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One question I get all the time from investors is why aren’t the lenders lending, especially if they got all that TARP bailout money? The answer is quite simple if you understand the complications of the issue. So let’s break it down.

First of all back in the good old days last year, financial institutions were required to maintain 10% liquidity compared to the bank’s assets in order to borrow from the feds to create new loans. Today the fed rate for banks to borrow money for the purpose of lending to consumers is around 0.00% (Zero). So if the lenders can lend at 5-10% and their cost of the money is nothing, they would be able to make a huge profit on the interest spread. It is a banker’s dream come true.

However, after TARP and the financial crisis that started last fall, the federal regulators increased the banks 10% reserves regulation to 12% so that the banks would be healthier incase of default. At the same time, everyone’s credit has been capped or closed all together. And the hardest hit segment was the small business sector. This includes a sole proprietor all the way up to a small company with less than 50 employees. Small business represents the largest source of jobs in the country.

With some many people being laid off and credit being shut off, we have been forced to live off of our cash reserves and now many of us are living off our cash as it is earned so our bank savings accounts, money market accounts and checking accounts have less cash in the banks. This has dropped the banks liquid reserves from the old requirement of 10% down to probably 7-8%.

So banks now need to increase deposits from us by 4-5% or sell off assets to increase their liquidity levels to the new higher 12% regulation. This has created a vicious circle were the banks can not lend to us, which forces us to use our cash now rather than leave it in the banks which further decreases the banks liquidity reserves to assets ratio.

To make matters worse, government is doing everything it can to stimulate the economy and prevent further market corrections. But until the market corrects itself, the banks will not be able to lend to us, and until they can, we have no choice but to live off our cash rather than deposit it in the banks for more than a few days at a time.

The market will correct itself despite the government, but the more the government does, the longer it will take. Many economists, and amateurs who have studied this situation, like myself agree that if the government would have just left the markets do its thing, we would have already seen the bottom of the market and the banks would just now be at a lever were than could start freely lending again.



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pärmar1/29/2010

admin3017@parmar.caI completely loved reading your post. I have bookmarked your blog post so I can read future blog posts. Peace, Christian Dabney @ parmar

lift top coffee table11/3/2009

advertds9@gmail.comI was wondering what is up with that weird gravatar??? I know 5am is early and I'm not looking my best at that hour, but I hope I don't look like this! I might however make that face if I'm asked to do 100 pushups. lol



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