Banks pulled in two opposing directions

by Frank James

Angry lawmakers are holding a hearing this morning to grill Treasury's Interim Assistant Treasury Secretary for Financial Stability Neel Kashkari on, among other matters, why banks aren't using the billions of taxpayer dollars from the Troubled Asset Relief Program, or TARP, the way so many expected them to, to make loans to consumers and businesses.

But James Kwak at the "The Baseline Scenario" economics blog raises an interesting point. Banks are being asked to do two things simultaneously -- improve their balance sheets on one hand and shovel money out the door on the other. Small wonder they're paralyzed.

Kwak writes:

Banks need new capital to protect themselves against falling values of their existing assets. But if they use the new capital to make new loans, you defeat the purpose of the new capital, because that new capital is no longer helping support the existing assets. These are two separate and somewhat contradictory goals. Note that, according to Bloomberg ... financial institutions have taken $978 billion in writedowns - so far - and raised only $872 billion in new capital. So while politicians rail against banks that took TARP money but haven't expanded lending, the banks at least have logic on their side. I've been surprised that no one in Washington that I'm aware of has been willing to point this out."

This isn't to say that some banks aren't doing some things that lawmakers question with the money, like paying dividends or doing acquisitions with TARP money.

But financial institutions clearly are being pulled in two opposing directions -- beef up capital and spend money.

Kwak cites a couple of Bloomberg headlines whose dissonance was brought to the attention of many by Tim Duy, an economics professor at the University of Oregon.

Fed's Kohn Says Regulators Should Encourage More Bank Lending Amid Turmoil: U.S. regulators should rise to the "challenge" of encouraging an expansion in bank lending amid a weakening economy and continuing financial-market turmoil, Federal Reserve Vice Chairman Donald Kohn said.

Fed's Kroszner Urges Banks to Increase Capital Reserves to Buffer Losses: Federal Reserve Governor Randall Kroszner urged banks to hold more reserve capital to protect themselves from future "cascading losses," as potential market fixes are "no guarantee" against another credit crisis.

So far at this morning's House Financial Services Committee hearing, no one has mentioned this push-me, pull-you that banks are undergoing.