Saturday, April 4, 2009

Why Is Bank Lending So Critical?

Martin Feldstein writes here in the WSJ that
Increased bank lending is the key to a sustained recovery. Households and businesses that cannot obtain credit are now unable to spend and to invest, dragging down total demand and GDP. The banks are unwilling to lend because they lack confidence in the value of the loans and other assets they already carry on their books, and therefore lack confidence in whether they have enough capital to avoid insolvency. Removing these high-risk assets is a prerequisite to get the lending mechanism in gear again.
Why all this emphasis on bank credit? That's not what I learned in graduate school. That's not what I teach in financial management.

Most people don't know that corporate America finances the majority of its investments in plant and equipment with retained earnings, not borrowed money. Since when does a business need to borrow to be successful?

Why is it that businesses can't increase equity financing to displace debt financing? Even the auspicious likes of a Martin Feldstein, whom we should all respect, needs to answer that question instead of insisting that our economy depends on credit.

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