TJP

Use Federally Sponsored Agencies to Restore the Flow of Credit

Byron A. Ellis – February 11, 2009

Geithner warned, “Unless we restore credit, the recession will be even longer and deeper.” His warning assumes that the recession and lack of aggregate demand are credit problems. However, lack of demand is a result of insufficient income, hence recessions are income problems.

Whether credit is flowing or not, unemployed Americans will not benefit from financial institutions overflowing with cash; from the point of view of banks, the unemployed are not creditworthy borrowers.

So, why is the Obama administration continuing the Paulson-Bernanke-Geithner model of giving taxpayers’ money to mismanaged banks? It didn’t make any sense under Paulson and it does not make any sense now, let the banks fail. Taxpayers cannot continue to bailout inept businesses, it is counter to economic efficiency.

Moreover, after receiving taxpayers’ funds, financial institutions have no incentive to create credit. In fact, the incentive is not to create credit, since the government bailout option would be available.

However, if the government signals that the outcome of financial mismanagement is government receivership; it is, more likely than not, that poorly performing financial institution would reorganize or be gobbled up by better managed institutions. The government should not force unwilling taxpayers to reward inefficiency.

The government could restore credit by creating Federally sponsored credit agencies. Federally sponsored credit agencies are financial intermediaries that the Federal Government has used, in the past, to supply credit for certain economic purposes, such as housing and agriculture. The agencies sell obligations in the financial markets and direct the proceeds to their core mission.

In 1917, the government established 12 Federal Land Banks, which made long-term loans to farmers with maturities ranging form 5 to 40 years. Thus, the government could establish a Housing Foreclosure Bank that addresses foreclosure problems; an Alternative Energy Bank that addresses funding for green jobs; a Small Business Bank and so on.

Thus, taxpayers’ money would not flow through existing inefficient financial institutions, which are modern day black boxes used to remunerate poorly performing managers.

Approximately 60 percent of gross domestic product is consumption and consumption depends on after tax income (disposable income). Thus, if consumption is down, disposable income must be insufficient to stimulate consumption. Low consumption causes inventory accumulation, production curtailment and layoffs. Inventory accumulation, production curtailment and layoffs adversely affect business investment and government tax revenues. As a result, income, as well as, aggregate demand diminishes.

More taxpayers’ money in banks will not increase income or demand for goods or services. Only taxpayers’ money used to create jobs increases income, and hence consumption, investment, and aggregate demand.

The government should use Federally sponsored agencies to restore the flow of credit, rather than mismanaged banks.

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