Obama forgot Samuelson when he told fat cats to start lending

There has been quite a lot of hub-bub today about President Obama’s fat cat remarks and his meeting with bankers exhorting them to lend. Let me tie these events in with a few other themes into a comprehensive picture of what is happening in politics and banking.

In a nutshell, we are getting a bunch of populist rhetoric which is pure politics to induce banks to lend recklessly and save the economy when basic economics would tell you that there is a deficit of lending capacity and demand for credit.  It is the absurd kabuki theater of depression economics.

Just to review:

• Two days ago, President Obama used his weekly address to the nation to sound off on banking reform, using unusually aggressive and populist language.
• The President then ratcheted up the populist rhetoric, calling bankers “fat cats” on a 60 Minutes episode which aired last night. 
• Overnight news came that famed Nobel Prize-winning economist Paul Samuelson, the king of the mid-century Keynesians, had died.
• Early this morning, we learned that Citigroup was exiting TARP and was due to raise $20 billion to do so.
• Then later today came news that the President exhorted those same fat cat bankers to start lending more money to help kick start the economy.
• Still later in the day came news that Wells Fargo was the last big bank to exit TARP.

It was quite a day for the economics profession and all of these events are related.

Playing politics

The first relationship comes via David Rosenberg, who lamented the damned if you do, damned if you don’t message that politicians like Obama are sending banks with their empty populist rhetoric. Rosenberg wrote:

Below we highlight President Obama’s weekly address, in which he blames the big bad banks for luring borrowers into the myriad of products during the credit bubble, a bubble that in our view was promulgated by the nation’s policymakers.

When things go awry, however, it is very easy for those in Washington to point the fingers at somebody else. What did Congress, the SEC, the Fed, and the White House think in that 2002-07 bubble period except that excess credit was creating jobs; in turn, those jobs were creating prosperity and that prosperity led to votes. Now the borrowers, who signed contracts, and as adults should also be held accountable, are being treated as “victims” by politicians and the media.

He then goes on to highlight these snippets of anti-Banker language in the President’s weekly address statements at the weekend (see full text here):

• But much of it was due to the irresponsibility of large financial institutions on Wall Street that gambled on risky loans and complex financial products, seeking short-term profits and big bonuses with little regard for long-term consequences.
• financial reforms that would target the abuses
• of risky dealings that sparked the crisis
• the authority to put an end to misleading and dishonest practices of banks and institutions that market financial products like credit and debit cards; mortgage, auto and payday loans
• But Americans don’t choose to be victimized by mysterious fees, changing terms, and pages and pages of fine print. And while innovation should be encouraged, risky schemes that threaten our entire economy should not
• I urge both houses to act as quickly as possible to pass real reform that restores free and fair markets in which recklessness and greed are thwarted
• That’s how we’ll restore a sense of responsibility and accountability to both Wall Street and Washington

I see these quotes as Marshall Auerback does, all hat and no cattle – populist rhetoric only now that the President is on the back foot over unemployment and banker pay.  But Rosenberg sees something altogether more cynical – an orchestrated campaign to shame and bully banks into going against their fiduciary responsibility and lending irresponsibly again!

As a long-time reader of our research and valued friend told us over the weekend, “he [Obama] finally threw the banks under the bus”. While not suggesting the adjectives are undeserved, I am afraid that the U.S. President has invited all consumer borrowers, creditworthy or not, to abdicate their financial responsibility. We now have borrowers as victims.” Ain’t it the truth. And the consequences will be profound. Our friend reminded us that in regard to our theme of “frugality”, the current reality is that “frugal” represents just the first wave in a fundamental change in behaviour towards complete self-interest and risks morphing into something a little more troubling, such as abdication of individual responsibility.

Meanwhile, the adjective used to describe the banks and their actions, were, in a word, scary (and if you want more on ‘scary’, read the WSJ assessment on Obama’s appearance on the television show 60 Minutes yesterday — talk about being completely out of control and inciting divisiveness — see Obama’s Slams ‘Fat Cat’ Bankers). This backlash against the banks, whose behaviour was condoned by the government when the credit and housing bubble was in full swing, is surreal.

As we said, the media has no problem in running articles that complain about the lack of credit being extended by the evil banks, even though it was excess debt taken on by a profligate consumer that got us into this mess to begin with. The front page of the Sunday NYT runs with Rates Are Low, But Banks Balk at Refinancing. Basically, 60% of mortgage borrowers carry interest rates that are above the current market cost, but refinancings are still down 57% from year-ago levels because the banks have battened down the hatches on their lending guidelines; “The plight of homeowners has become a volatile political issue”, according to the NYT. Well, that’s probably not the case for the 30 million Americans who own a home with no debt or the countless others who have a mortgage but also know how to live within their means. The article says “the banks that once handed out home loans freely are imposing such restrictions that many homeowners who might want to refinance are effectively locked out.” So, because the banks lent freely in the recent past, and this excess was at the root of today’s problems, then the banks should go back to those days of reckless lending behaviour.

Come again? Nowhere in the article is there any reason provided as to why the banks are “stricter” — maybe it has something to do with the amount of equity the borrower has in his/her house, or what his/her credit-rating has been cut to, among others. The way the media and politicians are portraying the situation is that it is every citizen’s god-given right to have credit. This is amazing. We aren’t exactly recommending a return to Calvin or Kant puritanical behaviour, but what we are seeing unfold right now is very disturbing.

TARP repayments

The President is playing politics of course.  And he is using the TARP repayments by Wells and Citi to do so.  It is quite crafty, if you asked me.

The message to banks is loud and clear:

You bankers are now free of TARP restrictions. That means you have been given a green light by the government to return to business as usual. Under no circumstances should you think this means a return to large bonus payments while everyone else is hurting. I will pillory you with verbal abuse. And while I don’t want to tax you, I may be forced to resort to action.  On the other hand, the green light means you had better start lending or you will get the stick.

Back in June I warned this is what was likely to occur. When BofA repaid it’s TARP money, I repeated this warning. But now that the President is all but ordering the bankers to lend, the narrative is even more compelling. This is how I presented the idea from a banking CEO’s perspective. I have highlighted the points consistent with Rosenberg’s statements:

the stress tests showed that Phil’s bank was in relatively good shape – at least compared to Big Bank’s peers. On the back of this information, Big Bank was able to issue a huge slug of new shares at a price 200% above its trough share price and fill any apparent gaps in Big Bank’s capital.  In fact, under the guidelines of the stress test, Big Bank could pay back all of the TARP money it received and return to business as usual.

There was one problem, however, and Phil knew it.  You see, Phil had become a lot more worried about the health of his bank after being caught flat-footed when the credit crisis hit.  The company had done a significant amount of work to get to grips with likely credit exposure.  And while the situation was good for Big Bank under the conditions predicted in the government’s stress tests, Phil knew that the conditions were not good at all in more adverse scenarios.  What should Phil do?

Before, we get into what Phil actually does, I should point out that this is a classic case of asymmetric information in which Phil, as a bank insider, has a lot more knowledge of Big Bank’s financial condition than the government, shareholders, or the investing public at large. Well, I would like to believe that Phil would do the prudent thing and remain ‘over-capitalized’ until he was sure that he could lend prudently without jeopardizing his firm’s capital base. But, there is clearly no incentive for that.  After all, hadn’t Phil been beaten over the head before Congress for ‘not’ lending money?  Why did Phil have so many billions of dollars in excess reserves at the Fed?  Why was he preventing the economy from regaining its footing? Was Phil hiding something? Perhaps Phil and his executive team need to be replaced?  On second thought, Phil decides the over-capitalization route is suicidal…

Big Banks lawyers and accountants have told Phil that he can legitimately claim to the public that Big Bank is well-capitalized and proceed lending…

Phil, who has zero incentive to restrict lending, has a lot of incentives to increase lending: threats from the government and a huge options pay package being the most obvious.

Do you think the toxic assets have magically disappeared – or perhaps become less toxic due to asset price inflation? The government obviously does and this is why they are telling banks to lend more money. The New York Times quotes the President after his fat cats meeting as saying:

America’s banks received extraordinary assistance from American taxpayers to rebuild their industry. Now that they’re back on their feet, we expect an extraordinary commitment from them to help rebuild our economy.

This and zero percent interest rates are only sowing the seeds of the next credit bust down the line, of course. But, who cares?  We’ll just act as if no one could have possibly imagined or predicted this turn of events.

(video of Obama below: note how somber he is. He sounds disappointed and let down.  He does pay lip service to the need for prudent lending but then goes on to exhort the banks to “go back and take a third and fourth look.”)

Enter Samuelson

That’s where Paul Samuelson enters the picture.  The old Keynesian had an interesting twist on depression economics, something Paul Krugman pointed out in an ode to Samuelson today. On page 353-4 of his 1948 textbook, Samuelson writes:

Today few economists regard Federal Reserve monetary policy as a panacea for controlling the business cycle. Purely monetary factors are considered to be as much symptoms as causes, albeit symptoms with aggravating effects that should not be completely neglected.

By increasing the volume of their government securities and loans and by lowering Member Bank legal reserve requirements, the Reserve Banks can encourage an increase in the supply of money and bank deposits. They can encourage but, without taking drastic action, they cannot compel. For in the middle of a deep depression just when we want Reserve policy to be most effective, the Member Banks are likely to be timid about buying new investments or making loans. If the Reserve authorities buy government bonds in the open market and thereby swell bank reserves, the banks will not put these funds to work but will simply hold reserves. Result: no 5 for 1, “no nothing,” simply a substitution on the bank’s balance sheet of idle cash for old government bonds.

Krugman uses this quote to talk about interest rates, but it also goes full circle back to Rosenberg’s point – namely that banks are not lending because they are capital-constrained. Forget about the phony stress tests. Bankers know the true state of both their own financial health and that of potential borrowers. Large corporations are relatively flush with cash and have the opportunity to borrow in spades. However, small business and individuals have seen difficult economic times and this is where the problem lies. Are you telling me banks should just turn on the credit spigot and let ‘er rip?

Easy money is not the solution, it is the problem.  Jobs are the solution.

The corollary of this is statement is that fiscal policy is more effective than monetary policy in a depressionary environment.  Quantitative easing is overrated.

Source

Breakfast with Dave – David Rosenberg, Gluskin Sheff