Business Insider

Peter Crabb: Fed doesn't need to keep coaxing banks into lending

What more can you do? Like trying to motivate your kids to do their chores, the U.S. Federal Reserve continues to try and “motivate” the banks.

Current monetary policy is such that these kids, commercial banks, have done little to increase lending, particularly to businesses for new equipment and expansion. This fact says as much about how weak the economy has become as it does about how little incentive there is for banks to take risks.

Glenn Rudebusch, economist for the Federal Reserve Bank of San Francisco, says, "the funds rate should be near its zero lower bound not just for the next six or nine months, but for several years.” He goes on to say in a report posted this week on the bank’s Web site: “In order to deliver a degree of future monetary stimulus that is consistent with its past behavior, the FOMC would have to reduce the funds rate to –5 percent by the end of this year — well below its lower bound of zero."

Thus, monetary policy can do little more. Perhaps the Fed has done enough, as new signs of economic improvement arise.

Last week the Conference Board reported that its consumer-confidence index rose to 54.9 in May from April's 40.8, primarily because consumers reported their outlook for economic conditions over the next six months improved. This rosier view of the future economy offset continued concerns about job losses today.

A review of past reports from the Conference Board shows large gains in confidence near to or right at the end of a recession. Overall, confidence is still low, but consumers say they are not as depressed as last fall and earlier this year.

If the economy is truly making a turn for the better, the multiyear monetary policy suggested by the Fed’s economist will cause nothing but trouble. The bank market currently predicts just such trouble.

Inflation expectations have risen dramatically. The yield spread, the difference between two-year and 10-year U.S. Treasury debt, has widened from near 1 percent at the end of 2008 to over 2.7 percent today. Since just the beginning of May, gold is up over 5 percent. Oil prices are more than 15 percent higher.

If monetary policy is ineffective, policy makers could devise new incentives for the banks, such as some new “troubled asset” program, or just wait it out. Reports this past week suggest banks must have plenty of incentives – new capital and profitable business.

Bank of America Corp. reported it has an additional $5.9 billion in equity with the conversion of some privately held preferred shares into common stock. The bank is close to raising all the mandated $33.9 billion in new capital following the stress test. Investors clearly expect good returns at Bank of America in the years to come.

Meanwhile at investment and consumer banking giant J.P. Morgan Chase & Co., Chairman and Chief Executive Jamie Dimon announced that the strong profit results reported in the first quarter would not be repeated, but a solid revenue trend has been restored. Mr. Dimon expects net revenue of $80 billion for both this year and next.

Financial markets suggest inflation is headed our way, consumers are less gloomy, and banks are back to making money. Our kids don’t need any further coaxing.

Since 2000, Peter R. Crabb has been a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.