Friday, November 20, 2015

Bank lending still booming

Outstanding loans at U.S. banks have increased over $800 billion in the past 12 months, and have been increasing at about a 7.5% annualized rate over the past year and two years. One area of bank lending—Commercial & Industrial Loans—has been expanding at 10.5% annualized pace for the past 5 years, and has expanded by over $200 billion in the past year, up 11.6%. Banks still have over $2.5 trillion of excess reserves (reserves in excess of what is required to collateralize their deposits), so bank lending could theoretically continue to expand at heady rates almost indefinitely.

As the chart above shows, the pickup in bank lending got started about two years ago, after being very weak from 2008 through 2013. It may just be a coincidence, but bank lending started picking up right around the time—in early January 2014—the Fed announced that it would "taper" its purchases of notes and bonds, which turned out to be a prelude to the end of the third round of Quantitative Easing. Prior to that time, banks had apparently been eager to accumulate excess reserves, and relatively unwilling to lend to the private sector. In effect, by accumulating excess reserves, banks were lending principally to the Fed. In the past two years this has shifted, with banks lending much less to the Fed and much more to the private sector. 

C&I Loans (shown in the above chart) are a good proxy for bank lending to small and medium-sized companies—those that are too small to access the capital markets directly by selling bonds. They've been on a tear every since the end of 2010. I've interpreted this to mean that banks as well as businesses have become more confident in the future: banks are more willing to lend, businesses are more willing to borrow. Lending isn't always good for economic growth, but in this case I think it has helped boost growth, because it is the result of increased confidence. The big international corporations may be borrowing to fund dividends and buybacks (and avoid double and triple taxation on their foreign profits), but I doubt that is the case with much smaller companies.

There is no sign here of any deterioration. Lending activity remains robust, and that suggests that the underlying economic fundamentals of the economy have not deteriorated and are possibly even improving. This lends support to the Fed's decision to start normalizing interest rates.

Since increased lending is a reflection of a reduced demand for money (borrowing money is like shorting a stock: you benefit if the value of the stock declines), it is entirely appropriate for the Fed to adopt a policy that attempts to offset that decline in the demand for money. Raising the interest it pays on excess reserves makes banks more willing, on the margin, to hold those excess reserves and less willing to increase their lending to the private sector. However, increasing IOER to 0.5% is unlikely to make a big difference, so we should expect to see further rate hikes going forward.

The risk the Fed runs is raising rates too little, too late. That's what has happened in nearly every business cycle expansion, and it explains why inflation almost always rises until the point when the Fed has finally "caught up" and tightened by enough to severely constrain the supply of credit—at which point the economy slips into recession. We are still years away from another of these credit roller-coaster rides, but that doesn't mean we don't need to worry.


Benjamin Cole said...

Scott Grannis: I am no fan of complex regulations, believing them to be inefficient and undemocratic.

That said, looking at the robust expansion in bank lending, what is the impact of Dodd-Frank?

Kenneth said...

Do you think there are significant excesses in the credit markets today? Perhaps sub prime auto loans has been claimed to be the segment with the most abuse and in greater magnitude than the subprime real estate segment in the previous downturn?

Hans said...

Bank loans are going to what sector? Subprime auto and student (Taliban) loans?

It was written that as subprime auto loans reach record levels, we are near to the end
of the economic business cycle.

Student loans, accounting for $1 trillion of debt, a third of which are in arrears.

And to what extent have bank loans gone to Wall Street, to buyback stock shares
in order to inflate earnings?

BTW, TTM S&P 500 earnings are now on a decline.

Dil said...

Very interesting, thank you.

The comments about the possibly coincidental fall in QE and rise in bank lending reminded me of a piece by Paul Kasriel, formerly from the The Northern Trust Company of Chicago, who believes that overall "thin air credit" has fallen recently and we need to be wary of interest rates increases.

He wrote in his October 2015 blog:
Five Bad Reasons For The Fed To Raise Rates Now And One Good Reason Not To

that "the sum of commercial bank credit and depository institution (primarily commercial banks) reserves held at the Fed ... In Q3-2015, year-over-year growth in thin-air credit slowed to 4.5% and quarter-to-quarter annualized growth slowed to 3.5%. This sharp deceleration in the growth of thin-air credit represents a tightening in monetary policy in a Friedman sense."

Therefore in his view, it is useful to add these two factors together.

He adds,
"The Fed has been engaged in quantitative tightening (QT) for about a year now. Unless depository institution demand for reserves were to fall, an increase in Fed policy interest rates would require a further contraction in the supply of Fed reserves. Barring a sufficient pick up in commercial bank credit, this would imply a further deceleration in total thin-air credit."

and ends with

"Rather than dithering over whether it should raise interest rates in December, perhaps the Fed ought to be contemplating another round of quantitative easing!"

Scott Grannis said...

Re student and subprime auto loans.

Student loans are indeed a big problem, as I've written numerous times. The federal government controls just about the entire market, and loans are extended to students with little or no regard for their ability to repay. It's a bubble waiting to pop. Eventually the taxpayer will take the hit because many or most of those loans will be written off. But this is hardly the end of the world as we know it. Student loans will inevitably be cut back, and colleges and universities will have to adjust their pricing downwards or else they will price themselves out of the market. It can be done.

Since 2007, student loans account for all of the net rise in consumer credit. Without student loans, consumer credit has not risen above its 2007 high.

However, household debt (which includes all forms of debt taken on by individuals) has grown very slowly since 2007, and household leverage (liabilities as a % of total assets) today is 15%, down sharply from its high of 22% in late 2008, and back to levels last seen in 1990. The debt service burden of households (payments as a % of disposable income) is at a multi-decade low.

Subprime auto loans total about $300 billion, which is a very small percentage of total household debt, currently about $14.3 trillion. Moreover, the default rate on subprime auto loans is less than 1%. Subprime auto loans, in other words, are not going to blow up the U.S. economy.

Scott Grannis said...

Re "Thin-air credit." By my calculations, this measure of credit (reserves held at the Fed plus total bank credit) now stands at an all-time high of about $14 trillion. That's up from about $9 trillion at the end of 2008, a 55% increase. That represents annualized growth of about 6.5%, which is about the same as the long-term trend rate of growth of M2. However, it is substantially more than the 3-4% annual growth of nominal GDP since 2007. I don't see how this equates to a tightening of monetary policy.

Scott Grannis said...

Benjamin, re "the robust expansion of bank lending." Look again at the first chart in this post. Bank credit declined for 2-3 years following Dodd-Frank. Even after strong gains in the past year or so, it is still far below its trend growth. Although hard to prove, I would argue that Dodd-Frank has contributed meaningfully to the lack of credit growth.

Benjamin Cole said...

Probably, although the C&I loans are now double 2005 levels.

I would say it is weak demand various crimping credit growth. Dodd-Frank should be canned anyway, in favor of a simple reform such as higher reserve requirements

Benjamin Cole said...

BTW---John Cochrane, Steve Williamson and a few other right-wingers are touting NeoFisherianism...the lowering of interest rates to fight inflation. Fed St Louis President James Bullard recently suggested we are at "permazero" whether we want to be or not.

The Fed's tools going forward may be a lowering of interest rates on excess reserves and a growing balance sheet (the latter a wonderful deal for income and capital gains taxpayers).

I ponder if zero-inflation economies are inherently fragile. Seems like they are. There is also the problem of a rapidly growing underground cash economy when you hit zero inflation. People start saving in the form of paper cash, and then start transacting in cash. This results in heavier taxes being levied on the above ground sectors, and eventually some sort of collapse or Latin-style economy.

George Phillies said...

Your bank credit graph looks rather like the "missing growth" graph you sometimes show us. I will let you comment and explain, or not.

Scott Grannis said...

George: Interesting observation, and I would agree that the relatively slow growth/rebound in bank lending is similar to what has happened in the economy in general. I've been forecasting a "sub-par recovery" ever since early 2009, for the following reasons: 1) burdensome regulations (e.g., Obamacare, Dodd-Frank), 2) too much spending (e.g., ARRA, food stamps, emergency unemployment benefits), 3) anti-business sentiment (e.g., we need to punish the banks for 2008, big corporations are inherently evil), 4) high marginal tax rates (especially corporate income taxes, which are the highest in the developed world), and 5) widespread risk aversion (as evidenced by very low interest rates, weak business investment, strong growth in bank savings accounts, generally strong demand for money and money equivalents). Bank lending has been weak (until recently) because banks were reluctant to lend (risk aversion) and people and businesses were reluctant to borrow (risk aversion leading to deleveraging). The recovery has been sorely lacking in confidence and "animal spirits" for the reasons cited above, and that's what's given us slow growth in bank credit and a sub-par recovery.