Banks, Lending and the Economy

Commercial banks have always played and, as far as I can see, will always play a role in the health of the economy. Commercial banks represent a kind of fulcrum of economic activity. If commercial banks are not lending at all, or are not moving toward an acceleration of lending, then one can bet that the economy will not be moving ahead in the near future. If commercial banks are lending modestly or are accelerating their lending, then it can be anticipated that the economy will be expanding or even over-heating.

Right now, the commercial banks are not lending, and there doesn’t seem to be much reason to believe that they will pick up their lending any time soon.

The Federal Reserve is doing all that it can to infuse liquidity into short term and long-term financial markets, but the banks are doing little or nothing in the way of expanding credit. There are two major reasons for this: first, the quality of the assets the banks are holding, and second, the quality of potential borrowers.

In the first case, I am not convinced that banks have finally gotten their hands around the quality of their assets. There is still too much uncertainty in financial markets - as well as real markets - for banks to be able to fully understand their position. Some financial assets still cannot be valued. Assets in foreclosure present an uncertain asset value to the banks. Credit card losses are mounting; auto loan losses are mounting, and, so on and so on…

We continue to receive news that does not bode well for the value of the assets of banks. For example, the front-page article in the New York Times trumpets on page one,”As Vacant Office Space Grows, So Does Lender’s Crisis." We have not yet seen the bankruptcies that will follow the miserable holiday season and this will lead to vacancies in the major malls as well as in strip malls. This will lead to further foreclosures and financial stress in real estate where there are already a lot of empty stores. We still have a wave or two to go through in the residential real estate market as the various ‘no doc-no down payment” loans re-price. And, although unemployment began to rise throughout the fall, many expect this trend to accelerate early in 2009 as the business failures and cutbacks start to add up. These movements and others not mentioned will only exacerbate the uncertainty surrounding the value of the asset portfolios of banks.

Banks will continue to be reluctant to lend if they don’t have a good idea of what the asset side of their balance sheet looks like. As far as potential borrowers are concerned, there used to be a saying in the banking community that banks will not lend to anyone unless they don’t need to borrow any money.

My guess is that this will be the major lending rule that most financial institutions will follow in the near and intermediate future. On the upside, financial institutions stretch and stretch their lending standards to earn extra basis points returns in order to outdo their competition. On the downside, banks focus on the quality of credit because charge-offs dominate bank performance. In the past, banks have not moved into riskier borrowers until other banks have moved and it becomes necessary to compete in lesser credits in order to maintain a competitive position. Here the question becomes: who wants to move first?

My answer is that bankers feel very defensive about their behavior in the recent past, so they will not want to be the leader in a new round of stupidity! Then, there is the Obama administration and its new plans for fiscal stimulus.

Firstly, there are rumors that any stimulus package proposed would not be enacted by January 20, 2009, let alone early in the spring. The Obama team has already responded to this by proposing, as a part of any stimulus program, a substantial package of tax cuts. The reasoning behind this is that it will draw bi-partisan support of the Republicans in Congress, which is something that is felt to be desirable in order to help achieve as much effectiveness for the economic program as possible.

An economic stimulus package, however, will not result in an immediate stimulation of bank lending. Therefore, on top of when the economic program is passed - partially or in full - banks must still solve their own difficulties, as described above, before much real lending takes place.

Secondly, there is the international situation. The world economy is worse than anyone thought it was and is declining from there. The United States is part of this world economy, and it cannot act independently of what is going on elsewhere in the world. Almost all of the nations of the world face similar situations and each faces the uncertainties mentioned above. However, how much is the rest of the world going to suffer from the continued decline in the United States economy and how much the United States is going to suffer from the decline in the rest of the world, is unknown. The Obama administration must act more responsibly toward the rest of the world than did the administration that left office earlier this past fall.

We now have another uncertainty - the events in the Middle East present us with another unknown. War is uncertainty itself! What impact this will have on the rest of the world and how it will work itself out cannot be predicted with any degree of precision. However, it is in the mix now and must be taken into consideration in our potential scenarios for the year.

To summarize these comments: the economy will not begin to turn around until the banks are in a position to start lending again. My expectation for this turnaround is beyond the middle of 2009, and, this might be delayed even further if there is a rash of bank failures during the year. There are still too many uncertainties to be more definite and, consequently, the prediction for financial markets will still be a downward drift, with lots and lots of volatility!

Comments

[Socialism c...:]

"Commercial banks have always played and, as far as I can see, will always play a role in the health of the economy."

IMO, they've played a role in the sickness of the economy. It's just that this time they took it too far, and the patient acquired not a normal sickness, but a grave one. I.e., it is precisely the pattern of living on debt that is the cause of this economic meltdown. And why do we assume debt-based living is normal? Because they want us to. Banks and the government. To keep us on *their* mutual treadmill. If any of us has ANY sense left, we'd be wise to withhold EVERY cent of spending until our government quits the bailout spending and overhauls taxation, moving to consumptive taxes instead of the theivous income & property taxes and the payroll taxes for their Ponzi schemes of Social (in)Security and Medicare!!!

Take back what is YOURS -- your income, property, and LIBERTY.

fairtax.org

Jan 05 01:11 PM

[overtaxed42...:]

I can summarize this article too: Fiat currencies will always be worth the paper they are printed on or less. Debt is not good to hold. Lenders want their loans to be backed with something worth more than the loan. Governments will fight for this corrupt and unfair monetary system because it allows them to benefit grossly. Same as with the lenders. Why even care if a loan is good or bad when the only ones who lose are the taxpayers?

If we return to the gold standard, it forces accountability upon governments and on these corrupt banking centers. It forces government to balance the budget and act with fiscal prudence. It also gives the taxpayers a currency worth its stated value that can't be manipulated to the financial institutions whims.

Jan 05 06:44 PM

[overtaxed42...:]

Oh yeah- Support the FairTax ammendment to start the ending of corruption in DC. Worry about your kids grades, not the IRS. Support the FairTax ammendment. Make April 15th just another spring day.

Jan 05 06:46 PM