Can we grow out of the subprime mess?

In this insightful entry Mish notes:
"They have enough now certainly to remain solvent and remain ... well above their minimum capital levels. But I am concerned that banks will be pulling back and not making new loans and providing the credit which is the lifeblood of the economy. In order to be able to do that ... in some cases at least, they need to get more capital," Bernanke added.

Bernanke Does Not Understand The Problem
Banks have every reason to decrease lending. There is rampant overcapacity in housing, commercial real estate, and the service sector. In addition there is over-leverage in hedge funds and over concentration of bank loans tied to real estate.

Bernanke wants banks to lend more, but all that will do is increase losses. The man clearly does not understand what the basic problem is. Yes, banks should be raising capital, but not to increase lending. Banks need to raise capital in advance of the approaching tsunamis in commercial real estate and credit card writeoffs, and the continuing tsunami in residential housing, all of which are going to further impair bank balance sheets.

Things We Don't Need
We do not need more Steak n Shakes (SNS), Pizza Huts (YUM), McDonald's (MCD), Panera Breads (PNRA), Starbucks (SBUX) or any other restaurants for that matter.

We do not need more Wal-Mart (WMT), Target (TGT), Lowes (LOW), Home Depot (HD), Best Buy (BBY), or Bed Bath and Beyond (BBBY) stores.

We do not need more Toyota (TM) dealers, GM dealers, or Ford (F) dealers).

We do not need more nail salons, dry cleaners, movie rental places, storage facilities, etc.

We do not need more houses from Toll Brothers (TOLL), Beazer (BZH), Hovnanian (HOV), Lennar (LEN), Pulte (PHM), Centex (CTX) or Ryland (RYL) . Inventory of houses is at an all time high.

Bernanke wants banks to raise more capital so they can do more lending. He never bothered to ask this simple question: For What?

It's always tempting to think that banks can grow out of the problem by making more loans. Certainly my reading of Bank of America's history suggests that BA tried to do this - they entered new markets - too late unfortunately. Citibank beat them in Latin America and by the time they got in they were stuck with making loans that were less profitable and those became non-performing very shortly afterward.

Certainly, the right question is for what - certainly not more real estate loans as Mish says but then isn't one of the roles of financial intermediaries to direct lending to profitable sectors whatever they may be. Some economists note that banks hold the key to growth by taking risks by lending to growth sectors. It is this risk taking that I think Bernanke wants to continue.

So do banks really know that they "cause" growth as in the financial intermediation and growth literature implies? Do they consciously seek out these "growth" sectors? I don't believe they do. Like all businesses, they experiment and good outcomes in one loan provides further information on future loans. It is this experimentation that Bernake wants continued, in other words, for banks to continue in their intermediation role. Hopefully, this will allow for a mean outcome over all banks that is positive allowing some banks to grow out of the problem. As Bernanke notes in the above post - not all of them will be able to do that.

Update: From Avinash Persaud A good bank is one that lends to a borrower that other banks would not lend to because of their superior knowledge of the borrower or one that would not lend to a borrower to which everyone lends because of their superior knowledge of the borrower.