Andrei Shleifer on the Junker problem

Via Brad DeLong, here is Andrei:

Andrei Shleifer is offering an justification for what Federal Reserve Chairman Ben Bernanke calls “credit easing.”… It is, Shleifer argued at a presentation at the American Economic Association in Atlanta, the best way to get banks to resume lending. In a crisis, the price of securities – mortgage-backed, Treasury debt, packages of loans, etc. – fall to fire sale prices, well below fundamental values…. Banks with the wherewithal to make new loans… prefer to buy securities because the opportunity for profit is so tempting…. “Because asset prices are out of whack,” he said, “injecting capital into banks doesn’t restart lending.” Banks simply use the money “to buy underpriced securities… to speculate.” “Financing of new investment by banks [via lending to business] is always competing with speculation. If speculation is more attractive, it is going to draw the attention of banks,” he argued.

The solution: The Fed or the government should buy a lot of securities, so many of them that the price rises and the banks no longer find them attractive for speculation and lend instead…

The original source, from David Wessel, is here and it includes a critique from Gary Gorton.  Here are my previous posts on the Junker problem; I'm not sure I have met an economist who has never made this mistake or is it one?  One question in this case is whether the security purchases lead to that cash being recycled right back into the banking system, and thus available for lending, as Fritz Machlup had suggested in his 1940 book on the stock market and capital formation.