Why Banks Aren’t Lending

Well it’s been a couple of weeks since my last blog entry, mainly because I’ve been spending time with some of my family who were visiting from NZ. It was great to have them here, but now that they’re gone I’m eager to get back to some writing.

A lot of my interest at the moment is in tax policy and I have some thoughts I’m hoping to share shortly, though I’ve been spending quite a lot of time digging out some solid data to ensure that I can accurately characterize the issues I’m concerned about. More on that in due course.

At the same time, I am also keeping my eye on some other economic issues, notably, at the moment, the expectation that the Federal Reserve is going to launch a second round of quantitative easing (QE2). It is widely believed that they will print several hundred billion dollars, which will be used to purchase treasury bonds from banks in order to inject additional cash into the banking system. The idea is that this will encourage banks to lend more money to businesses to create jobs.

However there is a fair bit of skepticism in the press about the magnitude of the impact this is likely to have. Part of the concern is that the banks are already sitting on very large cash reserves and yet are not lending much of it. Annie Lowrey commented on this in Slate yesterday (underline added) –

If QE2 is to work, it will have to work differently than QE did—and probably won’t work as well… So how might it work? One hope is that by giving banks cash in exchange for assets, the Federal Reserve will induce banks to lend. With more cash on hand, the banks will be more willing to make loans to homeowners and businesses. But the reason for the banks’ current stinginess has little to do with the size of their reserves—banks are sitting on excess capital, as are the big companies they like to lend to. Banks are not making loans because they don’t see anyone or thing worth lending money to. Just because they have $500 billion or even $100 trillion more to lend doesn’t mean they will decide to lend it.

So banks don’t see anyone worth lending money to. That strikes me as a little disturbing. The reason is that it makes me wonder what exactly it is that America’s business schools have been doing all these years (US News and World Report ranked 426 of them) to produce a population of business people who are apparently incapable of developing compelling business strategies that don’t depend on strong or growing consumer demand. In an economic climate like the one that currently prevails, I have to imagine that the best chance of stimulating real economic growth is through innovation that improves the productivity of business rather than directly increasing output. Yet bank funds are evidently not being funneled into investments that create this kind of innovation.

Of course there may be other explanations besides the inadequacy of America’s business schools (not that I’ve given up on that hypothesis, but it doesn’t hurt to speculate…). Perhaps the defect is not with business schools but with engineering schools producing graduates who don’t know how to innovate effectively – but of course that couldn’t possibly be true :). Maybe a more plausible explanation is that the kind of investment needed to create innovations that improve productivity is not typically provided in the form of bank loans, but through venture capital – which perhaps points to a more fundamental problem with QE2.

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