Guest post by Stephen Kinsella: NAMA will not get banks lending again

Stephen Kinsella19/10/2009

Stephen Kinsella: The primary objective of the National Asset Management Agency is to increase the flow of credit to the ‘real’ economy — that’s you and me, homes and businesses — by clearing banks’ balance sheets of ‘impaired’ assets. The story goes that these assets reduce the banks’ abilities to borrow on the interbank lending market, choking the banks of the necessary funds to lend out to small and medium businesses. Starved of capital, the businesses fold, and people are made unemployed; economy and society generally suffer.

The ‘impaired’ assets to be bought by NAMA are to be seen as the dam obstructing the flow of capital to these businesses, and their removal will start the process of lending by our retail banks off again.

This logic is flawed.

The cleansed banks will not begin lending once the transfer of loans to NAMA is complete, and NAMA’s bonds are swopped for ECB cash. Even completely cleansed banks are not enough to restore lending to previous levels for several reasons.

First, we are in a completely different business environment. Banks as for-profit going concerns are right not to lend to prospective borrowers whose businesses are too risky: that behaviour would throw away the cash NAMA just gave the banks.

Second, banks debt in relation to their equity—their leverage—is too high, meaning they need to pay down their debts quickly, and cannot do so while lending out more money, which would perforce increase their debt.

Third, despite evidence to the contrary, bankers are smart people. Bankers understand instinctively that the level of uncertainty in the economic system is very high, so they will try to increase their cash balances to compensate for that reduction in certainty. As JM Keynes once wrote: “The possession of actual money lulls our disquietude, and the premium which we require to make us part with money is the measure of the degree of our disquietude”. Our bankers now have a ‘liquidity preference’ for cash, meaning we won’t see increased lending to the real economy at reasonable rates of interest. Banks can always manage to lend at unreasonable rates of interest, but that doesn’t help the real economy.

Fourth, all our bankers understand that even if NAMA succeeds brilliantly, beyond even its greatest supporters’ dreams, their balance sheets contain another ticking time bomb: the coming implosion of the Irish residential mortgage market. The ECB will increase its interest rates in the coming year. When hundreds, and perhaps thousands, of homeowners throw their keys back in the bankers’ faces, and create another slew of bad debt to be mopped up, the bankers know they will need cash waiting to cover these bad debts, in addition to another bailout from the taxpayer.

Banks will not lend to risky propositions in riskier times when their balance sheets (and their fiduciary duty) is to deleverage. The bankers will wisely sit on the cash we will have injected into their balance sheets, and wait until the time is right to call for more.

It is now a foregone conclusion that NAMA will be brought in. NAMA’s basic form is unalloyed by months of intense public debate on the merits and demerits of this ‘bad bank’. Given that NAMA will not meet its objective to increase lending to the real economy, we must urgently consider major modifications to NAMA as it moves through the committee phase toward its eventual implementation.
Dr. Stephen Kinsella is a Lecturer in Economics at the University of Limerick and author of Ireland in 2050: How Will We be Living? (Liberties Press)

Posted in: Fiscal policy

Tagged with: NAMA


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