It’s Time to Take the Thumb Off of Consumer and Business Borrowing to Get the Economy Moving Again

Revitalizing credit, creating jobs, and stimulating the U.S. economy was the subject of a panel that I participated in last week at the U.S. Chamber of Commerce’s Capital Markets Summit. A lot of people have said that businesses — especially small ones — can’t get credit. A big question for the panel was whether that’s really true. Here’s what I said.

There are three interrelated problems at the moment.

First, banks aren’t lending because a lot of companies don’t want to borrow. They have horrible balance sheets left over from the financial crisis, they face weak demand, and they face uncertain futures because it really isn’t clear how quickly the economy will improve. Unemployment is still close to 10%. But that really understates the problem. At the end of last year the fraction of the workforce that was unemployed or underemployed was about 16 percent with three states — California, Michigan and Oregon — having rates greater than 20%. A lot of people have lousier jobs than they used to have, are taking part time work, or have stopped looking because there aren’t any jobs for them. That’s a lot of consumers who aren’t going to be buying a lot and they make the rest of the consumers in better straights worried.

Second, banks aren’t lending because a lot of the companies that want to borrow don’t look like such great credit risks. These companies have horrible balance sheets, face tepid demand, and uncertain futures! And when banks do lend they charge more. Adverse selection is more of problem in these times: the companies in the most dire straits are the ones who are most interested in borrowing.

The January Federal Reserve Board survey of lending officers found that banks are easing lending a bit but they haven’t unwound the severe tightening that has taken place over the last two years. The contraction of credit, tightening of loan standards, and spreads for loans have been extreme; the last quarter of 2009 was the worst in a very long time when it comes to granting credit. Thing are getting better but relative to a very bad situation. A couple of my fellow panelists observed that part of the problem is that bank examiners are being too tough.

Third, Congress and the Obama Administration are making the second problem worse. A lot of small businesses rely on personal credit cards. The CARD Act has made it harder for banks to charge for risk. The result is they are cutting off credit for some people and generally charging more to cover the costs of a bad credit risks they can’t identify. The CFPA as envisioned in the Dodd bill is probably going to make this worse. About half of small businesses rely on personal credit cards for financing. They have been affected by the general tightening of credit cards. A lot have seen the credit lines slashed that they used as working capital. A lot have seen the cards cut completely. And many have seen rates rise. The businesses that are really hurt are the ones that are relatively new and small — but it is these businesses that account for most job growth in America.

So what’s the solution? Exhortations to lend money from the regulators, Congress, and so forth aren’t going to work. The banks make money by lending money. They aren’t lending money because they see it as too risky in a lot of cases. By the way, the banks are sitting on a massive portfolio of risky commercial real estate loans that might explode this year. Many of those who are yelling at the banks to lend money are also criticizing the banks for lending too much money. They are also chastising consumers for borrowing too freely on their credit cards. And they are proposing regulations left and right to make it harder for banks to lend and for consumers to borrow. All the hot air and doubletalk coming from D.C. isn’t going to get us anywhere.

We have to get the economy moving again. Here we have a chicken and egg problem. Businesses need to borrow to hire and expand but they can’t do that if people are out of work and worried. Sound macro policy is important but I’m not going to get into that because it is too far from what I specialize in. But what is clear is that the government should be taking the thumb off of business and consumer borrowing.

That means ratcheting back some of the efforts by bank examiners to make sure that banks aren’t overextending themselves and making bad loans. Obviously, given our recent experience, we shouldn’t go back to overly liberal standards but we should take into account that an overly severe approach has dreadful consequences for the economy. We should also impose a moratorium on government efforts to make it harder for banks to lend and for consumers to borrow. Now isn’t the time for the CARD Act, the CFPA, any of the plethora of regulations being proposed. Maybe someone can make a case for these regulations in a few years when things get better. The same is true for the capital gains tax. We should not be increasing the capital gains tax rate or even suggest we’re going to that — it discourages entrepreneurs from investing. One could have a vigorous debate on all these issues but one thing is clear — getting the economy moving again should be our first priority.

David S. Evans’ bio

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