Opinion

The Great Debate

Can recovery and credit crunch coexist?

By J Saft
November 12, 2009

jamessaft1.jpg(James Saft is a Reuters columnist. The opinions expressed are his own)

New studies from the Federal Reserve and European Central Bank show that, whatever else, a recovery in the economy is not being supported by a resumption in bank lending, raising concerns about how exactly growth will become self-sustaining when official stimulus ebbs.

The ECB last week released its loan survey showing banks tightened credit yet again for businesses and consumers, though at a less severe rate than in the previous quarter. Much was made of the fact that banks said they expected to ease terms to businesses, but not individuals, slightly in the last three months of the year.

Days later the Fed was out with its own survey, and again the news is getting worse more slowly, which must mean it is time to pop open the tap water. Banks are tightening terms and conditions to large firms, though fewer are doing so than before. Of course we should be thankful for small mercies, but the fact remains that this is a relative rather than an absolute survey, which means that even if fewer are being tougher the vast majority are being just as tight with money as they were three months ago when things were very tight indeed.

But wait, I can almost hear you ask, banks are making money again. If not making loans, what are they doing with it? Funny you should ask, they are lending it to the government. According to Fed data October marked the first time in years that banks held the same amount in Treasuries and Fannie Mae and Freddie Mac bonds as they did in commercial and industrial loans. Business loans have plunged 18 percent in a year, while Treasury and agency bonds are up 8 percent.

Banks are choosing to lend to the government and to government-backstopped mortgage firms because they see it as the best way to survive: hunker down, take fewer risks and content yourself with the thin gruel and thin margins of taking deposits and lending to the entity insuring those deposits. It’s a good way to get solvent but it will take a terribly long time.

Falling demand for credit is a factor too. Firms are concentrating on expanding margins by cutting back on costs, rather than positioning themselves for an upswing in demand. That means they want fewer loans to support capital expenditure. It also sadly means that they are not yet hiring.

OF JOB GROWTH AND SMALL FIRMS

The question becomes will the loans be there when companies do decide that it is time to tool up and hire again. There can be no certainty. Banks are still in pretty poor shape, more will fail and few look likely to expand.

If you believed in markets you would believe that this is simply setting the stage for new entrants to come in and make loans that the banks won’t. I’d like to believe this, but here we run into one of the terrible side effects of too-big and too-connected to fail. Who on earth wants to set themselves up in competition with government-backed firms? Some will do extremely well in making loans opportunistically to commercial real estate and industry over the next two years, but fewer than would be the case if there was a truly level playing field.

Two groups are doing reasonably well, but only because they don’t have to rely on bank credit: large credit-worthy borrowers and house buyers. Fannie and Freddie are still cranking out mortgages, and loans backed by the Federal Housing Authority have boomed. Rates are low, and though fees are high and terms tighter it has to be said that the decision to officially support the housing market by tax breaks and subsidized lending is making a difference. It may not be good policy, but it is effective poor policy.

Small firms seem to be getting particularly tough treatment; the Fed survey shows that terms, conditions, pricing and availability were all deteriorating more rapidly for the small than the large and medium-sized companies. Annaly Capital points out that while middle market firms paid only a slight premium in the loans market in 2007 and 2008, the difference between benchmark loans and middle market is now almost 6 full percentage points, meaning they pay nearly double.

A prepackaged bankruptcy for CIT Group and a chastened GE Capital will not improve things.

Two possibilities suggest themselves for how things play out. Banks may get their balance sheets in order and begin to lend again in force next year, meeting a need for investment as economic growth takes root, if indeed it does.

If demand rises and banks can’t meet it, look for more official arm-twisting, more ritual abasement by bankers called before Congress and, ultimately, more official interference in the process, probably in the form of insurance or even mandates.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

Comments
10 comments so far | RSS Comments RSS

Can we blame them? If they have loose credit standards, then their irresponsibility is to blame for a borrower’s inability to pay. If they have tight credit standards, then their caution is to blame for prolonging the recession (since they aren’t making capital available to support business growth). Given the recent public outcry demanding criminal charges for banks with “reckless” lending practices, what banking executive in his right mind would -want- to go down that road again so soon?

We the people asked for this–banks are just giving us what we demanded. They aren’t in it to provide a service to those in need; they’re in it to make money. Since lending to businesses and individuals is becoming more trouble than it’s worth, it’s no big surprise that banks would prefer to lend to Uncle Sam–at least the government doesn’t default on its loans and then blame their inability to pay on the financial sector.

I say more power to them. If loose lending standards are to blame for the problem, then we can’t also demand to include them as part of the solution.

Posted by Nick | Report as abusive
 

Well, it just shows the way banks are spending bail-out money. Hmm, actually it does not. So it begs the question, where are those billions?

Posted by Laco | Report as abusive
 

James,

Thanks for noticing and telling the truth. I find it refreshing, amidst all the ‘Recovery’ hype.

I own a small and successful business that was not hit by the recession – I’m even doing better now than a year or two years ago.
I stopped using credit, I have no debt, and my credit score is good. Still, there’s no way for me to get financing for expanding my business.

Posted by yr | Report as abusive
 

Just wanted to say how glad I am that you’re back extracting compensation from Reuters 8^). September to November is way too long to be away [although I hope you made the most of your time off.] Rereading your posts from the last 6 months, it is clear your column should be required reading for all US gov’t. officials, not to mention rational investors. The rest won’t pay attention anyway…

Posted by Mike Fahey | Report as abusive
 

For the USA, all the expectations of a recovery based on stimulus money, central bank policies, availability of easy credit, are unsound.

A recovery based on smart deployment of existing equity, capital, venture risks, R&D, using the minimum of financing, for the production of exportable products is sound.

In another words, any return to the business and economic model of the past 15 years, which government policies encourage, is not recovery. It is double delusion.

Posted by The Real Deal | Report as abusive
 

Maybe it’s not such a bad thing that the funny bail-out money is kept within the virtuous circular freak-show of the mortgage-bank and government (leaders?) entourage.
It doesn’t look to me like the “talking up the market” is working very well, and the more “less bad news than last time” and “better than forecast or projected” stories that come out, the (even) less credible they become.
Hopefully when the economic situation does improve it’s not pre-doomed to failure by being entirely built on banking and property, a bit of growth via real (local and not too narrowly focused) productivity would be nice.

Posted by Peter H | Report as abusive
 

To Laco:
Well, it just shows the way banks are spending bail-out money. Hmm, actually it does not. So it begs the question, where are those billions?

I have a pretty good idea. It is all being held as excess reserves with the Fed. When the 1st stimulus was about 800 billion, the excess reserves by odd chance were also around 800 billion. Then I read that another 200 billion of stimulus was planned. And walla, the excess reserves have just gone up another 200 billion. Unrelated?

Posted by FedWatcher | Report as abusive
 

I agree, the banks had to hold back, the debits and credits confuse me though, is this not interest round tripping ? Debts need to be serviced, at such low interest rates, is it relevant though ? Has increased fees made up for interest turn ?

Posted by Casper | Report as abusive
 

If recovery and credit crunch can co-exist, all the economics textbooks will need major rewriting!

 

One man’s debt is another man’s credit scheng1. My biggest worry is that one man’s credit will be the rest of mankind’s (including women and children… even those unborn yet) debt. Democracy is dead, long live the monarch?

Posted by Peter H | Report as abusive
 

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