Despite constant urging by Washington for banks to increase their lending, credit conditions remain tight. Small-business lending continues to lag, and credit card issuers have slashed credit lines and canceled thousands of accounts. Just before Memorial Day, the Obama administration unveiled its latest effort to jump-start lending, a new Small Business Lending Fund (SBLF), which will make available $30 billion to community banks to promote small-business lending. The proposal already has cleared the House Financial Services Committee.
But is there any reason to believe that this modest investment will do what the hundreds of billions of Troubled Asset Relief Program (TARP) dollars failed to do - namely, encourage banks to start lending? Not likely. As with previous efforts, the new fund fails to address the most important reason banks aren’t lending: Washington bureaucrats and politicians are making it impossible for them do so.
Every loan bears some risk that it will not be repaid. In making a loan, a lender has two considerations: First, it must be able to price the risk of the loan accurately or, second, it must reduce its risk exposure by reducing the number of loans it makes, the amount it lends or the risk profile of those to whom it lends. Regulations that interfere with the ability to price risk accurately thus inevitably produce efforts to reduce risk exposure by curtailing lending.
Since President Obama was inaugurated, Congress has launched one of the most ambitious legislative agendas in American history - proposals that would fundamentally transform the economy: from remaking the health care system, to a far-reaching set of taxes and regulations to combat climate change and remake the energy system, to a comprehensive financial overhaul bill that would fundamentally reshape the banking system.
How, one wonders, can borrowers and lenders possibly price the risk associated with the imposition of the massive new cap-and-trade system or other new environmental regulations? How could a start-up or growing company anticipate the costs to be imposed by the health insurance reform legislation? How can a lender make a loan today knowing that a new Bureau of Consumer Financial Protection or state attorney general might later decide the loan is “abusive”? Or what future taxes will have to be levied to fund our unsustainable budget deficits?
When the new SBLF was unveiled in February, I testified before the House Financial Services Committee along with several businesspeople and bankers. Their refrain was nearly uniform: Washington’s tax-and-regulation orgy was spawning unworkable uncertainty for small businesses and banks, leading to curtailed lending. The SBLF doesn’t address that.
But the inability to accurately price risk goes beyond macroeconomic-level uncertainty: Congress’ meddling in credit markets has directly interfered with the ability of lenders to price the risk of lending accurately. Proposals for still more interventions provide still greater threats of uncertainty, further undermining confidence and predictability.
Consider Exhibit A of unintended consequences: the Credit Card Accountability, Responsibility and Disclosure Act of 2009 (the “Credit CARD Act”). While some of the provisions of the legislation are largely harmless or even mildly beneficial, other provisions of the law interfere with accurate risk-based pricing, such as limitations on the ability to raise interest rates or declare a default when borrower risk increases. The market response has been entirely predictable - faced with new limits on the ability to raise interest rates when borrower risk changes, lenders have simply raised interest rates across the board for all cardholders. Equally predictably, card issuers have reduced their risk exposure by slashing available credit lines by more than $1 trillion in the past year, canceled thousands of cards and levied new fees on inactive and other risky accounts, in some part because of the obstacles created by the CARD Act. About three-quarters of small businesses rely on credit cards (often their personal cards) to finance their businesses, especially women and minority entrepreneurs, who frequently are excluded from traditional small-business lending. This legislative assault on access to credit cards has slowed economic recovery and driven consumers and small businesses into the hands of pawnbrokers and payday lenders.
But this pummeling of the credit card market is still not enough for Congress and the Obama administration. A House bill introduced by Rep. John F. Tierney, Massachusetts Democrat, (with more than 60 co-sponsors) would impose a national interest rate ceiling of 16 percent on credit cards, guaranteeing a massive constriction of credit card availability (and a boom for payday lenders). The looming creation of a new Bureau of Consumer Financial Protection in the Federal Reserve with the authority to regulate virtually every consumer credit product in America and to punish those loans deemed (after the fact) to be “abusive” will further discourage lending to consumers and small businesses. Congress also is still considering allowing bankruptcy judges to “cram down” underwater mortgages and home equity lines of credit to the value of the underlying home, which would further increase their risk, reduce their availability and probably be a death knell for home equity lines of credit (a major source of small-business capital) until the long slump in property values reverses.
Bureaucrats also are to blame. Although presidents and Treasury secretaries have promoted lending to spur economic recovery, the incentives of individual bank examiners are counterproductive to this goal. But bank executives around the country have complained that bank examiners have become obsessively cautious in how they value a bank’s assets, thereby demanding an increase in reserves - and a shrinkage in lending.
Bureaucrats face well-known incentive problems that lead them to be more risk averse than is socially optimal. For example, analysts have long observed that the Food and Drug Administration can claim little credit for speeding a beneficial drug to market quickly, but gets massive political criticism if it fails to block a dangerous drug. Similarly, individual bank examiners can claim little credit if responsive oversight enables a particular bank to increase its lending slightly, thereby promoting economic recovery. But any given bank examiner is likely to find himself subject to his own painful examination by his superiors if “his” bank fails on his watch. As a result, bank examiners have erred on the side of caution, even if that defeats the administration’s goals of expanding lending. It is worth noting that the narrow-gauge mission of the new Bureau of Consumer Protection virtually guarantees that its head will face similar pathological incentives to act overcautiously, thereby stifling innovation and exacerbating the credit crunch.
Legend holds that the term laissez-faire originated when Louis XIV’s finance minister, Jean-Baptiste Colbert, asked French industrialists what the government could do to assist their business. Laissez-faire - “leave us alone” - was the response. Banks and businesses all over America are saying the same thing today - if only Washington will listen.
Todd J. Zywicki is a George Mason University law professor and a scholar at the Mercatus Center.