Saving the Banks will Accomplish – Nothing

Editor’s Note: The old saying is that during a deflation cash is king. This is because as prices fall  money becomes more valuable (i.e. it buys more). So it makes sense to hold onto it as long as possible and wait for it to increase in value. Because people hold onto their money it becomes scarce and harder to come by.

During a deflationary recession people also hold onto their money because they are uncertain about the continued supply of money (will they lose their job due to the recession, etc) so they in addition to holding money for appreciation, they are also “saving for a rainy day”.

Conversely during inflationary times money is becoming less valuable (buys less over time) so people want to get rid of it before it loses too much purchasing power and they even borrow as much as possible so they can pay it back with less valuable dollars.  Keep that in mind as you read Andy Gordon’s excellent article on why bailing out the banks won’t help the economy. ~ Tim McMahon, editor 

The Banking Sector: Throwing Good Money After Bad

By Andrew Gordon

How many times have you heard, “the economy won’t turn around until banks start lending?”

It’s so obvious… Banks got us into this mess, so it’s banks that will have to get us out.

From the President on down, nobody is disputing such a self-evident premise.

And that includes Wall Street. Here’s a typical statement – from RDQ Economics LLC in NY, “They [the Obama administration] should be focused on stabilization” of financial firms “and stimulus — and that should not only be ‘Job 1,’ that should be the only job right now.”

Of course, the financial crisis has killed Wall Street. So the statement might seem a little self-serving, except for the fact – once again – that everybody agrees with it.

I don’t buy it.

Maybe banks were the problem – when Bear Stearns was taken over and Lehman went under.  When nobody knew which were the good banks and which were the bad banks and interest rates shot up as a result.

But it just takes one stupid question to realize we’re so past that now…

Who will the banks lend to?

To you and me? Wait a minute. We’re saving more. From a negative savings rate, we’re now saving about five percent of what we earn.

It’s about time. We couldn’t go on forever spending more than we make. It was bankrupting us.

Do you really want to buy a new car? Richard Wagoner, CEO of GM, wants you to. So does Ben Bernanke. And, let me go out on a limb and submit that President Obama also wants you to.

But what’s good for the economy isn’t necessarily good for you and me.
But surely companies need more loans from banks? If companies weren’t running so low on cash, why are so many of them cutting their dividends (37 so far this year)?

Aren’t the auto companies strapped for cash? Aren’t many banks scraping the bottom of the cash barrel? Couldn’t they use loans from other banks?

Yes, yes, and yes, BUT…

Fewer sales mean a smaller cash flow. When you’re earning less cash, the last thing you want to do is get a loan and go deeper into debt. Ask any responsible CEO: Higher interest payments and lower earnings aren’t a good combination.

Then there are the irresponsible CEOs, who have made a ton of bad decisions and are now forced to take out loans. Just ask Vikram Pandit of Citigroup and Bob Nardelli of Chrysler how it feels to put their companies into deeper debt?

No self-respecting bank would give these companies a loan. They’re getting them from the government.

Responsible companies – especially those in cyclical industries – are paring down debt right now, not increasing it.

In other words, we’re way past the point where banks are holding back the economy. In fact, there are very good reasons why the government shouldn’t spend hundreds of billions of dollars to a trillion dollars more to save banks…

  • Throwing good money after bad. The so-called stress test isn’t nearly tough enough. Many of the banks getting government money won’t survive.
  • The adrenaline shot is diluted. When banks were leveraged 30 and 40 to one, these banks might have been able to kick start a lagging economy. Not anymore.
  • Inflated pay scale. A reality check is long overdue. Without the lucrative derivative market and with lower leverage, banks can’t afford to pay their 20-something employees millions of dollars anymore.
  • Where’s the accountability? On a scale of 1 to 10, remorse gets 0 and a sense of entitlement gets 11. Dozens of banks were engaged in reckless behavior. They bullied Freddie and Fannie. They gave out billions of dumb loans. They infected other banks all over the world. Has any banker said, “I’m sorry?” Not that I know of.

We shouldn’t be asking our banks to go back to the bad ol’ days of dumb lending and dumber borrowing. It’s not fair to lenders or borrowers.

But even if banks wanted to return to their loosy-goosy lending ways (which they don’t), they wouldn’t find enough pent-up demand for credit to lift the economy out of its current doldrums.

Banks are a problem. But they aren’t the answer. Their festering issues are hurting the market because Wall Street thinks that banks are more important than they are.

It’s the ultimate lose-lose situation…

Save the banks and the economy still drops like a rock.

Don’t save the banks and the markets drop like a rock.

I’m bearish. And you should be too. There’s no easy way out of this dilemma.

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About Tim McMahon

Work by editor and author, Tim McMahon, has been featured in Bloomberg, CBS News, Wall Street Journal, Christian Science Monitor, Forbes, Washington Post, Drudge Report, The Atlantic, Business Insider, American Thinker, Lew Rockwell, Huffington Post, Rolling Stone, Oakland Press, Free Republic, Education World, Realty Trac, Reason, Coin News, and Council for Economic Education. Connect with Tim on Google+

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