Fed Admits that Tight Lending and Unemployment May Slow Recovery

I have repeatedly said that the banks won’t significantly increase their lending to individuals and small businesses until the economy stabilizes, no matter how much money the government gives them.

I have repeatedly said that the whole concept of a “jobless recovery” given the economic fundamentals we have currently is nonsense, and that the rising tide of unemployment will keep the economy on the ropes for some time.

Now, as Bloomberg points out, the Fed may finally be grudgingly admitting as much:

The Federal Open Market Committee, at the conclusion tomorrow of a two-day meeting, will probably maintain its assessment that “tight” bank credit is impeding growth, said economists including former Fed Governor Lyle Gramley. Lending contracted for five straight weeks through Sept. 9, a drop that in part reflects Fed orders to banks to raise more capital and toughen lending standards, analysts say.

A failure to restore the flow of bank credit carries the risk that the economic recovery will be slower than the Fed anticipates, or even that the U.S. lapses into another recession, economists say…

“The financial system is still far from healthy and tight credit is likely to put a damper on growth for some time to come” [San Francisco Fed President Janet Yellen said in a Sept. 14 speech].

The Fed has taken other steps to make sure banks avoid riskier loans. In July 2008, it tightened mortgage rules by requiring lenders to determine a borrower’s ability to repay and barring other practices that led to the collapse of the housing market.

Minimum regulatory-capital requirements may change as officials in the U.S. and abroad craft new financial rules. Consumers are less credit-worthy as the job market deteriorates and after a record loss of wealth from plunging share prices and real estate values.

Rising unemployment will slow the pace of the recovery, Bernanke said on Sept. 15.

Whether the Fed’s policy of requiring more capital is good or bad is beyond the scope of this essay.

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