Just Lend And Be Done With It!

July 15, 2010

by Mario Rizzo  

Recently, there have been reports in the Wall Street Journal and the Financial Times that Ben Bernanke and others are concerned that banks have not been lending “enough” to small businesses. The accusation is that lending standards are too strict. 

As Jack Hopkins, the director of the Independent Community Bankers of America, says in the WSJ article linked above:  

“I keep hearing remarks that credit standards have tightened, and I don’t believe that… I need to make loans to survive, to make money.” 

So what happened? The WSJ reports:  

“Some lenders argued that current lending standards are a return to more-normal conditions following a period of laxity.” 

Some simple observations and then a quotation from Frank Knight’s review of J.M. Keynes’s General Theory:  

1. We have just come out of a period when real interest rates were held at very low levels. This sparked a boom and excessive risk taking.  

2. Many firms and activities over-expanded during the boom period. We cannot expect them to return to the status-quo ante.

3. Small firms were among the riskier activities.  

4. Small firms are still among the riskier borrowers.  

5.  The Obama Administration has created additional uncertainties by its rhetoric, the soon-to-be-passed 2,300 page financial regulations, the flowering of ObamaCare regulations.

I believe that Bernanke and friends would reply. Yes, there are real risks out there but the reluctance to lend is self-fulfilling. This reduces aggregate demand and makes it harder for (small) firms to survive.  

So Bernanke has no “macroeconomic knowledge problem.” He knows that we would all be better off if there were more lending because matters like credit allocation as well as restructuring of firms and economic activities after a period of misallocations are irrelevant to business cycles. Feed the Aggregate Demand God and all will be better. He better have that view or else the feasibility of macroeconomic management might be thrown into doubt. It gets – shall we say – complicated.  

Finally, let me end on a relevant quotation from Frank Knight’s 1936 review of Keynes’ General Theory:  

The … inference drawn by Mr. Keynes, and labelled “much more fundamental”, repeats a statement already quoted, along the same general line. It is that since “the extent of effective saving is necessarily determined by the scale of investment and [since] the scale of investment is promoted by a low rate of interest” (up to full employment), “it is to our best advantage to reduce the rate of interest to that point relatively to the schedule of the marginal efficiency of capital at which there is full employment” (GT, pp. 374-5).

Passing over the fact that there is no way of knowing at all accurately when there is full employment, meaning no “involuntary” or “frictional” unemployment, there are two notable omissions.

Again, nothing is said either as to the consequences, monetary and other, of having a central bank unremittingly pumping money into the system by an arbitrarily low interest rate, or as to the political status of the official or board by whom it would be done. It surely re-quires an optimist to believe that it would or could be done without resulting in an unbalanced capital structure in industry, and more of an optimist to believe that the resulting situation could be cured — as Mr. Keynes must imply — by a further overdose of the same medicine which would have brought it about. 

From: “Unemployment: And Mr. Keynes’s Revolution in Economic Theory ” Author: F. H. Knight Source: The Canadian Journal of Economics and Political Science / Revue canadienne d’Economique et de Science politique, Vol. 3, No. 1 (Feb., 1937), pp. 100-123. Quotation above at p. 119.  Published by: Blackwell Publishing on behalf of Canadian Economics Association

7 Responses to “Just Lend And Be Done With It!”


  1. Bankers will tell you there is no demand for loans. Small businessmen will say they’ve given up trying. Call it the discouraged borrower syndrome.

    Channels of credit to small business have evaporated in the downturn: home-equity lines and credit card lines. Borrowers who used those channels are likely not attractive for regular business loans. It would be interesting to have data on brrowings against life insurance policies.

    Some of Bernanke’s comments are for political effect. He knows perfectly well that many banks are under-capitalized and cannot lend. Also, examiners have been pressuring banks for higher standards.


  2. According to today’s Wall Street Journal, banks are returning to risky lending practices.

    http://online.wsj.com/article/SB10001424052748704746804575367172177309754.html?mod=ITP_moneyandinvesting_0

  3. Troy Camplin Says:

    One of the benefits of not being able to get loans, though, may be much stronger small businesses, which will not be saddled with debt and which will be forced to grow more slowly — and perhaps more healthily because more closely.


  4. Troy;

    That’s a lot of maybe’s and perhaps’…

  5. Mario Rizzo Says:

    It looks like Obama and Bernanke are on the same page. The former wants legislation to increase small business loans. It seems to me much like the idea behind Fannie and Freddie — special loans for special interests.
    http://content.usatoday.com/communities/theoval/post/2010/06/obama-seeks-tax-breaks-more-lending-for-small-businesses/1


  6. And credit policy works both ways. As discussed at Coordination Problem, some folks think the poor should not be able to borrow. At least not legally.

  7. Seth Says:

    While reading the USA Today article, I couldn’t help but be reminded of politicians rallying around home ownership as the path to prosperity several years ago. Now small business is the path to prosperity.

    It sounds good to voters. It make it look like politicians are doing something.

    But, it seems easier to predict what might happen if we narrowed the target group of “winners” here. If Obama thought more Buffalo Wild Wings was the answer to prosperity (or votes)and tilted incentives to having more BWWs, what might happen?

    Probably the same thing that happened with housing. We’ll get too many BWWs and find out that people want to eat only so many chicken wings.


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: