Megan responds to my last response to etc. First up:

Taking the last point first, I’d suggest he consult the work of people like Christina Romer, Ben Bernanke, or any of dozens of other writers on the Great Depression, all of whom are pretty much united in believing that while the bank holiday, the FDIC, etc. may not have been sufficient, they were certainly necessary preconditions for recovery.  I believe Brad DeLong has said as much in re: the awesomeness of the New Deal.  Or he could consult writers like Anil Kashyap, who say the same thing about Japan.  If you do not get the banks lending and creating money, everything else you do will fizzle.  Frankly, I have a hard time believing that we are even arguing about this.

Wait, are personal deposits threatened in this recession? No? Okay, good. In answering Ms McArdle, I kind of assumed she’d also been reading me at Free Exchange. Perhaps this is not the case. Anyway, a few weeks ago, I wrote this post, which included this passage:

In a second corner we have Richard Caballero, Anil Kashyap, and Takeo Hoshi, who argue that the big problem with Japanese banks was not that they could not provide adequate credit to the economy, but that they continued to supply credit to the economy when they shouldn’t have. In a paper titled, “Zombie lending and depressed restructuring in Japan”, they write:

This paper explores the role that misdirected bank lending played in prolonging the Japanese macroeconomic stagnation that began in the early 1990s. The investigation focuses on the widespread practice of Japanese banks of continuing to lend to otherwise insolvent firms. We document the prevalence of this forbearance lending and show its distorting effects on healthy firms that were competing with the impaired firms…

Aside from a couple of crisis periods when regulators were forced to recognize a few insolvencies and temporarily nationalize the offending banks, the banks were surprisingly unconstrained by the regulators.

The problem is that zombie banks kept credit flowing to “zombie borrowers”. Without good investment opportunities available (given economic conditions) these loans merely propped up failing firms.

The paper certainly presents a case for restructuring the banking system, but not one based on the need to enhance lending in recession. Rather, they note that the bad banks make life difficult for the good banks by hanging on to market share. Megan continues:

Why aren’t the banks lending?  Yes, in part, it’s that the economic uncertainty is making people unwilling to borrow.  And what is a major, major source of that economic uncertainty?  The fear that a lot of banks are about to fail.  There’s also, however, the fact that bank debt is not exactly trading at handsome rates, and like everyone else, banks are afraid that if they need to tap some capital to tide them over, they won’t be able to.

Yes, there is fear that some banks may fail. But there are a lot of banks in the United States, and not all of them are Citigroup. So the issue here is not that no lending is available (and this was Megan’s initial point — that a lack of lending would reduce the multiplier on the stimulus). And the Treasury has taken steps to limit the negative competitive effect of propping up zombies, by throwing open TARP money to many, many financial institutions. Is there still an argument for more intervention, in particular, to find ways to wind down the systemically important insolvent banks? Absolutely! But I don’t think it’s absurd to say that such actions come with intolerable risks to the financial system.

Megan says I “slam” her by saying that she’s looking for a way off the Obama train. My point was this — she said she had buyer’s remorse, and given the ludicrous ideas coming out of the GOP, and John McCain, that makes no sense, economically speaking. I don’t know why someone focusing solely on the policies would write that, and so I concluded that Megan was focused on something other than just the policies. Which perhaps was improper. My bad! But still, it makes no sense.