The U.S. should create new banks that will lend not hoard money.Since the financial crisis began, the U.S. has put $23.7 trillion in cash and guarantees to rescue failed institutions and create or save jobs. While the White House argues that this has saved or created 3.3 million jobs, the simple fact remains that 8.4 million have vanished since the recession began in December 2007.

And with the economy growing at a 1.6% clip in the second quarter, it is far short of the 2.5% rate that Nobel Prize-winning economist Paul Krugman says is needed to keep the unemployment rate from rising above its already high 9.5%.

Banks Are Hoarding Not Lending

The reason all this government spending isn't boosting the economy is simple: It's going into the coffers of banks that hoard it instead of lending it. To get the economy moving again, the government either needs to lend it directly to consumers and businesses or to create new banks -- unencumbered by the bad loans that are causing the old banks to hoard capital.

How so? The theory behind pumping money into the economy in a deep recession is simple: Get the cash into consumers' hands and they'll spend it. The resulting boost in demand will increase the sales of companies that produce products to meet it. The companies will have to hire more people, and the newly employed workers will spend their paychecks. This will further spike demand, and the spark of government stimulus will set off a firestorm of economic growth.

What Could Possibly Go Wrong?

Why isn't this working? A key part of the plumbing is clogged up. The banks that got us into this mess in the first place are extremely risk-averse. They are taking the nearly free money the government is providing them and investing it in risk-free assets like Treasury bills.

According to the Federal Deposit Insurance Corporation (FDIC), in the first quarter of this year, all FDIC-insured institutions had a total of $9.2 trillion in deposits, up 2.7% from the first quarter of 2009. During that period, banks' holdings of securities -- 61% of which are U.S. government securities -- rose 14.7% to $2.5 trillion.

Yet loans made by these banks have dropped while the quality of the loans has worsened. The FDIC reports that between the first quarters of 2009 and 2010, total loans and leases fell 3% from $7.7 trillion to $7.5 trillion. Reserves to protect against those loans going bad skyrocketed 35% from $194 billion to $263 billion. Meanwhile, the value of the loans for which borrowers weren't making payments soared 40% from $292 billion to $409 billion -- representing 28% of banks' equity capital, up from 21% the year before.

Business Got Squeezed

Interestingly, the fall in total loans and leases masked a surprising result -- consumers were getting far more loans while businesses and construction firms got squeezed. How so?

The FDIC reported that during that same period, loans to individuals climbed 32% to $1.38 trillion while credit card loans rocketed up 78% to $718 billion. But it seems consumers aren't spending their money -- the savings rate rose to 6.4% in June 2010.

Meanwhile, commercial and industrial loans tumbled 17% to $1.19 trillion and construction loans dropped 26% to $418 billion. And this drop in loans to companies that would hire people is impeding a recovery in the job market.

How to Unclog The System: Create New Banks

There's no way to break through this clog in the financial system's plumbing. Instead we need to bypass it. One way to do that is for the government to make loans directly to consumers and businesses. In theory, the government could hire loan officers who operate in much the same way as they do in commercial banks. But my hunch is that would not fly politically.

So we could go with a suggestion I first made on DailyFinance's sister site, BloggingStocks, on Oct. 7, 2008 -- create new banks. These new banks would be unburdened by all the bad loans of the incumbent banks and thus would be in a better position to make loans due to their clean balance sheets. This idea wasn't greeted with a chorus of approval.

But in February 2009, Stanford economist Paul Romer seemed to buy into it soon after I spoke about it on KCRW radio. He helpfully ran some numbers and estimated that if the government capitalized these banks with $350 billion of then-available Troubled Asset Relief Program (TARP) money at a 9-to-1 ratio of loans to capital, it would create $3.5 trillion in lending capacity.

Infrastructure Bank

And on Sunday, Laura Tyson -- an economics professor at the University of California, Berkeley, and former chairperson of Bill Clinton's Council of Economic Advisers -- suggested creating a new infrastructure bank. Her idea would "invest in things like interstate high-speed rail that require coordination among states and attract private co-investors in projects like toll roads and airports that generate dedicated future revenue streams."

Since we've tried all the conventional ways, and they haven't worked well enough, creating new banks is an idea whose time has come for getting the economy moving.

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the solution to the banking problem is small local banks doing banking bussiness the banks now are to big harder to control and they can abuse customers with all kinds of fees and get away with it we need more small banks and let big banks go bust. onece people start pulling theyre money out they will ge it but it may be to late

August 30 2010 at 11:10 AM Report abuse rate up rate down Reply

starting new banks will certainly get the attention of the banks that do not want to lend. what a great idea.

August 30 2010 at 10:58 AM Report abuse -1 rate up rate down Reply

This guy is an idiot! That is not the answer to create more banks. My is fiat, it's not real. All they are doing is creating more debt. Personal debt also destroys an economy. They are just creating more debt that can never be repaid, don't they get it. The only way we will ever recover is when this country goes back to real money, GOLD and SLIVER!!! HELLO you freaking idiots!!!!!!!!!!!!!

August 30 2010 at 9:04 AM Report abuse rate up rate down Reply


August 30 2010 at 9:03 AM Report abuse -1 rate up rate down Reply

The problem is too big to fix. Record stimuli, FED's 0% interest have not stopped the downward spiral. Why? Banks have been lending to the wrong borrower for decades. Since 1980s loans to the businesses have contracted, and loans to the consumer has expanded. Business loans are used to create value. They contribute more to the real economy. The likelyhood that they will be paid back is higher. But consumer loans do not provide value. Consumers consume. They do not produce. Today, banks are 98% invested in consumer loans. The collateral for consumer loans depreciate in time. They do not create value. This is the cause of bank troubles today. 50 years ago banks would be invested in pristine US government bonds. If that was the case now, a housing market crash would not effect the banks much. Alas, it is too late. Now, about making the banks lend to the business again... It is hard for the FED to turn the boat around because banks see this as what it is: A deflationary crash! They do not want to lend. But the problem does not end there. Borrowers do not want to borrow! FED does not control the market: ******************** *************************** 1. FED makes credit available 2. Banks do not want to lend because they don't think they will get their money back. 3. Borrowers do not want to borrow because they don't think they can pay it back. So, what is the problem? Let them not lend, not borrow, no? NO. Because when we borrow, banks create money out of thin air and this money inflates the money supply. Without borrowing, deflation cannot be avoided:

August 30 2010 at 8:54 AM Report abuse +2 rate up rate down Reply

Where is Teddy Roosevelt now that we really need him. Laissez Faire capitalism if left to its own devices will eventually consolidate all capital into a single corporate entity. What is good for that one corporation is bad for the rest of us. Lowering taxes and deregulating business is the reciepe for economic bubbles followed by long periods of economic recession or even depression. It was not collective economic policies that doomed the Soviet Union; it was centralization. Unfettered free market winner takes all capitalism is as unsustainable as divying everything into equal proportions and passing it around. Humans thrive where there is diversity of economic acitvity. Unregulated capitalism uses monopoly to control markets, squealch competition, raise prices and narrow choices. New banks? Perhaps, but what about cutting some of the big banks down to useful size.

August 30 2010 at 8:51 AM Report abuse rate up rate down Reply

How 'bout cutting taxes ??

August 30 2010 at 8:19 AM Report abuse +4 rate up rate down Reply

For a man in the finance business, he knows very little about business. Most of the people who want to borrow money are not credit worthy, so why loan to them. People who have good credit can get money. Consumers are saving now, not spending, because they don't feel comfortable in this economy.

August 30 2010 at 8:17 AM Report abuse +1 rate up rate down Reply

No need for new banks, all of US out here on Main Street have found a different way. A local small community bank, my insurance company now has a savings/checking finance line of business, or credit union. Should have let them fail. The republicans are alway screaming let the economy fix itself. Only the strong survive. Stop pumping money into the broken system. Well how do you explain TARP and whatever happened to Laissez faire -- Look what de-regulation has done, to airlines, to telecommunications, and now to banks. what a mess.

August 30 2010 at 8:16 AM Report abuse +2 rate up rate down Reply

I don't think the banks are "hoarding cash". I think they are building "excess reserves" because they know that the other assets on their balance sheets, i.e. mortgages, commercial real estate, MBS are all being carried on the books at way above market price. So they have to compensate for the eventual write down of their assets by holding more cash. Otherwise the write down or mark-to-market of their assets will destroy their equity and they will be insolvent. Assets are variable and have been trending down since 2007, liabilities tend to be sticky. Try telling a bank depositor that he lost 15% of his money due to an asset write-down. Liabilities + Equity = Assets Always has been true and always will be.

August 30 2010 at 6:42 AM Report abuse rate up rate down Reply