When Will Banks Start Lending Again?

The Federal Reserve, as we know, has been pumping all kinds of reserves into the banking system. For the banking week ended May 2, 2009, Federal Reserve Bank Credit stood at $2.041 trillion. This is up from $0.894 trillion for the banking week ending September 3, 2008, an increase of $1.147 trillion.

Total reserves in the banking system jumped from $44.1 billion in the month of August 2008 to $881.8 billion in the month of April 2009. This is an increase in total reserves in the banking system of $837.7 billion.

Note that the difference between the amount of credit the Federal Reserve extended to the economy and the increase in total reserves in the banking system is $309 billion, the amount of Federal Reserve credit that ended up in coin and currency outside the banking system.

This massive growth in total bank reserves can be picked up in the year-over-year growth in total reserves as represented in the accompanying chart. Note that the year-over-year rate of growth in total reserve for April 2009 is 1,924%.

The crucial point I want to make here, however, is that in the banking week ending September 3, 2008, Federal Reserve credit stood at $894 billion. The increase in total reserves at ALL commercial banks from August 2008 through April 2009 was $838 billion. In eight months the Federal Reserve added just about the same amount of dollars to commercial bank balance sheets that it had accumulated on its own balance sheet in the 94 years beginning in 1913!

And what did the commercial banks do with the funds the Federal Reserve forced into the banking system? It sat on them. In the next chart we get a picture of the excess reserves of all commercial banks in the United States. We see the commercial banks are holding $824 billion in excess reserves. That is, in August 2008, the commercial banking system held between $1.0 and $2.0 billion in excess reserves. So, almost all of the increase in total reserves in ALL of the commercial banking system between the first of September 2008 and the end of April 2009 went into excess reserves! There was next to no lending going on in the whole banking system.

What happened to loan growth in the United States banking system? Well, in the fall of 2008 the year-over-year rate of growth in the loans and investments held on the balance sheets of all commercial banks was over 10%. In April 2009, the year-over-year rate of growth in loans and investments held on the balances sheets of all commercial banks was just over 2%. Loans in the commercial banking system increased by a little more than this number but, the decline in the loan series was even greater than what took place in loans AND investments.

The bottom line is that the banking system was putting out next to nothing in loans or in investments in securities. The banking system basically has sat on the reserves that the Federal Reserve has pumped into the economy.

There is only one conclusion that I can draw from the analysis of these data. Commercial banks are so petrified at their condition that they are not putting any money out into the business or financial community.

I don’t care what the stress tests show. Behavior speaks louder than stress tests. Commercial banks aren’t lending because they can’t take the risk that they will put any more bad loans onto their books. At least cash holds its nominal value and is not subject to default risk!

When will banks begin to lend again?

Unfortunately, I don’t like any of the answers I come up with that would account for them lending more in the near term.

Comments

[PastTense:]

Your comments are quite contradictory: On one hand you are saying "The bottom line is that the banking system was putting out next to nothing in loans or in investments in securities."

But you also say that "In April 2009, the year-over-year rate of growth in loans and investments held on the balances sheets of all commercial banks was just over 2%. Loans in the commercial banking system increased by a little more than this number"

So apparently there was an increase of 2% or so.

I don't know what the average maturity of banking loans is. Say it is 4 years. That means that 25% or so of the loans are paid off each year. In other words if the banks weren't making new loans (as you are suggesting) their total loan portfolio should be declining at a rate of 25% a year. But it's not, instead apparently the banks are making new loans (or rolling over old loans instead of requiring they be paid off) at a rate of 27% or so of their total portfolio.

May 13 01:19 PM

[1 of 4:]

People in the banking world I'm talking to say they're doing renewals and admin work. Pretty tough to find qualified commercial borrowers in this economy, so no one is tripping over themselves to extend loans to new borrowers. Basically, we're now looking at a Fed constructed earn out for the banks: short term rates next to zero, lend out longer term to known high quality customers at interest margins close to 4%, or buy Treasuries.

May 13 01:32 PM

[libbyscotter:]

That's a big advantage of quantitative easing: if the banks won't lend, not even to the Treasury, the Fed will do it for them.

May 13 02:57 PM

[Alan von Al...:]

I did a lot of reading today. Bankers are doing mortgage refis and lending to term borrowers, cutting lines of credit and credit cards. ABA is lobbying to tax credit unions. The whole picture seems to be very passive. I think they expect the Fed to drain reserves as soon as inflation kicks in, which it must. So why lend?

May 13 03:04 PM

[Jasper M:]

Seems that a critical mass of the financial community may have finally realized that the government's various levers of manipulation will Not produce their intended effects, if resorted to in a deflationary environment.

Banks either 1) sit on money ( = 0 velocity, = zero inflationary pressure)
or 2) they lend it into a credit saturated environment, likely to poor prospects, the loan goes bad (=they lose money, credit pool declines, deflationary)

Government strong arms debt forgiveness from mortgage holders, and lender to Chrysler, Result is money frightened out of those credit markets (=less credit available, = deflation)

Fed promises to buy Treasury's output wholsesale, = a tacit admission that those securities will become illiquid in the volumes to be offered, frightening off other buyers. For every $ the Fed creates this way, more $s will leave (=net Less credit available for the Treasury, = deflation).

Same thing would apply if, say, some proxy were bidding up the SPY on the Administration's behalf - once it becomes clear that intervention is what's the keeping the market up, it becomes equally clear that the SPY is dangerous to hold, and investors will flee. Result is a Lower SPY, with Proxy left holding the bag.

May 13 04:41 PM

[yuman:]

Would someone enlighten me on M1 multiplier research.stlouisfed.or...[1][id]=MULT&s[1][... which stands at 0.87 now. My understanding is that for each dollar in reserve, 0.87 gets into the real economy. Would this encapsulate the total effect of load creation and destruction?

May 13 07:04 PM

[yuman:]

The link in my previous comment was broken by SA. Here it goes in plain text :research.stlouisfed.o...

May 13 07:07 PM

[nobby73:]

Jasper M

Your analysis is both accurate and frightening. There is an argument that the Fed has a responsibility to boost confidence, to get people spending and hiring, or at least not cutting jobs. The problem is, if they throw too much too early and the underlying reality does not reflect this, we could start a new and more aggressive downward trend, with nothing left in reserve to arrest it.

I think the reality for the banks is they see a saturated credit market - huge amounts of sovereign debt in the pipeline, existing commercial loan books deteriorating with political interference to protect workers vs lenders as with Chrysler, and solvent consumers looking to reduce borrowings. This suggests we are heading to "stagflation".


On May 13 04:41 PM Jasper M wrote:

> Seems that a critical mass of the financial community may have finally
> realized that the government's various levers of manipulation will
> Not produce their intended effects, if resorted to in a deflationary
> environment.
>
> Banks either 1) sit on money ( = 0 velocity, = zero inflationary
> pressure)
> or 2) they lend it into a credit saturated environment, likely to
> poor prospects, the loan goes bad (=they lose money, credit pool
> declines, deflationary)
>
> Government strong arms debt forgiveness from mortgage holders, and
> lender to Chrysler, Result is money frightened out of those credit
> markets (=less credit available, = deflation)
>
> Fed promises to buy Treasury's output wholsesale, = a tacit admission
> that those securities will become illiquid in the volumes to be offered,
> frightening off other buyers. For every $ the Fed creates this way,
> more $s will leave (=net Less credit available for the Treasury,
> = deflation).
>
> Same thing would apply if, say, some proxy were bidding up the SPY
> on the Administration's behalf - once it becomes clear that intervention
> is what's the keeping the market up, it becomes equally clear that
> the SPY is dangerous to hold, and investors will flee. Result is
> a Lower SPY, with Proxy left holding the bag.
>

May 14 01:15 AM

[Jasper M:]

nobby,
"There is an argument that the Fed has a responsibility to boost confidence"
Well, proponents of that argument can propound it to their hearts' content, but they have No Mechanism to accomplish that now. As after every other saturation of a credit inflation, everywhere you look, leverage is working backwards. Anyone embracing "confidence" will either be given cause to change his mind, or be separated from his capital (at which point he ceases to be a player).
Matters little what they "throw", it's a falling safe now. All the good 'beds' for new credit are occupied, so new credit will be (in aggregate) unproductive.
I do not see this as "stagflationary" - inevitable defaults (including Sovereign) will remove immense amounts of credit from the system over the next few years, reducing the money supply faster than the fed can create it. Inflation ('stag' or otherwise) can't catch on until so much credit has been destroyed that the physical Reserve Notes start to represent a significant fraction of the total (by some counts, they are less than 1% now, so we gots a ways to go).

May 14 01:26 AM

[Sellputs:]

Simply when trust is restored, and all the shoes have dropped.

May 14 02:43 AM

[nobby73:]

I agree, but I think of stagflation as rising prices but falling revenues, which is deflationary in terms of money flow (money kept by banks or put into gold is not flowing around the economy) but as sales fall and businesses are pressured into not cutting jobs, the unit costs will rise as a combination of wage pressures and higher borrowing costs. I feel the short term drop in retail prices is a consequence of distressed sellers, and this may get worse in the short term as the huge volume of retail LBOs start to head south and prices get cut in order to get some cash in the door, and if people simply cut back buying.

The ideal situation for banks would be for sensible borrowers to become foolish borrowers and foolish borrowers to become sensible, but I don't see how you can change people's habits...


On May 14 01:26 AM Jasper M wrote:

> nobby,
> "There is an argument that the Fed has a responsibility to boost
> confidence"
> Well, proponents of that argument can propound it to their hearts'
> content, but they have No Mechanism to accomplish that now. As after
> every other saturation of a credit inflation, everywhere you look,
> leverage is working backwards. Anyone embracing "confidence" will
> either be given cause to change his mind, or be separated from his
> capital (at which point he ceases to be a player).
> Matters little what they "throw", it's a falling safe now. All the
> good 'beds' for new credit are occupied, so new credit will be (in
> aggregate) unproductive.
> I do not see this as "stagflationary" - inevitable defaults (including
> Sovereign) will remove immense amounts of credit from the system
> over the next few years, reducing the money supply faster than the
> fed can create it. Inflation ('stag' or otherwise) can't catch on
> until so much credit has been destroyed that the physical Reserve
> Notes start to represent a significant fraction of the total (by
> some counts, they are less than 1% now, so we gots a ways to go).

May 14 07:22 AM

[Ernest Garf...:]

Your article is outstanding and timely! However, you paint the entire banking industry with one brush. Separate community banks from the rest of the industry and you will find large increases in lending activity. Besides, community banks lend more heavily to small businesses than do big banks. We can't keep up with the business run off by big banks.

May 14 10:10 AM

[User 407893:]

When supply curve moves up, demand curve will move too. Up or down? The only thing make sense for the bank business is to spend the money "wiser" than before.
Without lending money out, I bet what they could do is to increase the assets. Unfortunately one of the least risky assets would be land/houses. So I am seeing a wave of mortgage rate drops, continuing refi, and maybe not long enough, a slow bounce of house price. Through the refi market, the banks are shifting healthy assets, hopefully, and the winner will eventually be the banks with high buy powers, i.e., a lower equilibrium point of reserve and healthy assets.
Interesting to me is that the banks seems more like to return the money to the government rather than lend the money out to make profit, which indicating a weaker market prediction. In such a scenario, instead of enforcing so much inefficient bank reserves, why not the government just pursuing a higher level tax return to encourage small business and consumptions directly? Either way would not be efficient anyway. I would be happy to get a $300/month tax credit voucher to lease GM or Chrysler cars. This would make the demand curve up without giving up the couple billion dollar bailout money when they go to bankruptcy.
The big money created so far could build tens of new Dubai cities. But so far, I have seen several bank re-orgs, one fired CEO of a company which was historically claimed always be good for US, and a bankrupted company which was a logo of capital success of American modern industry in 20th century.

May 14 12:39 PM

[Jasper M:]

nobby,
The kind of credit supply contraction I expect will absolutely put paid to any attempts to artificially reserve jobs, much less raise wages.
You are correct on the pricing issue, but it goes deeper than current distress. Most of the dollar-denominated purchasing power out there 9by a Huge margin) is in the form of some kind of credit, and that means it can evaporate as soon as someone involved changes their mind.

Banks, and borrowers, will become sensible when they (and their competitors) are allowed to reap the proper consequences of their choices.

Garfield,
I don't think it was the author's intention to paint little banks with the same brush. But they represent a so much smaller chunk of the economy just now, And are (mostly) in much better shape, that they aren't really the problem. Be overlooked in these circumstances is a Good thing.

User 407&change,
Given the coming waves of ARM resets, and the Feds demonstrable inability to keep the 10 year note they are indexed to down to where those mortgage resets will be survivable, I wonder how housing prices can recover at all until at least 2012.
And I suspect t we'll have plenty more bad news by then.

May 14 01:46 PM