Obama's Influence on Bank Lending Is in Doubt

Dec. 15, 2009 — -- President Obama urged bankers Monday to do more in "every responsible way" to increase lending to consumers and small businesses.

But how much pressure is Obama actually exerting on banks, and what effect will it have?

Experts who spoke to ABCNews.com on the issue were skeptical, leaning on the side of not much.

The country's major banks have already repaid or are on track to repay billions in bailout funds from the government's Troubled Asset Relief Program -- a move that will free them from government compensation restrictions. But economists say that Obama and elected officials still, theoretically, have tremendous influence over the banks because of the banking reform efforts sweeping the nation's capitol.

"Fundamentally, they're in the midst of rewriting banking regulations that are going to affect how these guys operate for the next two decades or more," said Harvard economics professor and former Federal Reserve economist Kenneth Rogoff. "Certainly the president has a lot of sway over them."

Obama, he said, "has to say he's mad, because if he's not mad, he doesn't have any emotions. … But exactly what he's prepared to do is much less clear."

And harnessing his influence to promote specific goals will be difficult, Rogoff said.

"It's not clear how easily [Obama] can laser in mortgage foreclosures or increase lending to small business," he said.

Part of the problem, economists say, is that the administration and government regulators have been sending banks mixed messages.

The Federal Reserve and the FDIC, for instance, are worried about banks' capital positions and how strong their balance sheets are, said Vincent Reinhart, a former director of the Federal Reserve Board's Division of Monetary Affairs and a resident scholar at the conservative American Enterprise Institute. Emphasizing the health of a balance sheet during tough economic times can discourage more lending, he said.

"Making more loans right away at a time when the economy is weak isn't the formula for strengthening your balance sheet," Reinhart said.

"There's just an internal inconsistency in expecting banks to take on risk and also expect them to rebuild their capital," he said.

Lack of Credit or Lack of Credit Demand?

Former Treasury Secretary Paul O'Neill said that there is, of course, political benefit to Obama having apparently "talked tough" Monday. But O'Neill said that, at the same time, the government is promoting the kind of policy that has had disastrous effects in the past.

"On the political level, scolding the bankers is a no-downside way of being aligned with the regular people," he said in an e-mail to ABCNews.com. "In the meantime, the government is promoting new mortgages through the FHA at 97 percent of the face value of the property; the kind of policy that nearly capsized the world economy."

O'Neill said it was his hope "that bankers will make loans only in those cases where they believe there is a high probability the loan will be paid back with the agreed interest."

"If, in the alternative, they make loans to people and businesses not likely to repay them we will have, in effect, created a banking system run by the government … not a desirable outcome," he said.

Obama also can't set numeric goals for banks -- for instance, saying they should increase lending by a certain percentage year over year -- because it's difficult to determine what such goals should be, said Mark A. Calabria, the director of Financial Regulation Studies at the libertarian Cato Institute.

Calabria argues it's unclear what's had a greater impact on the decline of lending to small business -- banks tightening credit or businesses themselves pulling back on their borrowing. Uncertainty over taxes, environmental regulations and health care costs in Washington, D.C., he said, are keeping businesses on the sidelines with respect to hiring and investing.

"There's a degree to which businessmen are looking for things to shake out," he said. "At least when they know the rules of the game, they can plan accordingly."

What Obama Could Do

If the president really wanted to exert pressure on the banks, said Barry Ritholtz, the author of this year's "Bailout Nation," he would fight for the reinstatement of the Glass-Steagal act -- the law that once barred deposit-holding banks from behaving as investment banks -- and the mark-to-market accounting rule, which forces banks to immediately write down poorly-performing assets on their books.

Obama could also cap the size of U.S. banks, he said, requiring that no one bank contain any more than a certain percentage of the country's deposits.

Taxing Bonuses?

But Ritholtz doesn't see that happening.

"We could get really tough with them if we find the political will," he said. "Right now, everyone seems much more interested in populist ranting and demagoguery as opposed to doing something substantial."

Peter Morici, a business professor at the University of Maryland School and the former chief economist at the U.S. International Trade Commission, believes the U.S. should look abroad for inspiration on how to bring the banks in line, particularly when it comes to executive compensation. In the United Kingdom, he noted, a tax is being levied on bank bonuses.

Here in the U.S., he said, government officials "should have told (bankers) not to pay the bonuses or face really stiff taxes."

But Morici said the president's previous approach to banks likely means that Obama won't be taking such a step.

"You're known by your deeds," he said, and the administration, he said, has already "let the banks walk away with $140 billion in bonuses that are built on $240 billion in profits."

Reinhart said that bankers, in their efforts to maintain good relations in Washington amid an overhaul of banking regulations, will try to show the White House that they are increasing lending.

But he said it's unclear whether banks will actually do anything different than what they actually planned on doing in the first place. The banks could easily make it appear as if they are responding to administration demands without changing their original plans.

"You roll in the loans you were going to make anyway; you say they were in response to the administration's initiative. Maybe you gussy up the loan programs you already have on your books," he said. "Maybe at the margin, you do make more loans to some areas, but that probably means you cut back loans elsewhere."

Employment Doubts

Though Obama's meeting with bankers dominated the White House's economic agenda in recent days, the White House' top economic adviser Lawrence Summers made news recently with a prediction that the U.S. economy will see a return to job growth this spring.

This, too, was met with skepticism by economists who spoke to ABCNews.com.

"I think it's a little on the early side, but I hope he's right," Harvard's Rogoff said. He said the prediction may be one of "smoke and mirrors" because it's unclear whether the new jobs will be temporary ones created by government initiatives or if the job growth will be more organic.

Rogoff said he didn't expect to see job growth until the second half of 2010, but added that, even still, the job market would "remain difficult throughout next year."

Rogoff bases his prediction on his research, with the University of Maryland's Carmen Reinhart, of past financial crises around the world.

Following a financial crisis, he said, "unemployment rises much more and for much longer than after typical recession."

"I expect it to get worse before it gets better," he said.

AEI's Reinhart said that Summers' prediction of spring job growth is "not unreasonable" but added a caveat: Even as the number of jobs grow, the unemployment rate won't go down quickly because the country's "discouraged workers" -- those who stopped looking for work and haven't been included in the government's unemployment stats lately -- will reenter the jobs market.

"As people on net begin to get hired, they'll come back to the labor market. The unemployment rate will stay high for a while," he said. "…That's bad news if you're running for Congress."