Regs, tax breaks expiry to hit lending

May 25, 2010

By Jim Saft

With tax credits for house buyers gone and tough new banking regulations on the way, expect lending in the United States to come under significant pressure.

Demand for mortgages, kept artificially high through the end of April by juicy credits for first-time and other buyers, has now crashed and, at least to judge by the fundamentals in the housing market, should stay low. Loans to consumers too will be getting, appropriately, more expensive, at least in part due to costs imposed by new financial regulations, which while if anything not tough enough from a prudential point of view will without doubt make banking less profitable.

Supply of loans to businesses will also be hit, and demand should remain slack.

The upshot is sluggish movement of money through the economy and, believe it or not, a Federal Reserve that keeps interest rates ultra low because of domestic concerns rather than simply because of fragility in Europe.

This is what happens in a balance sheet recession. People and enterprises repay loans rather than borrow and hold cash rather than invest. Money sits idle on deposit with the Federal Reserve rather than multiplying into loans and activity in the economy.

First, take a look at the housing market. Data from the Mortgage Bankers Association last week showed that demand for loans to buy houses fell to a 13-year low, falling by 27 percent, after federal tax credits worth as much as $8,000 per borrower expired. Consumption of housing was brought forward but now the pool of natural first-time and move-up buyers is very shallow.

Advances for lending by the Federal Home Loan Bank system to members fell in the first quarter by 9 percent. Advances and mortgages as a percentage of assets fell to 66 percent, down 10 points from the peak, though this in part reflects competition from other looser government-sponsored lending.

Financial reform legislation now wending its way through Congress could slice 20 percent off of normalized bank profits, according to analysts at Goldman Sachs. Much of that will come from tighter regulation governing consumer lending, which again, while wholly justified, makes the business less attractive. To the extent that banks think they cannot price appropriately for risk, they will withdraw credit, preferring to make the far safer arbitrage between ultrashort overnight rates and short-term Treasuries. I’d be willing to bet that many of the people denied credit should never have had access to it on such easy terms in the first place, but that larger truth will do nothing to blunt the economic impact of declining credit and slower movement of money through the economy.

JUST WHEN THOSE SENIOR LOAN OFFICERS LOOSEN UP …
The Federal Reserve’s quarterly survey of senior loan officers, released in early May, showed two interesting trends. Supply terms on some measures were easing, though they remain almost certainly tight in a historical context. While most banks kept standards more or less the same, a significant number eased terms to either large or small businesses. As this is the second straight quarter of easing conditions, you can almost call it a trend.

Unfortunately, banks may only be reacting to the very thin demand for loans. According to the survey most banks continue to see weaker demand for loans from both businesses and consumers.

However you attribute it, the data show a savage downturn over the past 18 months; overall bank lending is down more than 20 percent from where it began 2009. Commercial and industrial lending is down about $350 billion and commercial real estate lending has fallen by $130 billion. Combine this backdrop with new policies which make lending less attractive and the removal of incentives to borrow and you have a recipe for continued sharp declines in credit.

All of this is showing up in the money supply data, which paints a picture of deflationary risk, though that may well prompt policies which ultimately stoke very high inflation.

MZM, a measure of readily available money, is down sharply over the past year, while a broader measure called M2 has been more or less flat. A still broader measure, M3, which is no longer compiled by the Federal Reserve, is down 5.3 percent in the past year, according to data from Capital Economics, which still tracks it.

For anyone who missed it, consumer prices actually fell in April and core prices rose, but at their slowest pace since the 1960s.

It is no surprise that the Federal Reserve said it won’t be selling assets until it raises rates.

The surprise may be that before we see higher rates or asset sales we will see the Fed again engaging in quantitative easing.

(Editing by James Dalgleish) (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.)

6 comments

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Amazing that for a Dollar that was, how do you say? ‘released from the cruel stranglehold of gold and efficiently propped up by debt’ we may find ourselves today wishing for the days of old.

Posted by usbychoice | Report as abusive

Though painful, the value of housing did not reflect true demand and supply. Demand was artificially raised by banks extending loans to people who had no business buying houses at inflated prices and then the banks transferring high risk loans surreptitiously to the taxpayer through derivatives and hedge fund markets that we know collapsed. To get the market back to reflecting true housing value we need to have these regulations in place so that risk is placed on the entity that extends the loan. We also need to eventually break up the behemoth financial institutions so that they don’t expect windfall profits and begin to act more like businesses that operate in a competitive market instead of an oligopoly (as if that’s going to happen).

Posted by armoderate | Report as abusive

The dynamic here is that banks have come to reenact the business model of aerospace: as it becomes more profitable to survive off government money in exchange for supplying defective products than to actually meet market index head-on through strenuous competition (a status eliminated by government largesse and intervention) – whaddya know – they choose the former.

All the other stuff is just window dressing. They didn’t really want to supply real money anyway because, if they did, that would be another thing at which major banks have miserably failed as though they all attended the same failure academy at the same time.

It takes far longer to rationalize than to recognize the obvious, that’s for sure.

Posted by HBC | Report as abusive

Simple facts are the US Government is in a catch 22. We are at over capacity in housing, imports, and energy output. if they raise taxes you remove just that more from the markets. population growth is on a steady decline under 1%. you can’t fix the the problem by adding 25M illegals to the tax roll, cause over half would be taking more out of the system, then they put in. we have 120 Trillion in unfunded mandates threw SS and medicare right now. they passed the Obama tax care bill to try and stop the hemorrhaging of falling tax revenue.

Right now cash is king. its better to seat on the side lines, cause the P\E is to high interest rates at 0. you can make more by waiting for the market to hit bottom. as I type they are below 10k. then you can get back in later and make more on the up tick.

This ride is not over, they just prolonged the pain till the first of the year. Oil will continue to fall with 15m barrels a day over capacity and climbing, demand world wide is in decline from the world markets pulling back.

You have a nice day now:)

Posted by Macwizz | Report as abusive

Last spring, the IRS released a report (1st authorized by Clinton EO, then surpressed by GWB EO following 2002 tax “changes”) that analyzed taxes paid by S&P 500 corps in the last completed yr (2006, I think). Two-thirds of the corps paid… NO Taxes whatsoever! Since the financial sector had grown to 40% of the index by then (pretty absurd, when ya think about it), may it be assumed that a good number of the tax-free were financial firms? Perhaps we should focus less on taxin’ those bonuses and more on taxin’ the firms’ revenue streams. The latter might just solve the problem of the former. [though I have yet to see that annual IRS report this Spring--- wonder where o where it is? [:) ]

Posted by DennisG | Report as abusive

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