Can Fed Make Banks Lend?

Mar.11, 2008 in Market Outlook

Fed pumps more money into financial markets

Central bank loans $200 billion to big investment firms to promote liquidity. But measures aren’t prompting banks to increasing lending.

http://money.cnn.com/2008/03/11/news/economy/fedauction/index.htm?postversion=2008031112

A main reason the Fed’s measures aren’t having a big impact on lending is because the problem with the markets isn’t a liquidity crisis, but a psychological one, said Barry Ritholtz, chief executive of FusionIQ, an asset management firm.

Banks are shying away from offering credit because they fear the rising defaults, and they aren’t buying securities backed by loans because they are unsure of the quality of the underlying assets. Even high-quality borrowers could run into trouble if the economy continues to tank.

“The Fed can’t make banks lend,” Ritholtz said.

Also, the Fed’s moves aren’t helping an ever greater problem facing many banks: A lack of sufficient capital. A measure of a bank’s strength, capital levels indicate the institution’s ability to absorb losses. As the value of assets backed by mortgages and other loans plummets, banks have had to raise capital by selling off operations or stakes in their companies.

Another way banks can improve their capital standing is to reduce the amount of loans they keep on their books. Citigroup, for instance, last week called for reducing its loan portfolio by 20% and cut the amount of new loans held on its balance sheet by half.

It’s pressures such as these that prevent the Fed’s efforts from having a great impact on the credit crunch. “The Fed’s liquidity measures are inadequate to address a capital crisis,” Todd said. To top of page

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