To Lend or Not to Lend, That is the Question

A day doesn't pass without a politician or pundit bemoaning the banking industry for not "doing more" to lend the money the government recently invested in leading banks.

What's stunning about this pressure is that it threatens to weaken the banks at the very time they need strengthening - as if the lessons of the financial crisis not only haven't been learned but are completely misunderstood.

Simply stated, the banks would lend the money if they thought it was profitable to do so. The only way you don't believe that is if you don't believe banks prefer to make as much money as they can.

If they aren't lending of their own volition but are pressured to do so, then they will be making loans that are at greater risk of losing money - and poor asset quality and underperforming loans are the proximate cause of the current financial crisis.

So we all have a profound interest in seeing the banks make good, sound loans. Anything less will drag out the crisis and delay the recovery.

What's happening is that the government's equity investment in the banks replenishes capital that was lost. Without the new capital, the banks would have to reduce the assets or loans they currently have outstanding.

So the government investment is increasing the amount of loans the banks can hold, as compared to not having the new investment.

And since the banks couldn't sell their current loans due to a lack of a market for them, the lack of new capital would likely lead to a run on banks and precipitate a true financial collapse.

And that's how a recession can become a depression.

So here's to hoping the banks become financially strong, soon.