Federal Reserve Chairman Alan Greenspan testified recently before Congress that the credit crunch stubbornly remains with us. He's right.

And unless we take a good hard look at the real reasons behind the problem, I'm afraid it might be here to stay.

The damage to the economy and our social order could be enormous. Entrepreneurs and small businesses, so important to economic growth and upward mobility in our society, need access to credit at reasonable prices.

Periodic credit crunches are familiar in history. The economy gets overheated, the Fed tightens the supply of money, and the more marginal borrowers are squeezed out. The economy cools, the Fed loosens the money supply, and funds are once again available to those who were frozen out.

Structural Weakness

The problem today is that an easier monetary policy is not bringing about the desired result of increased bank lending. Something else, something structural, seems to be at work.

Fro the 1950s to the early 1980s, deposit interest rates were held artificially low. Savers subsidized borrowers.

When the federal government lost control of its budget, beginning in the 1990s, market interest rates began to rise dramatically, particularly in the late 1970s. Savers voted with their feet to end the subsidy. They left the banking system in droves, forcing the elimination of deposit interest rate ceilings in the early 1980s.

Borrowers Take Hit

Freed from the controls, banks were able to pay depositors enough to attract money. But the higher cost of deposits had to be passed along to borrowers.

As the relative cost of bank loans increased, more and more top-quality borrowers bypassed the banking system by obtaining funds in the securities markets. Banks replaced these customers with higher-risk credits, lowering the quality of their loan portfolios.

Coming on the heels of the S&L debacle, the serious problems in the banking industry resulted in a regulatory and legislative firestorm. Regulators changed the rules, marking troubled loans to liquidation values and demanding greatly increased reserves to cover the potential losses.

Capital Rules Enacted

Hundred of banks were closed, and officers and directors of failed institutions were subjected to severe sanctions and personal liability. Capital requirements were raised substantially, and risk-based capital rules were implemented that raised the ante event further for business loans.

Congress piled it on an already reeling industry. Deposit insurance premiums were raised sky high. Massively expensive and burdensome new regulatory requirements were imposed, and the penalties for unsuccessful risk taking were increased.

Say what you may about them, bankers tend to be very rational economic beings. Tell them you are raising the cost of risk taking, and their appetite for taking risk will diminish. They will stop taking risks and will charge more for the risks they do take.

Loans Pose the Most Risk

I have no doubt this is in large part what has happened to business lending. The simple fact is that most of the risk in the banking business stems from making loans.

If we do not change course soon and ease the penalties and burdens we have placed on the banking industry, I believe the credit crunch will be with us for some time to come.

The marketplace might eventually develop a substitute for bank lending to entrepreneurs and small businesses, but not before considerable damage is done to our nation.

The roof of the problem is political. Having imposed on the taxpayers to the tune of some $200 billion to bail out the S&L mess, the politicians are in no mood to risk ponying up more money to bail out the Bank Insurance Fund.

Unless we address the issue of the scope and nature of the deposit insurance guarantee, we are not likely to see any significant regulatory relief for companies in the banking business. That will mean banks will continue to focus their efforts outside the lending business.

Mr. Isaac, a former chairman of the Federal Deposit Insurance Corp., is managing director of the Secura Group, a consulting firm in Washington.

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