Creating The Next Financial Crisis

by: Steven Hansen

Summary

Banks are easing loan standards.

Consumer credit is growing.

Savings rate is near all-time lows.

Recently the Federal Reserve released their April 2014 Senior Loan Officer Opinion Survey showing banks generally eased their lending policies for commercial and industrial (C&I) and commercial real estate (CRE) loans - and experienced stronger demand for both types of loans over the past three months. Additionally, this week saw the release of growing consumer credit [read analysis here]. Is this economically good news or bad?

Do banks really understand when to tighten or loosen lending?

It seems the banking industry sees trouble coming and tightens - but it is already too late. There is a continuous boom-bust cycle. Banks loosen until they see an increase in loans being written off - red line on graph below - and then start tightening. There appears to be no scientific method of understanding the "correct" lending requirements except by crossing the line and then reacting.

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Do Banks Understand When to Keep Loans on their Books or Securitize Them?

The majority of bank loans are for consumers. It seems before 2000 banks understood consumer economic cycles, and dumped loans off of their books in advance of recessions. In the Great Recession, banks were caught with a high level of commercial and industrial loans.

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Why are people or businesses borrowing?

I have the same issue with borrowing as I do with government deficit spending - it does not matter how much you borrow (or deficit spend) as long as the spending is biased towards future benefit. Buying ice cream provides no long-term economic benefit. Economist and entrepreneur Warren Mosler opined:

Yes, lending has picked up some. Here's some longer term perspective and note how said lending is a seriously lagging indicator, which makes sense. We could be seeing borrowing to pay utility bills, fund unsold inventories, etc. etc. all of which is followed by less spending. or it could be proactive borrowing to spend due to 'feeling good about things' that leads to a 'virtuous' up cycle. Problem is, imho, the federal deficit is too small and the auto stabilizers too aggressive for the 'borrowing to spend' to get ahead of it, which is why I've been writing about the downside risk for the last few quarters, with that narrative still intact and, to me, supported by the data. (yes, others see it differently)

It does matter why one borrows if there is no future benefit for debt whilst the debt is being repaid. It simply puts the economy in a position of paying back tomorrow for things enjoyed today - which lowers the real future spendable funds.

Would It be Better to Save and Purchase or Buy on Credit?

There is correlation between the declining savings levels of consumers (green line in graph below) and declining personal consumption (red line in graph below).

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How much of consumer spending is frivolous, or simply does not make sense financially?

Here I have no answers or statistics. We know that credit is important - but so is savings. At this point the ratio between income and spending is approaching historical highs - which indicates a declining ability to spend more, unless use of credit (borrowing) increases further.

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My Takeaway

My tea leaves are saying the median consumer is tapped out between spending the paycheck and credit limitations - although the business sector seems in relatively good shape. The primary way left to grow borrowing (for consumption) in 2014 is to loosen lending requirements. This sets up the next boom / bust cycle - and potentially our next Great Recession.

I am at a loss to explain why the bank lending requirements should be loosened.

My usual weekly economic wrap is in my instablog.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.