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What Are Banks’ Incentives to Lend?

Posted on | October 29, 2008 Time: 8:38 am |

Now that the TARP/Paulson/Bailout Rescue Plan has officially been put into motion, several companies have announced their application or intentions for part of the $250 billion allocation. It’s implied that the funds will allow the borrowers to shore up their capital ratios & balance sheets, then rightly get back to the business of lending money.

But wait a second…why should they? There isn’t a legislative mandate, no dollar tracking system to ensure that money flows through the institutions and into the hands of real people and companies. If you were a bank manager, would you send capital out the door? Out there is scary; it’s ugly and uncertain and everyone’s hoarding what little liquidity they have. It’s not a lending environment, and as Paul Kedrosky notes over at Infectious Greed, the main goal of the TARP plan was to save major banks from insolvency, and to save the markets from the never-ending fear of blowups.

As we saw with the CDS auction for Lehman, the collateral damage from each and every large corporate implosion is massive. We simply can’t handle multiple large shocks like that, not with the current weakened state of the global markets.

Let There Be Lag

Banks will lend again, but it will take time. Time for the proverbial dust to settle. If equity prices can be supported at higher levels for the major financials, it will be a big assist. So will CDS spreads coming down from their still way-too-high levels (Goldman was over 300 basis points Tuesday, while Morgan was at 400). As Kedrosky points out, loan loss provisions could easily spike yet for areas of consumer finance; if banks pass through their biggest chunk of fresh capital too fast, we could all be back right where we started…only this time, the Fed’s balance sheet would be too bloated to step in with any force.

Commercial paper issuance was up ten-fold as the Fed began its backstop plan. Over $60 billion was issued, and this is a key lubricant to Corporate America.

Ryan Barnes

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