Belmont Club

From bailout to stimulus

The NYT says Paulson is shifting the focus of the bailout.

Mr. Paulson said the $700 billion would not be used to buy up troubled mortgage-related securities, as the rescue effort was originally conceived, but would instead be used in a broader campaign to bolster the financial markets and, in turn, make loans more accessible for creditworthy borrowers seeking car loans, student loans and other kinds of borrowing.

“During times like these with a slowing economy and some deterioration in credit conditions, even the healthiest banks tend to become more risk-averse and restrain lending, and regulators’ actions have reinforced this lending restraint in the past,” Mr. Paulson said at a news conference.

The WSJ has the full text of Paulson’s exhortation.

This change of emphasis looks a lot better than rescuing bankrupts. But it still raises the question of whether the moral hazard problem has been solved. The Treasury has boilerplate plate encouragement to lend responsibly. But since when have exhortations to responsibility reliably worked? And besides, the whole point of the Paulson’s actions is to lend, lend and lend.

It is essential that banking organizations provide credit in a manner consistent with prudent lending practices and continue to ensure that they consider new lending opportunities on the basis of realistic asset valuations and a balanced assessment of borrowers’ repayment capacities. However, if underwriting standards tighten excessively or banking organizations retreat from making sound credit decisions, the current market conditions may be exacerbated, leading to slower growth and potential damage to the economy as well as the long-term interests and profitability of individual banking organizations. Banking organizations should strive to maintain healthy credit relationships with businesses, consumers, and other creditworthy borrowers to enhance their own financial well-being as well as to promote a sound economy. The agencies have directed supervisory staffs to be mindful of the procyclical effects of an excessive tightening of credit availability and to encourage banking organizations to practice economically viable and appropriate lending activities.

Open thread. Are we digging ourselves out a trap or straight through to China?