The Fourteenth Banker Blog

June 6, 2010

Ben Bernanke (Confused Economist) Lessons from the Gulf

Filed under: Running Commentary — thefourteenthbanker @ 12:11 PM

Ben Bernanke, economic oracle, hosted a forum on Small Business Financing in Michigan this week and had these eloquent words of wisdom from the throne of academic economic theorizing.

Unfortunately, lending to small businesses has been declining. Indeed, outstanding loans to small businesses dropped from almost $700 billion in the second quarter of 2008 to approximately $660 billion in the first quarter of 2010. An important but difficult-to-answer question is how much of this reduction has been driven by weaker demand for loans from small businesses and how much by restricted credit availability. To be sure, the distinction between demand and supply is not always easy to make. For example, some potential borrowers have been turned down because lending terms and conditions remain tighter than before the financial crisis, perhaps reflecting banks’ concerns about the effects of the recession on borrowers’ economic prospects and balance sheets. From the potential borrower’s point of view, particularly a borrower who has been able to obtain loans in the past, these changes may feel like a reduction in the supply of credit; from the lender’s point of view, the problem appears to be a lack of demand from creditworthy borrowers. Although lenders and borrowers may have different perspectives, our collective challenge is to help ensure that creditworthy borrowers have access to credit so that, should they choose, they can expand their businesses or increase payrolls, helping our economy to recover.

Ben, we give you this prestigious position and pay you to figure out complex problems.  Let’s take a look at your analytical approach, in your own words.

As we continue to examine the factors affecting small business lending, our thinking will be shaped by information from diverse sources. For example, our most recent Senior Loan Officer Opinion Survey on Bank Lending Practices suggests that, for the first time since the crisis began in 2007, most banks have stopped tightening credit standards.3 We also know, from the survey conducted by the National Federation of Independent Business that while only 8 percent of small businesses list access to credit as their principal immediate economic problem, just 40 percent of small businesses attempting to borrow in 2009 had all of their credit needs met.

If you were serious about understanding Small Business Lending you would go deeper than surveying the lenders, who of course are the experts and have no belief bias that might affect the survey results, and surveying the customers, who can tell you their experiences but are simply on the receiving end of a pipeline of money and have little real way of understanding why the pipeline is just trickling. So let’s just agree that your approach is a joke. You are speaking of Small Business Lending because politics requires you to do so. But it is not really where your interests lay. You would rather be working on funding the ECB through the IMF, buying toxic assets and carrying them at full value, buying hundreds of billions of treasury securities to supplement your trillions of mortgage-backed bonds, and maintaining a rate curve that starts at zero to recapitalize the players that created this mess. Either get serious or go back to Washington. The people of Michigan should run you out of the state.

Let me help you here. Your statistics are meaningless. Credit issued by banks to small business consists of term loans, lines of credit, and to a smaller extent business credit cards.  Business credit cards are mostly payable in full every month and are really a payment mechanism product and a way to drive interchange fee income back to the bank. So lets focus on term loans and lines of credit. In a recession, those struggling businesses with lines of credit will tend to draw them up. Their usage increases.  So imagine a water-glass that is half full and it fills up. That increases the total supply of outstanding credit. However, the water-glass was already there. The commitment was already outstanding. The rising of the level of water in the glass obscures the lack of issuance of new credit. It even implies more issuance of new credit if you are not aware of this dynamic (which you are, you just don’t want to let on)  New credit was not issued by the bank. Your constant focus on the outstanding amount of credit is a way to understate and misrepresent the more meaningful number, which is the flow of new credit to small business.

You have the power and ability to figure this out.  You need to get the information from the banks on what they do and how they do it.  You cannot rely on public information. Elizabeth Warren’s report already showed you that.

Now lets talk about an economic ecosystem.  Small businesses are like small schools of fish, plankton, whatever, in the Gulf of Mexico.  They exist in the millions, they do not get much individual attention, but they are an essential part of the economic ecosystem.  They do not wash up on the shore, they just disappear.

These undersea rivers of oil, though not nearly as concentrated as oil at the surface, are likely to affect the gulf through two mechanisms. The first is oxygen depletion, which has been estimated at 30 percent in the plumes. The other will be direct toxic effects of the oil and methane. says Harrould-Kolieb. Even small bits of crude, like those in the plumes, can suffocate fish by gunking up their gills.

Michigan is very close to the oil plumes. It is oxygen deprived. Figure it out, Ben. Figure out where the money for Small Business Lending comes from, which banks, which non-banks. Follow the money. Is there no money because of the toxic waste throughout the system?  Is there no money because the largest banks, those that represent something like 63% of national deposits, use their money elsewhere?  Make their profits elsewhere?.  What about their policies and operational systems?  Have you studied those?  What about the internal environments they create and what they incentivize?  How much have you studied that?  What about the skills they put out in the market?  How many business lenders are there and what is their credit experience?  What are they trying to sell?  Who are the managers and what are their motivations?  Are they masters at manipulating data and maximizing bonuses or are they masters at helping their Small Business operations take responsible risks?  If you wanted to you could figure this out. You might not be able to change much immediately, but at least you could identify the issues and shine light on the problems, and then maybe someone would work on getting them solved.

Hat tip Big Picture Blog for this chart.

Humans are more evolved than plankton or fish, or at least their brains are bigger.  When they go into an oxygen depleted zone they do figure out they can’t breathe, and they get back out.  They don’t go in again.  The absence of demand is not a static economic statistic.  It happens in an ecosystem.  Figure out the ecosystem.

Some time ago, there was no demand for Coke in China.  Did Coke simply shrug their shoulders and say, “Huh, no demand. Guess we’d better not supply that market.”??  A bank can create demand for credit cards for college students.  Why can’t it create demand for Small Business loans?  Because they are not as profitable.

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