The government hopes the $700 billion bailout will get banks to lend again. Why not require them to do so?

BY busadmin  October 27, 2008 at 2:58 PM EST

Wachovia; AP photo

Question/Comment: So the government hopes the $700 billion bailout will get banks to lend again. Why not require them to do so? According to the Wall Street Journal some of the banks are using the money for possible acquisitions, for lobbying against more stringent regulations, and to cover their bad debt. Why did they not require them to renegotiate bad mortgages? Isn’t that the root cause of all this financial mess?

Paul Solman: A number of sharp questions here and my responses may seem – may in fact BE – a bit quirky.

First, the government might indeed require banks to lend, but probably not if it restricts its ownership to non-voting preferred stock, as it has done. “Non-voting” means the shareholder doesn’t get to vote for members of the board of directors, or on general shareholder issues. So how exactly would a non-voting shareholder like the government force a bank in which it holds a minority stake to lend? Not clear. The government doesn’t want to “nationalize” or “socialize” the financial system any more than it has to, it would seem. Giving that system continued independence is the price it pays.

As to the banks using the money for acquisitions, there’s growing evidence that this is part of the government’s motivation for providing the money. See Joe Nocera’s article in the Saturday, October 24 New York Times.

Joe blasts this move and you too seem to disapprove. But I’m not sure that a backdoor consolidation of the banking system, with government money, isn’t better than having weak banks teeter or fail. (If the latter, they’d require government bailout money anyway.)

Before we get back to whether or not the government should force-feed the credit markets by coercing banks to lend, there’s an interesting issue here to discuss. Do we want a nation of lots of banks (some 7,000 at the moment, down from 12,000 or so before the Savings-and-Loan crisis)? Or do we want an industry with fewer, supposedly “stronger” institutions? There’s a good case for the latter, so long as they’re RIGOROUSLY regulated. Which in recent years (decades?) they most evidently were not.

As to spending the money on lobbying AGAINST regulation, that can’t be what the government had in mind. It’s also where the law of unintended consequences rears its perennial head: with non-voting stock, what can the government DO about it? But I agree it’s a scandal.

As to use the money to “cover their bad debt,” as you put it, hey, that was the original idea of the Paulson plan and it’s not crazy, nor was it ever. But buying up the bad debts from the banks is hard to do. And at what price? With what unintended consequences? So give the banks the money and bolster them against their bad debts THAT way.

Finally, back to your original point. SHOULD the government coerce lending? Well, maybe, but it’s not clear HOW. It sure has been trying hard enough, pumping money into lending institutions, trying to thaw the credit freeze. But if the world economy is turning down for the foreseeable future, who’s going to want to BORROW? That’s a major issue as well right now.