Bank lending is not "reserve constrained". Banks lend to any credit worthy customer they can find and then worry about their reserve positions afterwards. If they are short of reserves then they borrow from each other in the interbank market orn from the central bank through the so-called discount window. They are reluctant to use the latter facility because it costs more.
The point is that building bank reserves will not increase the bank's capacity to lend. Loans create deposits which generate reserves. The reason that the commercial banks are currently not lending much is because they are not convinced there are credit worthy customers on their doorstep. In the current climate the assessment of what is credit worthy has become very strict compared to the lax days as the top of the boom approached.
Those who emphasized the importance of the money supply (on nominal spending) saw the expansion as quantitative easing, and warned about eventual inflationary consequences. Those who emphasized the credit channel (as Bernanke) saw the expansion as providing credit that was temporarily unavailable in the private market. The fact that the balance sheet expanded on both sides, and in both cases with the private sector as counterparty, tells us that something else was going on.
The Fed & Treasury haven't deployed our fiscal resources to support aggregate demand, the policies have not been successful. They are simply an attempt to restore a highly destructive status quo ante.
You improve aggregate demand and incomes will rise and with that so will CREDITWORTHINESS, as well as the ability to service existing loans. This in turn enhances the banks' balance sheets and facilitates greater provision of credit. It's so easy, even a banker can figure it out.
If left alone to deal with the current problems, market mechanisms will push management and owners of insolvent institutions to ramp up losses. The result can be massive deflation, massive bankruptcies, massive destructions of physical assets, and enormous unemployment will continue until the debt structure is simplified. In the process, social unrest will grow to the point that the entire socio-economic system will be threatened.
Two real ways out of this mess are Government Jobs programs and debt forgiveness. Nothing else will work.
If borrowers can meet their payments, lenders will receive their funds and will return to profitability; in turn, some of the securitization processes will be revived. Of course, many banks are no longer used to making most of their money from interest payments, but it may be time to return toward a less trade-and-fee driven financial sector. Hold to maturity is a good starting point.
Marshall Auerback
