Add this to the growing list of theories to explain why banks aren’t lending.
So far the explanation we have are
- Lack of quality demand.
- Bank reluctance due to their own toxic assets.
- Bank expectations of a future firesale and the desire to hold dry powder to snap up assets.
John Hempton, who has been one of the fiercest critics of Sheila Bair’s seizure of Washington Mutual and its forced sale to JPMorgan (JPM), finds a way to connect the lack of bank lending with this event:
Now some people are into forcing the banks to lend. Willem Buiter (who is often clever and sometimes wrong) suggests confiscating banks that will not lend. Useless as tits on a bull he says.
That would be fine if he did not want to confiscate marginally insolvent banks too. A bank that is stretched for capital or liquidity would usually preserve both by restricting lending. You restrict lending so as not to be confiscated – except in Willem Buiter’s world where you lend to avoid being confiscated.
Now I thought that the confiscation of Washington Mutual was perhaps the single most destructive government action of this cycle. That was a minority view – and remains one. Felix Salmon thinks I am alone – but a paper from the New York Fed makes it clear that the confiscation of WaMu very rapidly increased the liquidity preference of mainstream banks and hence spread the crisis from the Wall Street Banks to Main Street.
The lesson of Washington Mutual – learned hard – was that you could have adequate capital but a minor run and be confiscated. The only way to cope was to have massive excess liquidity.
The paper is embedded here.
Inter Bank Market