What does it all mean?

Doug is a great guy and smart as hell – I’ve actually met him. (Loves the Veal Parm at the Palm.)

At any rate he’s gone and done his 20 for 2010. Good reading if you’ve got a couple of minutes.

Kass: 20 Surprises for 2010

Notice #8…

And notice what I wrote back in May 2009:

More Confirmation

Guess we’ll see how it all plays out in 365.

Banks, Predictions Banks, GS, PE

The banks have largely started to decry additional regulation or restrictions.  They’ve threatened (and I use that word quite intentionally) that if there are additional strictures, they will be forced to reduce lending.

Let me make a few things clear:

1. The banks lend because that’s how they make money.  They borrow cheaply from the Fed or depositors and lend at higher rates.  Hopefully without too much of a duration mismatch (pdf link), but that has actually been at least one source of their problems.  Otherwise, they’re just speculators (a post for another day).
2. When the Fed drops the overnight rate to 0-0.25% and institutes a policy of paying interest on excess reserves, it has impaired the fundamental reason for banks to lend: profit.  Since banks can now earn a risk-free return with absolute liquidity while not lending, they have a reduced need to do so.  They also have no need to pay interest on deposits since they have more liquidity than they know what to do with.
3. Banks can’t force people or businesses to borrow.  Right now, there are basically ZERO marginal borrowers because the whole world is over-leveraged.

If the Fed wanted banks to lend, they would reduce some of the liquidity programs and stop incentivizing the banks to sit on what liquidity remains.  To the extent that additional regulation would require leverage limits at the banks, it’s true that some lending would be reduced.  Massively increased leverage levels was what allowed the banks to lend with such reckless abandon.  So, yes, if we return to a world with Glass-Steagal and leverage limits for ALL banks, lending could be reduced.  However, this is not a bad thing (despite legislators’ protestations to the contrary).

We need to deleverage as a society because excessive debt has clogged our economic engine.  You can’t fix it by borrowing more money.  Hopefully the US Government will figure that out as well.

EDIT – Barry Ritholtz, after REALLY stinking up the joint on GS bonuses, posts reports largely the same analysis I just walked you through as done by John Mauldin.

Banks Banks, Fed