Bank lending has stalled despite the large sums of cash provided to recapitalize banks. Why? Well, bank deposits are down. And we have to remember that there is a systemic relationship between savings and investment that is at the heart of institutions of financial intermediation. That is, in fact, why these institutions exist in the first place --- to coordinate economic affairs in a way that the savings of some become investment funds for others.

Now politicians such as Barney Frank are demanding that banks lend even if their deposits don't justify it because, well, that is why we gave them the money. Interesting that this comes from Barney Frank, one of the main political agitators for riskier lending practices that got the banks into trouble in the first-place. Barney Frank personifies the politician as economic criminal throughout this entire episode of public policy errors. His current policy urgings will just lead to the same sort of behavior by banks that got us here. I am pretty sure Barney and his friends would think an earthquake in NYC would be good for economic growth because we would have to rebuild the city so construction would go up. What is seen and what is unseen anyone?

What we have here in the case of the bank bailout is another confirmation of a general rule that is seen in a variety of walks of economic life --- aid just doesn't work, whether to a foreign country or your local bank or to a private citizen, unless it is (a) embedded in a favorable rule environment, and (b) results in fundamental change to the practices of the recipient. Ironically, if the receiver is already embedded in a good rule environment, they would already be making the fundamental changes due to profit/loss signals. Countries, for example, that have good poliitcal/economic rules of the game will attrack foreign direct investment and thus do not need foreign aid. As Vernon Smith is fond of saying: "It is trade, not aid that is needed." Similarly, local banks that are in a rule environment that protects private property, permits free price adjustment, and works on the basis of profit and loss statements will either act in ways to meet consumer demand in the most profitable way available to them, adjust in that direction, or go out of business. Government bailouts only reinforce BAD decisions by making the consequences of those bad decisions less deterimental than they should be to the firm and the individuals making them. So we are back to an age old economic concept --- if you subsidize something you get more of it, if you tax something you get less of it. It is an empirical question about "how much", but the tendency and direction is a theoretical point.

In the efforts to kick start the banking industry, US policy has simply subsidized bad decision making. The money transfers have "recapitalized" banks in name only. Insolvent banks have used the funds to stay afloat, to cover their acquisitions of other failed banks, to cover their own bad decisions, etc. They have NOT used the funds to lend and fuel investment.

The relationship between savings and investment isn't broken as in the simpliest Keynesian model. But, it is the Keynesian policy responses that have been pursued which are preventing private actors from making the correct adjustments to the new economic realities and thus bring into alignment saving and investment in a prudent and productive manner. Why is it so hard for everyone to see this?