Many regulators and commentrators have expressed their frustration that while US and UK governments have put billions of dollars in their banks, banks are unwilling to lend. This is exacerbating the economic problem, and we are now caught in a negative feedback loop. Some people think that banks should be forced to lend by their governments, probably at the same terms as last year.
Suppose I am the CEO of a bank. There are four ways forward for me - it is a classic case of Prisoner's dilemma.
a) I dont lend, neither does the CEO of any other bank - all of us are worse off equally - if the system doesnt crash I survive like everyone else, and if the system crashes we all go to 0 (including Wells Fargo).
b) I lend, but other CEO's don't - I might be worse off if the system survives, because I would have made certain uneconomic loans in the early days of the recession. If the system crashes, then all of us go to 0, and there is no difference.
c) I don't lend, but others do - My utopia. Hopefully everybody else lends and stabilizes the system, and when it has stabilized enough, I open up my lending and make hay when the sun is out shining.
d) I lend as well as all others - cooperation is the best (like in all PD games), as it will probably stabilize the system. Everyone will benefit equally or will be equally worse off.
In Prisoner's Dilemma, it is very hard to achieve cooperation - even amongst two prisoners. Here we are talking of hundreds of CEO's coming together and cooperating. Is it possible? Most likely not.
Are there structures of PD games that make cooperation a logical outcome? That is where regulators need to drive the system to.