Friday, November 21, 2008

How NOT to get banks to lend money

Jonathan Carmel argues that the Paulson plan gives under-capitalized banks an incentive to take "heads I win, tails the taxpayers lose" bets:
If the Treasury plan is successful in restoring the LIBOR market, banks will be able to raise tremendous amounts of cash very quickly by borrowing in the LIBOR market. The money-center banks that borrow in this market have a wide array of risky investment opportunities available to them, much wider than was available to Fannie Mae or Freddie Mac.
Instead, he prefers direct equity investments in well-capitalized banks:
With increased equity capital, well-run firms that currently have strong equity positions would be able to greatly increase their borrowings and expand into the parts of the capital market left vacant by banks which have fallen. This also ameliorates the moral hazard problem since the healthy wellcapitalized banks that would directly benefit from such a plan are unlikely to have been the main culprits that caused the initial crisis.
He also cautions against purchasing bad loans or increased deposit insurance:
...we should be careful about having the government try to spend our way out of this crisis. Every dollar that the government uses to buy tainted assets, bailout banks, or cut taxes creates an extra dollar of safe Treasury securities which inevitably diverts a dollar of private investment capital from risk-bearing securities.

1 comment:

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