TARP, the Troubled Asset Relief Program, and the intense public scrutiny and criticism of recent months have constricted bank loans to consumers and businesses as banks adopt a “make-no-mistakes” approach, says Pamplin dean Richard E. Sorensen. Forgotten by the industry, operating in this atmosphere of fear and mistrust, he says, are customers with sound repayment records. The Recovery Act, he contends, has the potential for producing similar unintended, negative consequences.

Sorensen, who became knowledgeable about bank loan issues through his current service as chair of the board of Plastic Packaging Inc., of Hickory, N.C., authored an op-ed, “Unintended Consequences of Government Action,” that was published in the August 14 Richmond Times-Dispatch, and excerpted below.

Richard E. Sorensen, Pamplin Dean

“Fearful of making bad loans, bankers are making only a limited number of safe loans. As a result, banks are much better capitalized, but little funding is being made available for consumer and business loans.

“Many banks are also actively searching for loan covenant violations in existing loans, in an attempt to call in these loans. Some banks are also attempting to re-price existing loans at higher rates and/or requiring additional collateral for existing loans. Local bankers, traditionally authorized to negotiate loans with long-term local business customers, can no longer make such loans. Loans now have to be reviewed and approved by bank “loan risk” officers who have limited direct knowledge of the customer and are frequently located in distant bank headquarters.

“The entire process is aimed at increasing bank profit and liquidity and avoiding the mistake of making loans that may go bad in the future. Forgotten in the process are long-term banking relationships with firms with excellent loan repayment records. Many valuable long-term employees have left, and many of those remaining feel demoralized. Many banks are trying to return TARP funds, in an attempt to eliminate government ownership and meddling.

“The American Recovery and Reinvestment Act of 2009 has the potential for producing similar, unintended, negative consequences. As Recovery Act funds are provided to state governments as part of the plan to stimulate the economy, state governments are reducing their own budgets because of under-realized tax revenue, partially cancelling the impact of Recovery Act funds. This approximately $1.5 trillion in previously unanticipated government expenditures will eventually lead to a greater federal budget deficit, a significant increase in the money supply, higher taxes, higher inflation, and lower economic growth.

“Unfortunately, even the intended consequences of TARP, the Recovery Act, and concurrent Department of Treasury and Federal Reserve actions have not been well defined. If the intention was to save the banking system, TARP has been extremely successful. If the intention was to allow banks to extend loans to business and individuals, and thereby revive the economy, the intended outcomes have been less than successful. This uncertainty concerning intended outcomes makes it difficult to determine the effectiveness of government action. In many cases, unintended outcomes of government action may reduce or possibly eliminate the intended outcomes.

“Where appropriate, all future legislation should include measures of anticipated outcomes, along with plans for the evaluation of the effectiveness of the legislation. Only by comprehensively identifying the intended outcomes of government action can problems of unintended consequences be resolved. Accurate measures can then be developed, data gathered, and reviews conducted to determine the effectiveness of such action. A better understanding of alternative approaches that the government might use to address these issues can be established. This information concerning the anticipated effectiveness of alternative approaches, can then serve as valuable input for future government action.”