Sunday, November 13, 2011

Ideology Matters

Suppose I presented an argument to you regarding why banks are not lending out nearly as much money as pre-crisis (never mind statements I have heard on to the effect that lending is tough because it feels like they are pushing on a string to pursue desired growth):

1) The Federal Reserve is holding interest rates artificially low via open market operations, which may require the use of the printing press to sustain when the market becomes suspicious of the creditworthiness of the U.S. government, which is highly likely to result in high inflation, which to anyone who is not a numpty means that loans created at today's rates will sustain economic losses;

2) The Federal Reserve will raise interest rates sometime in the next year or two because it can not sustain low rates without the threat of high inflation, which is not desired, meaning that any loans created today have a real chance of bearing losses since deposits (the funding source for loans) may ratchet up to a 3-5% interest rate whereas mortgages created now may have a 4.5% rate.

Basically, I have presented to you a predicament: I do not see any real solution to the conundrum of what banks should do to lend profitably. No matter what they do, I believe there will be economic losses. The real questions would be 1) which scenarios are most likely; and 2) is there any way to make a profit based on the scenario?

Yet, for some ineffable reason, when I was explaining this to the EPA employee sitting to my right on the train back from New York, he said I was making an argument for nationalizing the banks! Anyone who knows me knows that is not what I believe. More importantly, how the hell do you get to that point from my argument, when I am trying to explain why banks are being cautious in lending?

Basically, I think ideology matters. No free-market rational person would think that the scenarios above argue in favor of bank nationalization. However, a person who believes that government is a force of good (such as an EPA employee), and that banks are sitting on money that they should be lending out to help people who are hurting (rather hypocritical, since he ranted about how the banks were irresponsible in lending pre-crisis, ignoring the stupidity of Basel II, the hypocrisy of Barney Franks, Mr. "I want to push the string on subprime", and the negative real interest rate regime of Greenspan/Bernanke post dot-com bubble), maybe the scenarios above suggest that a private actor will not lend out money, so the government should nationalize banks for the good of the people.

Never mind that the second scenario I described above would be a repeat of the savings and loan crisis, where the taxpayers footed the bill. Never mind that the first scenario I described above could be a repeat of stagflation.

N.B. I should list my skepticism about the U.S. government's creditworthiness at another time. But I will add I was not surprised that this person focused on the rise in interest rates due to an increased risk premium as bad, while ignoring the cause of it, mainly Congress's propensity to expand the budget each year. If you have an accumulation of bad decisions, then at some point everyone realizes that. The realization is not bad - it is necessary. Sadly, he could not understand that.

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