What will it take to get the economy moving again?  Two years after everything simply stopped long enough to watch Lehman fall momentum is still against us.  When credit markets stop they are very hard to start back up again for a large number of reasons – the most important is the one at the heart of any free market, risk.

Interest rates near zero and a Federal Reserve pumping all the cash they can into the economy may seem enticing, but when banks can’t get any kind of interest on the loans they write they become very nervous about the risk inherent in any loan.  Is it really worth loaning out billions of dollars if you’re not sure you’ll be paid back?  So the usual mechanism to crank up the speed of the economy, cheap money, simply doesn’t work.

Perhaps there is a role for government – specifically state government.

The technical term for our situation is “Liquidity Trap” and it’s starting to make the news – the link is to my previous analysis of that problem.  It’s a very unusual type of free market failure that occurs very rarely, so our leaders tend to not be very keen on what to do.  The only thing that has been shown to work to get things moving again is a New Deal of some kind, something which our politics has been unable to develop an interest in.

While it’s probably impossible to get anything important done at a federal level, states have a lot more freedom and a lot more information.  The way things are set up states are the level of government where nearly all big investment takes place in the USofA, with federal money for highways and other big projects going through states before being spent.  They manage large investments well because they are big enough to assemble a lot of capital but small enough to be able to manage projects up close and personal.

Why not use this experience and scale to convince banks to open up their lending windows again?

There are many ways that states can effectively get capital flowing.  The most obvious would be to guarantee loans for certain types of business expansion.  It would meaning assuming the risk at a state level, which may not be all that palatable but it is unlikely to cause problems for at least a few years – and by then the economy could be generating more tax revenue to cover it.  States can also provide matching funds to improve loan to value ratios for some enterprises that might look a little too risky for a bank to loan them the full amount.

Failing all of that, at the very least a Governor can use the bully pulpit to convince the largest banks in the state that they have an obligation to help out (and get some excellent PR in the process, of course).

Minnesota is a good place to try this kind of experiment because we have an extraordinarily diverse economy that includes manufacturing, agriculture, and a lot of finance.  We’re home to a number of large banks and investment houses, including Wells Fargo and US Bank.  These institutions may find that risk is generally too high to make the loans they used to, but close at hand risk always becomes easier to manage.  A program like this should probably start with a conference of all these players where they are asked a simple question – what can we do to help you manage risk in a way that gets you writing loans in Minnesota again?

At the very least shedding some light on the problem will change the nature of it. Banks have been bailed out and given very cheap money to play with. All of this was done for the purpose of getting the credit markets loosened up and moving once more.  It hasn’t worked.  Asking “Why?” will get the attention away from the money we’ve spent, some of which is already gone, and back onto what it was supposed to do.

What do you think?  Any other ideas for leveraging the power and influence of the state to get things moving again?