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Saturday, December 12, 2009

Cutting Bad Loans Now Will Ease Credit Later

Last week we heard that the Obama Administration had a new initiative to convince banks to give more low-interest or even reduced documentation loans to small businesses.

This is not good news for small businesses.   This "solution" will increase the number of likely-bad loans on the banks' books.   As their lending capacity is both finite (capped by leverage limits, meaning they can lend only a set multiple of their assets) and likely to decrease in the future (as the leverage multiple is likely to decrease due to government regulation), the number of bad loans given now, combined with the bad loans given during the money-for-nothing fueled real estate bubble, will hobble the banks real soon.

The loser:  The rest of us who want to get loans for anything next year or thereafter.  

Encouraging banks to loosen certain restrictions on some loans in order for them or the government to "look good" is going to restrict the banks' ability to lend to the good risks.   Only so many loans can be made or kept on the banks' books.   The securitization market decline also means the banks cannot easily "off-load" these loans anymore.  

Delaying the "pain" of the bad loans of the last decade will only make more people suffer the pain, and for a longer period of time.  

Hopefully we will see fewer -- or none -- of these short-sighted bad policy moves in 2010.   Otherwise we will never have a true economic recovery.

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