PRIVATE CAPITAL EXISTS
Even if existing banks could not attract capital on their own, their inaction creates opportunities for other institutions to commit capital to funding investment projects in our economy. Walmart would like to get into the banking business. Pension funds, university endowments, venture capitalists and corporations all bring money to new investment projects. For example, a profitable corporation (there are many of them these days), could cut their dividend in order to fund projects that would have otherwise been funded by a bank.
PRIVATE CAPITAL IS READILY CROWDED OUT BY TREASURY CAPITAL
Treasury Secretary Henry Paulson has said the money was aimed at rebuilding banks' reserves so that they would resume more normal lending practices. But reports then surfaced that bankers might instead use the money to buy other banks. Indeed, the government approved PNC Financial Services Group Inc. to receive $7.7 billion in return for company stock and, at the same time, PNC said it was acquiring National City Corp. for $5.58 billion.
Even if by luck or judicious micro-management the Treasury were to prevent these payouts, the flow of private sector funds toward funding new projects would still be reduced, thereby offsetting the Treasury investment. In this case, the banks receiving the Treasury investments would cede less business to new entrants to the banking industry and to alternative institutions that fund investment projects. For example, profitable non-financial corporations would no longer have to cut their dividend to finance their projects, because they could obtain the funds from one of the Treasury-partnered banks. The total amount of funds available for investment projects is just the same.
Bush, Paulson, most economists, and I agree that a nationalized banking sector is by itself undesirable. But the Treasury purchase plan is going forward because the purported benefits – a more capitalized banking industry – outweigh that cost. The purported benefits will never materialize because private capital is pulling out -- and will continue to pull out -- of the banking sector to make way for Treasury capital.