Talk to Me Like I’m a 4-Year-Old: Why Aren’t Banks Putting Those Reserves to Work?
Carlos Lara and I just spent 5 hours in the car driving to an undisclosed location in Indiana to meet with some life insurance people for our forthcoming book. Not surprisingly, we talked about the $1.1 trillion in excess reserves, and what it would take for them to start trickling (gushing?) out.
I explained that I have always found this typical explanation incomplete: “The banks can’t lend right now because they fear another wave of defaults and so they have to be ready for their balance sheets to take another huge hit.”
I don’t think that can be the whole story. I don’t doubt that this is basically correct, but I’m an economist so I need it to be right in theory before I can accept it even if I’m sure it’s right in practice.
Specifically, here’s my problem: Suppose the banks didn’t fear any future defaults. Then they’d start making new loans and earning a lot more than Bernanke’s piddling interest payments. So their balance sheets would get better more quickly than if they kept their reserves parked at the Fed.
OK, so if the way to increase your shareholders’ equity (i.e. gap between assets and liabilities) in normal times is to lend out excess reserves, that fact isn’t changed per se by the possibility that a bunch of your assets are bad. In fact it should make you even more eager to seek the most profitable use of your reserves.
Like I said, I know there is something wrong with my argument; I believe the people who are saying the banks aren’t making new loans because they’re worried that a bunch of their current loans will stop performing. But I just want to hear the explanation spelled out a little more.
For example, is it really like this: The banks are like households, and they have standard operating expenses. Right now they have cash coming in the door every month from people paying down their credit cards, mortgages, car loans, etc. But if those people get laid off and stop making payments, now the banks can’t pay their leases, utility bills, employees, etc. So if they have a stockpile of reserves, they can start drawing them down. But, if they had foolishly invested all of their excess reserves even in super great projects yielding 80% over 5 years, they would have to shut down if those projects were illiquid and they couldn’t meet their basic expenses.
Is the above paragraph in the right spirit?
Last point: If indeed it’s true that the banks are keeping their reserves on hand, in case they need to draw them down to cover their operating expenses, then…
Doesn’t that mean prolonged unemployment will lead to those reserves getting back into the hands of the public??
