If Banks Can't Take Risks, Uncle Sam Must

My article a week ago in this space lacked a positive note about the 1991 banking legislation. Its provisions are designed to make bankers more cautious and risk-averse. And its impact on big U.S. banks, particularly those that have international operations but some capital weakness, could be devastating.

Today I will be at least a little upbeat.

Something must be done to save the economy from the consequences of congressional shortsightedness.

But, to begin with, Congress won't undo what it has done. The Fed can't do the whole job by lowering short-term interest rates. And Congress, faced with expanding deficits, can't lower taxes very much.

For growth to take place, private capital from nonbanking sources must replace the private capital that the new law will drive out of the risk-taking banking system.

But most private investors are highly risk-averse. They don't like to evaluate credit risk. (This is why they had invested in banks in the first place).

The only way to lure private investors is to reduce the risks to acceptable levels.

Something for Everyone

When Congress reconvenes and consumer confidence has failed to improve, lawmakers will look for ways to reduce the risks to private capital. They will find that only the federal government can do the job.

Congress will discover that the most logical course is for the federal government to guarantee either all or part of the credits that it just caused the banking system to cast out.

The idea may seem preposterous, substituting a direct risk for an indirect one. But let's just say we're going to provide a stimulus to parts of the economy that need it.

For starters, let's support new home building. This always leads us out of recession, and it allows more people to fulfill the American dream.

And as for small businesses, the risks of lending to them can be reduced by guaranteeing, say, 50% of their borrowings.

For exports, let's have a guarantee program that doesn't just benefit Boeing and a few other major players, but that guarantees some portion of smaller exporters' credit.

How about environmentally sound businesses? Why not?

Unconventional Solutions

This may sound crazy, but the world is a crazy place, and sometimes it takes one set of mistakes to cancel out others.

In an ideal world, there would be plenty of capital for everything. But timing, as they say, is everything. It will be a long time before Congress will do anything that benefits banks, but it doesn't have to be a long time before it endorses programs that trade federal contingent liabilities for economic growth.

Just be thankful that the U.S. government doesn't have a 50% risk weighting attached to those contingent liabilities.

Mr. Lowy, author of "High Rollers: Inside the Savings and Loan Debacle," is counsel to the law firm of Rosenman & Colin, New York. This is the second of two commentaries on the new banking law.

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