At least a dozen people asked me to comment on the New York Times article So When Will Banks Give Loans? Most seem to believe the bank bailout package is part of some complicated scheme by the treasury and Fed to give banks taxpayer money explicitly for takeovers.

Indeed that is the very essence of the tale the New York Times is spreading.

The Times article is a bit disjointed, so I rearranged paragraphs slightly for ease in understanding. My insertions are in braces. From the New York Times ....

It was Oct. 17, just four days after JPMorgan Chase’s chief executive, Jamie Dimon, agreed to take a $25 billion capital injection courtesy of the United States government, when a JPMorgan employee asked [on a conference call] “Chase recently received $25 billion in federal funding. What effect will that have on the business side and will it change our strategic lending policy?”

[Dimon Responded] “What we do think it will help us do is perhaps be a little bit more active on the acquisition side or opportunistic side for some banks who are still struggling. And I would not assume that we are done on the acquisition side just because of the Washington Mutual and Bear Stearns mergers. I think there are going to be some great opportunities for us to grow in this environment, and I think we have an opportunity to use that $25 billion in that way and obviously depending on whether recession turns into depression or what happens in the future, you know, we have that as a backstop.”

Read that answer as many times as you want — you are not going to find a single word in there about making loans to help the American economy. On the contrary: at another point in the conference call, the same executive explained that “loan dollars are down significantly.” He added, “We would think that loan volume will continue to go down as we continue to tighten credit to fully reflect the high cost of pricing on the loan side.” In other words JPMorgan has no intention of turning on the lending spigot.

It is starting to appear as if one of Treasury’s key rationales for the recapitalization program — namely, that it will cause banks to start lending again — is a fig leaf, Treasury’s version of the weapons of mass destruction.

In fact, Treasury wants banks to acquire each other and is using its power to inject capital to force a new and wrenching round of bank consolidation. As Mark Landler reported in The New York Times earlier this week, “the government wants not only to stabilize the industry, but also to reshape it.” Now they tell us.

Indeed, Mr. Landler’s story noted that Treasury would even funnel some of the bailout money to help banks buy other banks. And, in an almost unnoticed move, it recently put in place a new tax break, worth billions to the banking industry, that has only one purpose: to encourage bank mergers. As a tax expert, Robert Willens, put it: “It couldn’t be clearer if they had taken out an ad.”

There Is No Lending Conspiracy

Stop the nonsense. There is no conspiracy between Paulson and the Banks. Paulson and Bernanke want banks to lend, but the ridiculous policies of the Fed and the Treasury make it difficult for banks to do so, especially in the current economic backdrop.

I mentioned one aspect of the problem in GE Needs Fed Bailout To Finance Operations; Dividend At Risk.

The government stepping in to provide cheap financing to GE is not doing anyone any good. Paulson wants banks to lend, and by doing so is artificially driving down short term rates. Why should GE get short term financing from banks, when it can get a better deal (at taxpayer expense) from the government?

Fed Becomes Lender Of Only Resort

Indeed, each of Bernanke's vast array of lending facilities is causing an unwanted side effect somewhere else.

Perhaps banks would have been willing to lend to GE, but not at the same rate as the Fed's Commercial Paper Funding Facility. And by competing against the banks it wants to lend, the Fed is guaranteeing it will be the lender of only resort.

That is just one reason not to lend. Here are more:

·                     Rising unemployment

·                     Rising credit card defaults

·                     Rising foreclosures

·                     Rising bankruptcies

·                     Massive overcapacity

·                     The TAF, PDCF, TSLF, CPFF, MMIFF, ABCPMMMFLF

That last acronym is not a typo or a joke. It stands for Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility. Indeed, there are 6 different facilities by which the Fed can lend to damn near anyone it wants, while accepting whatever collateral it wants.

Banks are supposed to compete against those facilities? In a backdrop of rising unemployment, rising credit card defaults, rising bankruptcies, rising foreclosures, and massive overcapacity? When the Fed keeps driving interest rates lower and lower?

Also note that Congress is pressuring Fannie Mae and Freddie Mac to lend more, and at terms that are going to cause defaults to rise at Fannie and Freddie. Banks don't want to compete against Fannie and Freddie either.

Terms of the Bailout

Now let's review the terms of the bailout. I talked about terms of the bailout in Compelling Banks To Lend At Bazooka Point.

Here is a brief synopsis: Paulson gathered the nine largest banks in a room, told them they were splitting $125 billion, and in return the Treasury will receive preferred shares that pay a 5 percent dividend, rising to 9 percent after five years.

Had it not been for those dividends, banks might just have parked the money in treasuries as a provision against future losses or perhaps lent to someone like GE at some sort of reasonable rate.

However, at 5% rising to 9%, banks would be losing money doing either of those. Other lending in the current economic environment of overcapacity and rising unemployment would be reckless. Given that set of constraints, banks are coming to conclusion that only sensible use for that taxpayer money is mergers.

In mergers, operations can be consolidated, people fired, and perhaps the banks can make enough to come out ahead.

Could That Be The Treasury Game Plan All Along?

Of course not. At this point the Fed could likely force any mergers it wants. There was no reason to go through these gyrations if all the Fed or Treasury wanted was mergers. Look at the complicated way we arrived at this situation. Bernanke has six lending facilities, and Paulson changed his mind 3 times on how he was going to use taxpayer money.

Bernanke really is attempting to spur lending. It's just that he does not have any clues about how counterproductive his facilities are. Bernanke is not the only one who is clueless. I awarded The blue ribbon for complete economic silliness to Paul McCulley at PIMCO for his Paradox of Deleveraging. See Keynesian Claptrap From PIMCO and Something For Nothing vs. Paradox of Deleveraging for an analysis.

New York Times Theory

·                     Paulson asked for taxpayer bailout money explicitly to get banks to merge.

·                     To cover up his tracks, Paulson changed his mind three times on how to spend that money.

·                     To guarantee the merger outcome, Paulson called all the big banks in a room, forced them to take loans at a rate that would ensure they would not want to lend it, but instead would want to use it in mergers.

·                     Prior to the above three points, the Fed embarked on a series of lending facilities cleverly disguised to make it undesirable for banks to lend to each other or for anything else, while purporting to do the opposite.

My Theory

The economic constraints and poor policy decisions by the Fed and Treasury make mergers a better alternative than lending money or sitting in cash.

Mish

GlobalEconomicAnalysis.blogspot.com