Last week President Obama gathered key bankers at the White House to implore them to lend more. Past blogs have examined the structural changes in the economy which have affected unemployment. See Are There Too Many People? One of the cornerstones of lending is integrity of the collateral backing any loan. Our new economy has done much to undermine the worth of any collateral.
The Old Industrial Economy
In Can You Lend for Thirty Years?, I described the industrial economy led by General Motors, US Steel, Goodyear and DuPont. Industrial formation was characterized by large plants, large numbers of workers and sophisticated machinery. These companies generated large amounts of cash and had substantial financial reserves. There was a “wall of equity” and substantial assets for a banker to lend against.
The Modern Economy
The old industrial economy has been withering away. Witness bankruptcies of many of our industrial icons: GM, Chrysler, Bethlehem Steel, Delphi and a host of other companies. We have shifted to a service based economy. Gone are the “hard assets” that bankers loved. Collateral to support a loan to Accenture or Home Depot is entirely different:
- Software
- Patents
- Knowledge Workers
- Distribution Networks
- Commercial real estate
- Leases
- Good Will
Bankers desire easily marketable collateral with determinable market value. A patent usually lacks an easily determinable value (reference the enormous growth in patent litigation) and is not easily saleable. Couple this with workers who can take their knowledge with them to the next employer and a declining real estate and lease market and you can understand the bankers’ reluctance to lend.
Focusing on Old Solutions
Faux Powerlessness Part Deux highlighted the White House banker summit and President Obama’s pleas to the bankers to lend. But why would they do this? Recessions lead to declining asset values. There are even more disincentives to loans to small businesses. Small businesses have the added problem of declining residential real estate which is often used as collateral.
The Federal Reserve has worsened the lending environment by encouraging banks to use virtually free money to speculate and “play the yield curve.” Thus, it is not surprising that bankers have abandoned traditional lending to businesses.
New Ideas
What the White House has not focused on is the change in the nature of businesses and the new kinds of collateral necessary to support loans. The more “ethereal” nature of collateral in a service based business economy retards traditional lending. Perhaps the White House should be encouraging equity stakes rather than debt solutions. But, creative thinking outside the box has not been a hallmark of the first year of the Obama Administration and its economic advisers.
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Related posts:
- Faux Powerlessness
- Faux Powerlessness Part Deux
- Are We a Socialist Country?
- Trust Once Lost
- Perverse Incentives
Tags: collateral, GM, patents, software
