Federal Competitive-Lending Bank Could Be Used to Spur Credit

Crisis Policy Forum, Quipu Economic Forum :: Comments (0)

13 February 2009 :: by J.E. Robertson

There is talk of a major overhaul of the US banking system, with some analysts and economists saying the situation is so dire that widespread “nationalization” —or government takeover— will be necessary, and others saying there needs to be a bad-debt takeover bank, that takes on the huge financial risk of major banks’ “toxic assets”, so that the banks can “clear their books” and begin to lend.

But another possibility looms as the likely more appealing option: the creation of a Federal Competitive-Lending Bank (FCLB), whose purpose would be to create competition in the credit markets by getting credit to consumers and setting rates that banks are reluctant, at present, to set, because the credit markets and the rate of return are less favorable than the credit market standards have been leading into this crisis.

As Vikram Pandit, the head of CitiGroup, told Congress this week, the banks have been slow in adjusting to the new reality, which will likely mean tighter margins and harder work keeping everything viable. This may or may not be about human frailty, about wishful thinking, about a psychology of denial; what matters at the heart of it is that allowing those weaknesses to slow progress on corrective action is not a sound option. A federal competitive-lending bank would drive banks to rethink the present climate now, rather than later.

One of the chief areas of appeal for the FCLB concept is that the banks’ extreme caution with regard to lending is causing a downward spiral effect that makes the banks’ own troubles more like a self-fulfilling prophecy than an inevitable calamity. The banks could do a lot more business than they are doing, but they are nervous and no one wants to be the first to leap into the abyss.

That rates of return in a new lending paradigm are as yet unknown and perhaps unknowable intimidates those who would like to return to past rates of return and the easy-offloading of debt through questionable derivatives that are now out of favor with investors, accountants and regulators. But lending in the new lending paradigm will be the only way to make money from lending, assuming a return to the immediate past is not an option, which it appears not to be.

How would the Federal Competitive-Lending Bank actually work? Would it be loaning government money directly to consumers? Yes and no. An initial infusion of cash would be helpful, but it would also be helpful to direct funds derived from private banking activity to the competitive-lending fund, with the express purpose of allowing that fund to then use such revenues to drive lending practices toward more sustainable practices with more viable rates of return.

The private banking sector will clearly balk at the idea of a government-run bank undercutting the interest rates at which they would like to lend, but it must be said, there is no reason to expect that this system would be harmful to the banks or to their prospects of doing business in this new and precarious environment. A set of comparison rates and policies would allow the banks to organize themselves around principles of competitive lending that would, ultimately, restore confidence in their viability as credit-issuers and in the dynamism of the marketplace in moving capital to the areas of private investment or consumer spending where it will be most productive.

Banks have withdrawn from the market; they are afraid to keep gambling on the necessarily intensely competitive parameters of consumer and business lending. The lack of lending is one threat to long-term economic output, but so is the banks’ unwillingness to engage in competitive behavior. That level of apprehension is contrary to the dynamic functioning of financial markets, industrial mass production, home-buying and expanded consumer spending.

The FCLB could be chartered as a government institution, funded in part via taxes derived from banking activities above a given profit-over-transaction-value ration threshold. It could be given limited power to infuse credit markets with new loans, as per the need to get money moving to the economic “end-users”, the consumers and businesses whose use of that credit will keep generating new and consistent economic activity at healthy rates, sustainable over the long term.

The nation’s banks and major financial institutions have failed in their central promise —even if that promise was beside the point to their in-house strategists—, i.e. establishing stability in an ever-more-complex financial system. If that stability can be generated by a new institution whose central focus is the generation of market-oriented competitive financial activity, that stability itself will benefit the very financial institutions currenty starved for it and scared to operate normally without some guarantee of a stable business environment.