Good-bye credit crunch, Hello slog

January 25, 2011

If you have forgotten the credit crunch it appears you have company: U.S. banks are lending again.

Bank earnings reports and data from the Federal Reserve confirm that, at long last, banks are beginning to step up lending, a much-needed ingredient for a stronger and more sustainable recovery.

The good news is that lending is growing to commercial and industrial companies — exactly where you want to see growth if the U.S. is going to address its unsustainable dependence on domestic consumption. That’s good so far as it goes, but with a fragile euro and an undervalued yuan the upside is decidedly limited.

That’s because, in part, consumers are still quite restrained, or are being restrained, at least to judge by weak to middling lending levels to consumers and to support house purchases.

With 17 of the top 25 U.S. banks by assets having reported earnings, a lending turnaround is in evidence. Among the 10 largest regional banks, loan books expanded by 0.6 percent in the fourth quarter, according to FBR Capital markets, and nudged up slightly at the four mega-banks. This compares to a 2 percent shrinkage in the previous quarter and real carnage in the two years before that.

According to Federal Reserve data, commercial bank loans and leases shrank by 10.3 percent in 2009 and 6.3 percent last year, both a cause and a result of the recession and the sluggish and largely jobless growth which followed. Fed data from December shows business lending growing at a very good 7.4 percent annual clip, with continued weakness in home equity, commercial real estate and consumer lending.

The growth in commercial and industrial lending is significant, given the strength of the turnaround, but that sector is going to have to row very hard if consumers are unable or unwilling to spend freely.

A look at the Fed data for the first two weeks of January shows continued mild expansion of business lending combined with stability in real estate lending and a small fall in consumer lending.

NECESSARY NOT SUFFICIENT
It is for this reason, if none other, that the U.S.’s seeming inability to convince China to allow the yuan to strengthen poses such a threat to U.S. growth and to its medium-term prospects. Even if the Federal Reserve engineers asset price inflation, there is really little chance that domestic demand over the next few years can provide strong growth. The U.S. must export more, both for its own sake and for those of its creditors.

Consumer credit has actually been stronger than the headline figure if you adjust for loans the banks consider unlikely to be repaid, according to James Marple, senior economist at TD Economics.

“Correcting for charge-offs shows that household deleveraging did lead to a slowdown in credit issuance. On a year-over-year basis, revolving consumer credit was slightly negative in early 2010 — a new phenomenon for credit cards — while nonrevolving net credit issuance slowed, but did not actually contract,” Marple wrote in a note to clients.

“Importantly, over the last several months, there has been a considerable improvement in consumer credit growth. Even with the impact of charge-offs, total consumer credit rose in both October and November — the first two consecutive monthly gains since June and July of 2008.”

Remember, in a fiat money economy the creation of credit is the creation of money. The Federal Reserve couldn’t make banks lend by dropping interest rates, but it appears that its program of quantitative easing may have worked, at least on this measure.

The Fed’s recent Survey of Senior Credit Officers, which measures conditions in the business of lending to hedge funds and other securities firms, showed a similar thawing of conditions.

Banks are more willing to take on risk, according to the survey, and are making money available to financial markets more cheaply and on less stringent terms.

If QE has prompted the banking system to begin to create money again, will inflation be unleashed? My guess is that there is still too much slack in labor markets for that to happen, but there is every chance that we will see, or are already seeing, bubbles in asset markets.

While credit creation can be a self-reinforcing cycle, it is only a virtuous one if the credit is invested in areas that are productive.

The sweet spot for the U.S. would be consumer stability combined with a gently falling dollar so the country can, over years not months, export its way out of its woes.

The rest of the world is not, judging by recent events, going to want to cooperate.

(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.  email:jamessaft@jamessaft.com)

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