You can lead a horse to water, but… In the world of finance and economics, you can throw taxpayers’ money into the banks, you can slash interest rates and you can usethe ultimate weapon: threats of nationalisation. But you can’t easily force banks to lend, as Mervyn King, Alistair Darling and most of all, Hank Paulson, have found out. In a new report to clients called “Getting Banks to Lend”, Andrew Smithers ofSmithers & Co outlines the reasons as he sees them behind banks’ self imposed Scroogery. As today’s troubles are caused by excessive levels of debt, “it may seem perverse” to see the UK and US governments so worried that banks will now lend too little. But these concerns are entirely justified, says Smithers. The bottom line is, banks don’t want to lend, he says. “They are frightened and they advise governments that they should support them by buying their toxic assets, so that they can then work out of their current difficulties. This is bad advice”. And bankers are the “worst people” to give advice about banking. “They didn’t understand the problems and we fear that many still don’t. They also have massive conflicts of interest”. In Smither’s view, there are three key causes of confusion: 1) Past excesses will be made worse by a sudden cutback in new lending. We cannot undo the past. 2) If only one bank had been silly, retrenchment would be sensible. But, to assume this in general is a fallacy of composition, as a general cutback will increase defaults and lead to bankruptcy not retrenchment.3) The value of bank assets is a moving target; the less banks lend, the greater will be the losses on their existing assets.What governments should do is clear, he says: We need a proactive and large injection of new equity into banks as soon as possible and only governments can force this and provide the money. Ah, but what governments will do is, sadly enough, almost equally clear: They will inject new equity but only as a reaction to further troubles. In the meantime, they will take advice from bankers and waste tax-payers money on buying toxic assets or guaranteeing loans. There are two conditions required for a global economic recovery, notes Smithers. One is a further refinancing of banks by equity injections, accompanied by a write-down in their current assets “so severe that those assets can then rise in value”. Banks will then become profitable, which is a necessary condition for new lending to be adequate. But, more equity injections are a necessary condition for this to be possible. The other condition is more reliant on big external factors, says Smithers: “sufficient domestic demand stimulus from Japan and Germany as well as the UK and US”. In the end, everyone has a theory about the reasons behind the lack of lending. Andrew Ross Sorkin over at DealBook had a beautiful quote on this from an “influential senior official at a big [US] bank” a while back: “It doesn’t matter how much Hank Paulson gives us,” said an influential senior official at a big bank that received money from the government, “no one is going to lend a nickel until the economy turns.””The official added: “Who are we going to lend money to?” before repeating an old saw about banking: “Only people who don’t need it.” But let’s hear from Ken Lewis, Bank of America chief (just named Banker of the Year by the American Banker) who in an appearance on 60 Minutes in late October expressed confidence that things will eventually turn around because banks won’t keep money under the mattress forever. But, he warned, we won’t see a bottom until at least the first half of next year. “You can make more money lending,” he said. Well, noted Ross Sorkin, “at least to people who don’t need it”. There are endless views on this, but we rather like this neat little explanation, from James Kwak at Baseline Scenario:Banks are run by people, notably CEOs. CEOs are people like the rest of us (just richer and, often but not always, fatter). They are motivated by two main things: (1) making a lot of money and (2) not looking like an idiot. Maximizing profits for their shareholders is far down the list. Boards of directors are primarily motivated by (2), not looking like an idiot (and getting sued). In good times, when people underestimate risk, this leads to lots of leverage and juiced-up profits. In bad times, both motivations produce behavior that may be irrationally conservative from the standpoint of the shareholders. A CEO with a $5m base salary who knows this year is going to be terrible and that he won’t get much of a bonus has no incentive to increase profits. He does have an incentive to make sure his bank stays in business - so he keeps getting that base salary - which means being as conservative as possible with cash. He also has no desire to go bankrupt and get hauled in front of a Congressional hearing (motivation #2), which again means being as conservative as possible. We may have to wait for greed to once again take over from fear in the heads of those CEOs. Luckily, notes Kwak, “it always happens”. Related links:Why banks won’t lend
One day doesn’t make a trend - DealBook
Treasury moves to boost bank lending - FT
Friday, 5 December 2008
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