As the Fed embarks on quantitative easing we have entered a Brave New World of economic policy and investing. The purchase of Treasury securities is a needed step in repairing the economy, but just because the supply of loans may increase does not mean the demand for loans will follow. Now that the Fed is printing the green stuff, there needs to be demand from businesses and consumers for credit.
According the Federal Reserve’s Senior Loan Officer Survey the demand for credit has decreased across all segments. Roughly 60% of senior loan officers reported demand for C&I (commercial and industrial) loans declined; 54% reported demand for commercial real estate loans declined; demand for residential real estate loans declined between 9% and 64% (depending on credit rating); and demand for consumer loans declined by 47%. The message is clear, even though the money may be available, businesses and consumers either do not want to accumulate more debt or see no opportunities to deploy that capital.
Increasing the demand for credit will come from two sources: Inflation and fiscal stimulus. If the Fed is successful at inducing inflation then businesses will recognize the profit opportunities that arise as prices increase. Once suitable profit opportunities exist, businesses will demand credit. These suitable investment opportunities depend largely on the consumer.
Through fiscal stimulus the government can restore the ability of the American consumer to do what they do best…consume. However, the traditional methods of fiscal stimulus have not worked and are not likely to work. Household balance sheets have been destroyed and falling home prices have made the consumer feel less wealthy. Simply putting money in their pocket will not work since the propensity to save has increased. Consumers are saving more because they are fearful of losing their job or income.
This is where the government can use unconventional methods of fiscal stimulus. In particular, the government needs to become the employer of last resort, much like the Fed is the lender of last resort. By providing jobs the government can induce consumer spending and as a corollary consumer credit demand. However, unlike the New Deal, the jobs the government must provide need to be more skilled. The job losses in this recession have hit the financial services sector particularly hard. It is unlikely that these unemployed have the skills to work on specialized infrastructure projects. However, the government currently controls several large financial institutions that could be used as an employer of last resort.
By virtue of the fact that many financial institutions have been declared too big and too important to fail they have become de facto utilities. These institutions are deemed so essential to the public good that they require government support. The US government could become the employer of last resort by using Citibank, AIG, Fannie Mae and Freddie Mac to rebuild the financial infrastructure, much like the New Deal rebuilt the industrial infrastructure.
Of course, this would be a radical, unconventional step and requires the political will to rebuild a broken financial infrastructure. However, the benefit is that the organizations would no longer be opaque and the Federal Reserve could use them to restore the securitization markets while also monitoring and regulating risk. Once the financial infrastructure is repaired and the government has become the employer of last resort, consumer confidence will return and bring with it profitable business opportunities.