We’re getting questions about whether banks that receive taxpayer funds from the Treasury are “hoarding” that cash, rather than using it to support lending.

We know that banks aren’t hoarding yet, since at most they’ve had cash for two days.

Remember that there is a two-fold purpose to this program: (1) strengthen the banking system (prevent a collapse), and (2) increase lending.

We think that profit-maximizing banks have an incentive to lend.

In some cases, when a bank does not use new capital to support additional lending, they are still accomplishing our policy goal of a strengthened financial system.

So while we can’t tell you that the anecdotal reports of other plans for the cash are provably wrong, we think these reports are largely distractions from what banks will actually do with your tax dollars.

And we believe the “solutions” that are being suggested to “ensure” that every taxpayer dollar goes directly to support more lending would be counterproductive. We want banks to use the taxpayer investments both to strengthen the banking system and to increase lending. Since this is a voluntary program for banks, we cannot mandate the specific use of each taxpayer dollar, and if we try, banks won’t participate.

Banks are undercapitalized. They need more capital so that:

• they can increase their capital cushion, and thereby lower their probability of being insolvent;
• other banks and other financial institutions have the confidence needed to loan them short-term funds; and
• they can support more lending.

There are three goals here, not one. If a bank takes an equity investment and if that investment helps with any of the above goals, that’s a good thing. The most effective way to increase lending is to move toward a banking system that has more capital, more liquidity, fewer projected failures, and is more efficient than today’s system.

If, for instance, a bank has a capital hole because it lost a lot of money on bad investments in mortgage-backed securities, and if it’s at risk of being insolvent, then more capital will reduce that risk and make it more likely that that bank will continue operating and (eventually) lend more. Even if that bank doesn’t use this specific investment from Treasury to support more lending, but instead to strengthen its own capital cushion, if that taxpayer investment keeps that bank from going out of business, that’s a good thing, and lending will increase over time.

Similarly, if a bank takes […]