Thursday, December 3, 2009

Are Banks Strangling the Recovery?

The latest FDIC Quarterly Change in Loans Outstanding shows a dramatic tightening in credit, as the chart at left shows. Remember the awful days of late 2008 and early 2009, when the economy fell into a tailspin and the S&P 500 bottomed at 666? The cause of that pain ultimately stemmed from contracting credit as shown by the steep fall in loans of some $256 billion over the six month period of late 2008 and early 2009.

Well, the most recent data shows that the contraction is now more severe than that period. Loans outstanding fell over $210 billion in the fourth quarter alone. Apparently, the primary factor between the US economy and a further tailspin is the Obama stimulus bill, which has added up to 3.2 percentage points to GDP, according to the non-partisan CBO. A secondary factor is probably the Fed, which is single-handedly keeping the residential real estate market afloat through massive purchases of mortgage backed securities (MBS). Given the contraction in lending shown above we should all be very thankful for the Obama stimulus and the Fed's quantitative easing program, which includes expanding the money supply by purchasing MBS. But, we are nearing the halfway point in stimulus spending and the Fed's purchase of MBS is winding down, as it is scheduled to end in the next quarter.

What then?

Bad things, I fear. And I am not alone. Paul Krugman sees a rising risk of a double dip recession. Jeremy Grantham, the stellar value fund manager with an unrivaled knack for getting predictions right, says that right now things look like April 1930, when the stock market went up nearly 50% over a six month period before the real crash later that year. I could cite a bevy of statistics to support the view that we should all fasten our seatbelts.

But I think it all comes down to the banks. The amounts of cash they are hoarding boggle the mind. The four largest banks in the US now hold $1.53 trillion in cash--which is putting a huge dent in their profitability--up 67% since 2008.

The chart at right shows that banks now hold about $1.1 trillion at the Fed earning a measly .25 percent in interest. Most of this money is government money, in that it most likely came from the various efforts of the Fed to bailout the financial sector.
Note that it is now at an all time high and soared $300 billion in the last quarter.

At one level, I am tempted to think the hoarding is about paying back TARP money, as BOA announced today. But, the numbers are way too large for that explanation. I also thought for a while that the banks were fearful of general macroeconomic instability. But, the hoarding accelerated as the downturn decelerated.

So the only remaining conclusion is the banks are terrified by their own balance sheets. They are holding reserves against losses yet to come. I think we could have avoided this by forcing out managers and letting new management write-down everything in sight. Or, as Joseph Stiglitz urged we could have just formed a new bank with no legacy asset hangover. But that train left
the station.

We just have to wait for losses to come in. Goldman Sachs posits that we will have 13 million more foreclosures in the next 5 years. Others note that commercial real estate is melting down right now. If correct, this suggests serious pain to come.

The banks know. Their hoarding may be leading indicator as well as the best predictive tool we have.

Did you know the Nikkei Index was at 40,000 on 1/1/1990 and today its under 10,000?

Any cursory analysis suggests we may be turning Japanese.

1 comment:

  1. I think I'm turning Japanese, I think I'm turning Japanese, I really THINK SO!