Why Won’t Banks Lend Money?

Wall Stree bull; photo by Guillaume (Barcelona), via Flickr

Editor’s Note: Paul recently answered “Five Good Questions” on the economy for the PBS Engage blog. You will also be able to find those answers here on the Business Desk all week.

Question/Comment: I heard on a news program that banks were not lending because of some regulatory mechanism that makes them lose money every time they do it. Can you tell me what is that mechanism and why is in place? – Frank

Paul Solman: I don’t know what you heard, Frank, but perhaps you’re referring to regulations known as “mark-to-market.” And even if you aren’t, they’re important enough to explain here.

The inky cloud hanging over the banking system is teeming with “troubled” or “toxic” assets. These, as I explained on the NewsHour the other day are nothing more nor less than bad loans, loans SO bad, nobody will take them off the banks’ hands at almost any price. The loans of Czarist Russia, say, after Lenin took over. Maybe worth a few kopeks on the ruble. Maybe not.

A bank’s assets ARE its loans. Loans are what they make money from. If the loans are no longer worth as much as the bank invested in making them, the shortfall will eat into the bank’s OWN money, its capital. If the loans are worth less than that, so the capital can’t even cover the loss, then the bank is busted, kaput, insolvent, bankrupt.

So much depends on what the loans are worth.

“What they’re worth?” harrumphs the hardliner. “They’re worth what they’ll bring on the open market!” Like anything else, they’re worth exactly as much as people are willing to pay for them. So their value should be MARKED down TO the MARKET price. “Marked to market.”

“But that’s crazy!” say the banks. “Prices are unrealistically low at the moment. This is a once-in-a-lifetime fire sale. To mark to market would unfairly put us under.”

Okay, that’s the story with the old loans. But your question, Frank, is about new ones – and regulation somehow stymieing that. (The more I think about it, the more I doubt this is what you meant, but in for a kopek, in for a ruble. I’m going to finish this explanation, your likely meaning notwithstanding.)

“So now you want me to make new loans,” says the bank, somewhat plaintively. “But suppose THEY go down in value – through no fault of my own!” (The bank means that the economy might tank further and even the best companies will be hard-pressed to pay back their debts.) “In that case,” explains the bank, “I’ll lose money on new loans, no matter how duly diligent I’ve been in making them, because of circumstances beyond my control, AND a regulatory mechanism that forces me to declare those losses way too soon!”

But like I say, maybe you meant something else. In which case, sorry.