College and professional football games offer new twists in both offense and defense practically every week. These efforts are designed to produce winners. However, in many cases, the Xs and Os on the chalkboard and on the practice turf do not move as anticipated in a game setting. As a result, changes have to be made continually in order to produce the desired results.
Similarly, because of the myriad problems continuing to press down and hold back the forward momentum of the nation’s economy, several steps have been taken over the past few days and weeks to mitigate the difficulties. All of them have been designed to help Americans and, indeed, citizens of the entire globe, better maneuver the daunting waves of uncertainty and thus reach the shores of greater financial stability and security.
To accomplish these goals and allow credit to flow more freely, the Treasury Department approved the doling out of $125 billion to purchase stock in nine of the nation’s largest banks. This investment was the first official distribution of funds from the federal government’s $700 billion financial rescue program approved on October 3.
To bolster balance sheets and stop the economic drain, the Treasury Department is taking the preliminary steps to give approval for using another $125 billion to purchase stock in key regional banks, hopefully by the end of the year. The logic behind this plan is simply that, if the problem is liquidity, why not provide liquidity? The rationale stemmed from a similar approach which seemed to be working in Europe (better than the original idea of using all of the funds to buy distressed assets), so why not try it here? I would like to say there was more to it than that, but there wasn’t.
The plan now underway to relieve the credit crisis by using public funds to invest in banks is not without precedent. During the financial chaos at the height of the Great Depression in the 1930s, the Reconstruction Finance Corporation (RFC) was created to enable the government to become a shareholder in thousands of banks across the country. This measure was eventually vindicated as the economy improved, and the $1.1 billion the government had invested in the nearly 6,800 banks was repaid. (The $250 billion the government is now investing is equal to about $1.6 billion in 1933 dollars.)
The purpose of the infusion of money into the major and regional banks is basically to help boost capital ratios and ease the flow of loans. Unfortunately, according to the Senate Banking Committee hearing last week, these monies are not being made readily available to the public.
The reason perhaps lies in the fact that the Treasury Department authorized stronger banks to use a portion of the funds to acquire weaker banks, and thus much of the money is being held or used for this purpose. The modest increase now being experienced in lending seems to be coming from firms drawing down lines of credit instead of financial institutions creating new loans.
The Treasury’s approval for such use of taxpayer investment has led to some criticism because it has opened the door to acquisitions and mergers that will not necessarily make additional funds available to those seeking loans. Furthermore, this caveat has created a perception that the government is stepping in to determine winners and losers. Additionally, some major banks are reluctant to release their purse strings out of fear that the financial situation will get worse and they may need the money for themselves.
The nine major banks that received the public investments did not have a choice regarding participation in this plan. They were basically required to accept it because the Treasury Secretary requested them to lend more money, to both customers and to each other. If one or two had been allowed to opt out, it would have sent a signal that the others were weaker, thus risking more market panic and chaos. The smaller institutions do have a choice, and some strong Texas banks are opting not to participate. Others that are equally strong see it as a vehicle to obtain low-cost capital and earn greater profits.
While the government’s purchase of stock may eventually prove beneficial in slowing the financial slide, many business leaders believe that more is required. Thus, several other industries, ranging from automobile manufacturers to insurance companies, are looking to get in on the act. Some consideration is being given by federal authorities to these desires.
Moreover, to help ease the flow of funds and relieve the pain being felt by many Americans, the Federal Reserve this week ratcheted down interest rates yet again, as did other banks around the world. For reasons that will require another column to explain, this is not likely to be the most effective part of the effort, but we have to try it nonetheless.
Just as football teams normally adjust their plans to better meet the anticipated challenges as the game continues, extra fine tuning will no doubt be required in the coming weeks to stabilize the banking system and encourage additional lending. We will get there!