The Senate's Bankers

Politically directed credit – again.

You might think lawmakers would have had enough of politically directed credit after the $200 billion fiasco of Fannie Mae and Freddie Mac. But you'd be wrong.

On Wednesday, Senators Chuck Schumer (D., Fannie), Jack Reed (D., Freddie) and Robert Menendez (D., N.J.) called on the Treasury to set "lending goals" for banks receiving capital injections under Treasury Secretary Hank Paulson's rescue plan. The press release issued by Senator Schumer's office complained that banks receiving public capital "may not fulfill the main goal of the Treasury program, which was to increase lending activities in order to unfreeze the credit markets." Instead, these Senators said, the banks might choose to "hoard" the cash.

"Banks must understand that these funds aren't a gift," Senator Menendez warned, ominously. And here we thought that "not a gift" was covered in the part of the plan that requires the banks to pay interest on the capital to taxpayers on a preferred basis over private shareholders.

Note to Senator Schumer, et al.: Banks don't make money by "hoarding" it, or "stuffing it under mattresses," in the New York Democrat's words. They make money by lending. But lending has been constrained in part because losses on past lending and investment have left the banks short of capital. If a bank should decide that keeping that capital unfettered is better than going bankrupt, for example, that should not be taken as evidence of greed or a lack of public spiritedness. Nor would compelling banks to make loans ensure that "taxpayers are protected," as Senator Reed claimed. In fact, the opposite could be true, depending on the magnitude of potential losses from loans already on the books and the quality of the new loans.

Naturally, the Senators claim merely to want the banks to engage in responsible lending. Their letter includes disclaimers about not using "this capital to do the types of inappropriate lending or leverage with the exotic instruments that fueled this crisis." Of course! If only Citigroup had thought of that sooner: No Inappropriate Lending.

After more than a year of losses on mortgage investments, declining home prices and credit-market turmoil, the banks are busy rebuilding their balance sheets. More banks are likely to fail before this thing is over, and some of them will likely have received money from the Treasury along the way. The first priority for banks has to be to build up their capital base and dispose of dodgy assets so taxpayers don't take those losses.

What the banks need from each other is confidence that their balance sheets are sound. Calling on them to return to pre-crisis levels of lending, as the Senators do, has exactly the opposite effect: It increases the odds that they will take on business to please political masters, not because they can afford to do so.

Now that Treasury is buying bank stakes, the danger is that every politician in the Beltway will want a special dividend payable to him. This is one more reason for the Treasury, in this Administration or the next, to appoint someone to run this program who cannot be bullied. Mr. Paulson is still asleep at that switch. The Senators' letter is another reminder, if one were needed, that the sooner the feds get out of the banking business, the better for the banks, the economy and the country.