Should We Force Bailed Banks to Lend?

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It was only months, maybe weeks ago that banks were being scolded for their loose lending practices -- rightfully ridiculed for loaning money to anyone with a heartbeat, a smile, and an itch to get rich.

Oh, how the tables have turned.

Some banks are now drawing fire for not lending enough. Specifically, some are crying foul that banks that received direct injections from the Treasury aren't ramping up lending, and have instead opted to sit on the cash and wait or use it to acquire other banks.

"What we're trying to do is get banks to do what they are supposed to do, which is support the system that we have in America. And banks exist to lend money," said White House Press Secretary Dana Perino.

Treasury undersecretary for domestic finance Anthony Ryan added, "As these banks and institutions are reinforced and supported with taxpayer funds, they must meet their responsibility to lend and support the American people and the U.S. economy."

Responsibility to lend? Really?
Come on: Banks don't exist to lend money; they're in the business of lending money -- meaning it should be done responsibly, and only when profitable. And banks don't have a responsibility to lend; they have a responsibility to do what's best for their shareholders. (In this case, taxpayers, too.)

The money injected into these banks is dirt, dirt cheap: an initial 5% dividend and warrants worth 15% of the principal. That's a fraction of what Warren Buffett got from Goldman Sachs (NYSE: GS) and General Electric (NYSE: GE). With cheap money like that, any reasonable bank would be lending every penny as quickly as possible … provided it was the best use of the funds and the borrower was an attractive candidate. Right now, that category is a dying breed.

These guys aren't brain-dead
Can you blame banks for not wanting to lend money right now? The reason they aren't lending isn't because they want to swim through taxpayers' money like Scrooge McDuck … it's that they know darn well the economy is in phase one of a brutal economic downturn.

Back in July -- when things were "stable" -- Citigroup (NYSE: C) Chairman Win Bischoff warned that real estate could fall for another two years. And how about unemployment? It's now a touch above 6%. During the 1980-1982 recession, it shot past 10%. During the Great Depression, it surged to 25%. Banks have written off about $600 billion in bad debt in the past year. Nouriel Roubini expects that number could reach $3 trillion. And we wonder why banks aren't eager to flood the economy with loans?

Look, the last time the government forced an institution to lend resulted in the beauties known as Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE). And their final outcome probably wasn't coincidental.

Besides, who says banks aren't lending enough? Despite the exhilarating headlines, one piece of credible analysis from the Minneapolis Federal Reserve shows that lending to non-financial entities remains healthy.

Can't do anything right
Another group is peeved that some banks are using the cash to scoop up weaker competitors. As the New York Times put it, "the dirty little secret of the banking industry is that it has no intention of using the money to make new loans."

Sure enough, PNC Financial bought National City financed with a $7.7 billion injection from the Treasury. An unnamed JPMorgan Chase (NYSE: JPM) executive recently commented that the $25 billion his bank received "will help us … be a little bit more active on the acquisition side or opportunistic side for some banks who are still struggling." The nerve!

The alternative, of course, would be to let weaker banks fail, reliving the joys that Bear Stearns, Lehman Brothers, and WaMu brought us. If bigger banks like JPMorgan or Wells Fargo (NYSE: WFC) are willing to buy beleaguered competitors with their cheap funds, are we really going to complain about it? Perhaps if banks had the funds a few months ago, someone would have stepped up and bought Lehman Brothers, bypassing this whole thing to begin with.

Reality hurts
I guess the bottom line is that the $700 billion bailout was never designed to get banks lending at the foolhardy rates they had been in recent years -- it was designed to prevent banks from collapsing after being besieged by fear. If the painful medicine we need requires banks to scale back lending, good riddance.

For related Foolishness:

• We Still Have a Long Way to Go
• The Bailout: Myths, Half-Truths, and Inconsistencies
• How We Can Fix a Problem We Did Not Create