You're failing to see the difference between the supply of loanable funds and what funds are being loaned out. Just because I'm not lending out what I *could* doesn't mean there isn't money to lend. Right now, global credit markets still have plenty of money, just not a desire to make loans. You've mentioned Caterpillar a few times now, but it's no different a situation than anyone else's: nobody wants to take the risk of lending Cat any money. That is, nobody wants to take that risk *at the prices Cat is offering*. Markets will clear if prices are allowed to adjust on their own, and if Cat must offer higher interest rates to lure investors, so be it. That doesn't mean there isn't money to lend out.

Right now, investors would rather flee for the safety of commodities (gold, oil) and even U.S. Treasury securities, rather than what the federal government wants American taxpayers to buy up. Austrian Business Cycle Theory teaches us that this is not inherently a bad thing. After the last several years of lending excesses, created and spurred by government interference in markets, we're seeing a necessary contraction as errors are eliminated from the market.

What's falsely perceived as "a lack of money to lend" is actually "a lack of trust to lend money." A lot of banks currently don't trust each other's ability to repay loans. They're waiting to see who's next to fail, merge and/or be bought out. This is perfectly sound behavior: a free market would allow participants to wait things out until they can get quality information.

What we have instead is the Federal Reserve "injecting liquidity" as part of its self-anointed role as "lender of last resort," and now the federal government is the "buyer of last resort." This by definition skews what neoclassical economics would call the optimal alignment of supply and demand forces. Austrian economics clarifies further: government interference has no profit motive and thus perpetuates errors, hindering entrepreneurs (who by definition have a profit motive) who would eliminate errors from markets. Austrian market processes in a nutshell: because information is imperfect, supply and demand are not naturally aligned, but it's the entrepreneur who seizes upon profit opportunities and thus brings them toward (if not to) alignment.

Now, back to what the Fed and feds are doing. Why should I, via inflation, be punished because someone couldn't get a loan except by central bankers creating new easy money? Why should I, via taxes, be forced to "invest" in something that I would otherwise not touch at all? "Collectivist" is the only word that can describe this: the individual is subjected to the whims of the majority, sharing in others' successes (if they are successful) but made to share the costs of their failures.

"This bank owned $1 million in Fannie/Freddie securities. The bank examiners have REQUIRED them to write down the value to $0. With that accounting move, the bank's capitalization ratios on their balance sheet no longer permit them to loan money (FDIC rules).

In a free market, your sister's bank would still be able to lend money if it has it, and its account holders could pull their money out if they don't like the bank's risk-taking. And instead of various regulations to prohibit/restrict behavior, bank officers can be held in check by courts. If they intentionally misrepresent material facts, they'll go to jail for fraud.

Do you see the real problem here? Government made worse what it created in the first place. Instead of letting people buyers and sellers determine what they think is the true value, the federal government is going to use our money to buy things here and now.

BTW, our firm, uh, was one of the top shareholders of Freddie and Fannie. And Lehman. And AIG. We took a real bath, but we're far more diversified than four companies, so we'll survive. Knock on wood, we're one of the few bigger companies who are still profitable. Our share price has taken a beating, but we're still paying a dividend. It's helped that we never did investment banking and thus never leveraged ourselves or otherwise exposed ourselves to the huge risks that ML, Bear Stearns and Lehman did.

"As long as their current loans continue to perform the bank will survive. But the only way to get back into a position to lend money is by retiring existing loans and getting the capitalization ratios back in compliance."

Do you see the irony? This comes from the same federal government that imposes such a standard on a bank while itself accumulating more and more debt (that others must pay!) as a regular routine.

"This problem is systemic. Are there banks with enough cash to still loan money? Probably, but as you say, they are reluctant to do so because of the risk to their balance sheet and regulatory compliance."

And trust, as I explained above.

"BTW, I offered to take the Fannie/Freddie paper of her hands for book value... she said I'm long line behind a number of shareholders."

Of course, the government is forcing the book value of zero, as you stated. Forced. Why not a true market value? Simply letting people act freely would do wonders to fix what government hath wrought.

Government states a book value of zero, then declares what's probably a too-high value on other things. Once again, if the latter is such a good deal, let others take the risk, instead of making me ride along. Is it too much to ask that I be left alone, that I not be coerced into joining what I deem a ride into hellfire?

I miswrote something earlier: Obama didn't say he'd postpone his social spending because of the bailout. He actually said he'd postpone his...middle class tax cuts. As if the Clinton Era proved we'd have gotten them anyway.

Posted by: Perry Eidelbus at September 29, 2008 2:56 PM

One thing I meant to add to the first paragraph. Or just because I'm not able to lend out money doesn't mean others aren't able (although waiting) to lend out money.

There's plenty of liquidity already! Kudlow is so full of it.

Posted by: Perry Eidelbus at September 29, 2008 2:59 PM

So government regulators have REQUIRED banks to write down the value of assets on their books to zero. Gee, that sounds familiar. [second link]

And "even the worst" of those assets "are worth no less than 40 cents on the dollar" yet the government has it's own price - 20 cents on the dollar. That sounds familiar too. [second comment]

Posted by: johngalt at September 29, 2008 3:41 PM

PE: Not sure I'm getting the nuance between "would lend it but don't have it" and "have it but won't lend it" from a liquidity perspective. Businesses that file chapter 11 because they can't roll over a routine line of credit at an affordable rate won't care. Moreover, this puts the financial system into a death spiral.

I agree that current regulations are a serious problem, i.e. those cited, and contributed to the crisis. However, those are the rules the government set and that the companies played by. It's no more helpful to say, "Shouldn't have done it" than Obama's position on Iraq that "we shouldn't have gone in there." The fact is that we are in both situations and must deal with them.

I do support a switch, even retroactive, from mark-to-market to mark-to-model and would be interested in your thoughts in that regard.

Posted by: Boulder Refugee at September 29, 2008 6:03 PM

"PE: Not sure I'm getting the nuance between "would lend it but don't have it" and "have it but won't lend it" from a liquidity perspective."

Well, let me try to put it this way. Paulson, Bernanke and Kudlow claim it's the first. That means there's no money available, regardless of how much people want it, no matter how "worthy" people are to borrow.

But the truth is that all the "injections" by the Fed are unnecessary. The truth is the latter example. There's money out there, but lenders are extremely cautious -- as they should be in these uncertain times. What they need most is *time*, because once things start settling down, they'll be able to gauge who can pay back money and who's not worth the risk.

"Businesses that file chapter 11 because they can't roll over a routine line of credit at an affordable rate won't care. Moreover, this puts the financial system into a death spiral."

Not necessarily. Only those who survive by repeated borrowing won't make it, which isn't a bad thing. Perhaps it's about time they relied on a more stable business model.

"I agree that current regulations are a serious problem, i.e. those cited, and contributed to the crisis. However, those are the rules the government set and that the companies played by. It's no more helpful to say, "Shouldn't have done it" than Obama's position on Iraq that "we shouldn't have gone in there." The fact is that we are in both situations and must deal with them."

Actually, blaming regulations is a warning that we need to let the market be free: more government won't get us out of it! As many have said, you don't rely on the arsonist to put out a fire that he set in the first place. So when Pelosi and Obama blame "deregulation," as they did today, it's a flat-out lie.

"I do support a switch, even retroactive, from mark-to-market to mark-to-model and would be interested in your thoughts in that regard."

I'm not an accountant, but I take a simple Austrian view: let buyers and sellers agree on whichever method works best for them. I personally view the clash over accounting methods as a red herring. It's coming down again to government setting rules that could very well be wrong. Both have strengths and weaknesses.

Mark-to-market realizes that we may not know something's true future value, so at the time we can only value it based on a current market price. Mutual funds' NAV, and margin account values, necessarily go by MTM. Part of my job is approving employees' personal investments based on being low enough that they won't negatively impact our clients' trades, and when they're trading options or futures, we go by what's effectively MTM. The problem is when you bought something for $1 million, and if it declines in value, mark-to-market means your books will show a loss. But in fact, you won't experience a loss unless you're actually trying to sell the whatever at that moment. If I buy a $500K house that in a year is worth less, even if it's down to zero, that doesn't necessarily mean I'll go bankrupt.

Now when you're dealing with something illiquid and/or uncertain in value, mark-to-model is useful. But even so, it inherently leaves people free to value changing/uncertain prices pretty much at whatever they want. Warren Buffett's been to correct to call it "mark-to-myth," although not to the extent he'd like us to think. But a lot of investing companies have used it to hide losses in their investments, and if they had had to report things based on mark-to-market.

In the end, we need not complicate things with accounting methods. We need only to let buyers and sellers be free to agree on a price, and for each side to accept the consequences of the decision without using government to coerce others into bailing out one or both sides. Putting this into an example, if you're going by mark-to-model in what you're offering to sell me, but I insist on mark-to-market, we of course won't agree. But it's not the accounting method that's important, it's the *price*. Value is subjective, however you calculated it.

Posted by: Perry Eidelbus at September 29, 2008 11:17 PM | What do you think? [12]