The Economy Cannot Grow if Credit Keeps Shrinking
Posted by Michael A. Kamperman on July 27, 2009
An analysis by the Wall Street Journal showed that the total loan portfolios of the nation’s 15 largest banks shrank by an aggregate of 2.8% in the second quarter. Most of the lending that did occur in the quarter went to mortgage refinancing and credit renewals for existing business customers. Less than half of the loans that were made represented new commitments by the banks representing new transactions for the economy. The banks claim that demand remains weak from potential borrowers, and potential borrowers claim the banks have overly restrictive lending standards. The truth is both viewpoints are true. Many of the highest quality borrowers are looking to contract, not expand. Meanwhile, the banks have significantly raised the bar on what it takes to qualify for a new loan, whether it is a consumer loan or a business loan. According to the WSJ, loan portfolios at the nation’s 15 largest banks have decline by 10% from year ago levels after acquisitions are netted out. The fact that lending is still contracting at the same pace as it did in the last couple of quarters means there is a real possibility the economy contracted at a similar pace as well. Economists are looking for a much more benign contraction in U.S. second quarter GDP. I would not be surprised if the number is much worse than expected, just like it was in Britain.
Fed Chairman Ben Bernanke, in a much hyped Town Hall style meeting to be broadcast this week on the PBS News Hour program, claimed that back in 1929 and 1930 the world was experiencing a normal recession. Then, major Central Europe lenders (Austrian Creditanstalt) faltered and further panic set in causing the Great Depression. His thesis is that since the large “banks” have been rescued the crisis has been averted. But we have no way of knowing if the rumors of trouble with certain banks indeed kicked off the Great Depression. It could be that the event was just the next inevitable phase of the crisis and the back then hoped for “green shoots” of 1931 vanished. We have built up significant hope in 2009 that the worst is behind us and blue skies are just around the corner. However, the shrinking credit extended by our largest banks is painting a very different story.
What I think Chairman Bernanke is missing is the world of lending has changed since 1931. Back then most of the credit extended in the economy came from commercial banks. If the commercial banks were lost the economy would be lost with them. However, in the 2000’s the vast majority of lending has come from the shadow banking system fueled by the asset-backed securities market. This market is dead and as CIT can attest the shadow banking model is broken. Yet our largest banks have not only failed to pick up the slack, they too are shrinking the credit they extend to the economy. Perhaps the real cause of the Great Depression was the inevitable “Great Un-Ravel” (yes I just coined that term) that was destined to occur one way or another as a global economy with too much debt ran into contracting economies and deflation. Just like early 1931, we have a global economy with massive imbalances that are still unraveling. We just don’t know what will be the next shoe to drop.
