I'm listening to all these government plans and proposals, and while most seem understandable to me and I can see ways to mitigate the 'moral hazard' aspect - I find myself very confused by the interbank loan guarantees proposal.
Perhaps the fine print will clear this up, but I find myself confused and don't know who else to ask. Economic brainiacs of the Kossacks, can you explain this?
To clarify, I'm talking about the following:
"In addition to injecting money into the banks, according to the plan, the United States would also guarantee new debt issued by banks for three years — a measure meant to encourage the banks to resume lending to one another and to customers."
So I'm left wondering the following:
- The govt is guaranteeing these loans with no upside, what happens if/when they default? Since we're guaranteeing, shouldn't we be making the loans ourselves or getting a stake in the upside? Isn't this essentially an interest free loan from the government? (meaning, since the loan is backstopped by the government, it's essentially the same as the government making the loan to the borrower itself, with profit going to the lender)
- Doesn't this incentivize both sides to take large over-sized risks? The lender can afford to make riskier loans since the loan is backstopped by the government and the borrower will now feel emboldened to double down when they are in trouble. Rather than going bankrupt as is needed to unravel their debts they will take one last ditch loan to try to get back in the game and since standards will likely go down for the lender, they can get the money for the high risk maneuvers.
I understand that the goal of this program is to get more credit flowing, it just seems to create some very unintended incentives.
Please let me know if you can figure this out. I know this isn't a Democratic issues, but not sure who else could explain this to me.
Updated for clarity