I was talking to my friend who is in 20 million dollars deficit on a major building project in Manhattan that is already under way. His story is that the first bank gave a promise for the money, then folded. The bank that acquired the other bank went forward and promised the money. Then it folded. This went on for a few rounds, and now he is hoping that following the bailout he won't go bankrupt together with all the contractors and workers that rely on this. Now multiply this by hundreds of thousands of projects across America and various industries… Another friend is a real estate broker, and was telling me that people are putting properties on the market at "sell at all costs" prices.

Here is the point of this post: I wonder, if the banks are going to do a "take the money and run" — how is the government making sure that the money is actually getting to the people who need it?

Kim Duncan replies:

The banks will sell assets to TARP and reduce their short-term borrowings (repo, Fed facilities, unsecured inter-bank borrowings) in order to reduce leverage. That will only marginally allow the recapitalisation that is required before banks begin to expand lending once again. We are in a credit contraction and TARP will not put an end to this process which could last years.

Your question is based upon a false premise. People who need the “money” (actually credit) are not necessarily the ones who deserve the credit. Is the project your friend trying to finance actually worthy of the investment? Required returns on investment are going up on everything since capital is scare, debt finance is contracting and asset prices are declining. The project will have to compete for its funding and its provision will not be based upon “need” but rather the risk-adjusted returns.

However, the other part of your question - “Take the money and run” is misleading. Banks will sell assets to the Treasury and reduce their borrowings. The Treasury will increase their borrowings by precisely the same amount which the banks reduce their borrowings. Leverage will be reduced in the banking system but the government borrowings will exactly offset. As a result, the same amount of cash freed up from lending to banks will be absorbed by lending to the government. As far as the banks are concerned, the lower leverage will not likely lead to lending capacity and hence the TARP will not, on its own, lead to new credit being offered to the private sector. The best that can be hoped for is that some price momentum of distressed assets will lead to an improvement in sentiment towards and between the banks thereby allowing the interbank lending and deposit markets to function. A first step, perhaps, but clearly no panacea.


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