the government, and raise your hand if you are sure they are going to be in business next year.  There aren’t any.

Concern about credit risk is a problem because right now no private entity is a good credit risk.  No one.  We are all subprime.

It’s not that bankers are evil people.  It’s not they they are trying to hide anything.  It’s just that the banks are reacting in exactly the same way that you or I would if someone asked us for a loan.  I’m sorry, I have a lot of cash, but I have to look out for myself, because I scared to death about what could happen in 2009.  Right now banks are not lending any of their own money.  The only reason that you can get a low interest mortgage is that the banks are acting as storefronts for the Federal Reserve are the only people buying mortgages right now.  This is true for pretty much everything.  The only things that people that are willing to lend right now are things that have an implicit or explicit government guarantee.  There’s no point it arguing whether or not we should have a state managed banking and financial system in the United States.  We are already there.

This is the problem that Friedman’s proposal doesn’t address.  You can fix up the banks balance sheets, and they still will not lend, because there is no one without credit risk to lend to.  The only people that are not a credit risk are people who already have cash, and they aren’t going to borrow, and it’s a self-fulfiling bad cycle.  A lot of the loans that would go out now will be non-performing precisely *because* loans are not going out.  The next set of non-performing loans will not be people that did “stupid stuff” but people with viable businesses and household accounts that are stuck because the economy has gone bad.

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