Tuesday, February 7, 2012

Deleveraging is history

These two charts may look pretty similar, but they represent two very different things. The top chart shows total outstanding Commercial & Industrial Loans (a proxy for bank lending to small and intermediate-sized businesses), while the bottom chart shows total outstanding consumer credit. Both started to decline in late 2008 as the economy cratered, the financial system was virtually paralyzed, and consumers were clobbered by collapsing home and equity prices. Consumers and businesses struggled valiantly to deleverage and de-risk, and banks were happy to oblige, not anxious at all to increase their lending at a time when every borrower was suspect and most banks were teetering on the verge of insolvency.

Things started to change about a year ago. C&I Loans are now rising at an 11% annual rate, and although consumer credit is up only 3.7% in the past year, it was up at an annualized rate of 7.8% in the final three months of last year. (Both series are seasonally adjusted)

One important thing about the releveraging activity that we see here is not that it will directly boost the economy, because more credit does not necessarily equate to more growth. More credit today means that everyone—businesses, consumers, and banks—feels more comfortable about taking on additional risk. It's a measure of rising confidence, and that bodes well for future growth. It's also important because it means that financial markets are functioning more normally. Credit expansion can't create growth per se, but it can facilitate growth by more efficiently distributing the economy's resources from savers to investors.

Of course, credit expansion in the context of the banking system's $1.5 trillion in excess reserves could also be the canary in the inflation coal mine—the first sign that banks are starting to use their reserves to create new deposits and thus expand the money supply. M2 has increased by $568 billion in the past seven months, for an annualized growth rate of 11%, which is about double the rate that M2 has averaged over the past 15 years. Too much of this sort of credit expansion could eventually be a bad thing. So far, however, we are only in the early stages, and I see it more as a harbinger of a healthier economy than of any significant near-term rise in inflation.

For now, these charts are additions to the long and growing list of signs that the U.S. economy is slowly and gradually improving.


ws4whgfb said...

There may be a new round of deleveraging coming up soon:


Your standard commercial loan goes for five years, at the end of which you either make a big balloon payment (what it is that balloons remind me of?) or you refinance, ...

The value of U.S. commercial properties has declined by an average of 45.7 percent since their all-time high in 2007, according to Real Capital Analytics. Those 2007 vintage loans weren’t exactly bulletproof: Typical terms included a 20 percent down payment and a five-year payment schedule that required little more than interest payments. An $80 million mortgage on a $100 million property is not so bad, but an $80 million mortgage on what is now a $60 million property is a problem. More than half of the 2007-vintage loans are expected to have trouble refinancing, and maybe well more than half.


Standard & Poor’s advises: “One-third of maturing loans are for office properties, for which five-year lease terms are fairly common — and if tenants don’t renew these leases, securing new, long-term lease commitments may be more difficult in the current environment. Those leases [were] signed in 2007, at peak rents will likely reset to lower levels as five-year leases roll.” S&P’s bottom line: “50%-60% of the 2007 vintage five-year-term loans maturing next year may fail to refinance, and retail loans are at the greatest risk.”

brodero said...

A missed fact...Household debt service plus Government debt service to GDP is at its lowest level in 30 years....

Benjamin Cole said...


I know of vulture fund real estate investors who say just what you say. The big stuff is coming to market now.

On inflation:

I think the threat is deflation. Many economists have been barking up the wrong tree now for three straight years. Ever we hear of the threat of inflation, despite the fact that a round of moderate inflation and robust growth would be a terrific tonic on the economy.

Is the purpose of macroeconomics to obtain zero inflation, or robust growth? You would think that syuccess is zero inflation.

Look at Japan if you think that is true. Be prepared for 20-year-long bear markets in stocks and property (in which values fall by 80 percent) and a 20 percent decline in industrial output.

The USA thrived from 1982 to 2008 with inflation nearly always in the 2 percent to 6 percent range. We are at zero inflation right now.

Can we have some boom times first, and then worry about inflation?

Junkyard_hawg1985 said...


A primer on cause and effect:

Rapid economic growth tends to cause inflation.

Inflation does not cause economic growth.

Being tall helps you play basketball better.

Playing basketball does not make you taller.

Unknown said...

You still have the albatross of the housing market weighing us down. Every major group with credibility that analyzes the housing market is predicting further price declines. The only group forecasting price increases is the the NAr. What a surprise...clueless shills.
S&P Case-Shiller -3.7%, LPS -4.8%, FHFA -1.8%, FNC -4.6%, CoreLogic -4.3%, Radar Logic -7.1%, Clear Capital -2.2%, Zillow -4.6%.

Sales activity will increase this year due to the improving economy and good affordability. The direction of house prices will not be determined by demand. It’s supply that will govern what happens. The banks have no shortage of REOs.

The banks are clearing out the delinquent mortgage squatters, and these houses will increase the supply of for sale homes. Further, the sellers will be motivated. The displaced former owners will not have the down payment or qualifying credit to buy anther house which removes them from the potential buyer pool reducing demand. So what we are left with is an increase in the supply of motivated sellers and a decrease in demand. That spells trouble for home prices.

To see this in action, take a look at the Las Vegas housing market. Affordability has never been as good as it is today. It costs less on a monthly payment basis to own a house than it does to own a car. Despite this fact, prices keep falling due to the imbalance between supply and demand. A similar dynamic will be operative over the next few years.

Benjamin Cole said...


The role of moderate inflation as an economic lubricant is well-known, see the "sticky wages' problem. Additionally, as we are over-leveraged now, moderate inflation would help us deleverage.

We still have the problem of commercial property loans, which were made in nominal dollars. Going through a steep property deflation (as we did) unless corrected, leads to long-term banking problems (see Japan).

The risk ahead is not moderate inflation, but Japan-itis. In fact, we are doing just what Japan did: Passively tighten the money supply and engage in deficit spending, That was an epic failure in Japan.

Do not listen to the Econo-Shamans and Theo-Monetarist chanting verse about the exalted and sacred status of gold and paper currency.

Modern economies do far better with moderate inflation. The USA had inflation of between 2 percent and 6 percent from 1982 to 2008, and it was one of the great long booms in US history. See arch-conservative George Gilder for his views on inflation, especially commodities inflation. Even Milton Friedman (and John Taylor, and Allan Meltzer and Ben Bernanke) all told Japan to print more money. Obviously, extremely conservative economists believe in printing more money when circumstances call for it.

Fighting inflation now is like applying leeches to cure anemia.

Junkyard_hawg1985 said...


You claim: "The USA had inflation of between 2 percent and 6 percent from 1982 to 2008, and it was one of the great long booms in US history." If inflation caused growth, the period betwen 1973 and 1982 should have been boom years, but they weren't because we had a fed that agreed with your view of inflation and money supply. When you do things to stimulate inflation as was done during the 1970's, it does not improve growth, only boosts inflation.

Benjamin Cole said...


Yes, I do not wish to duplicate the 1970s. I would be very happy with a replay of the 1980s, 1990s, or 2000-2006 eras.

We boomed with moderate inflation, I am not advocating double-digit inflation.

I also do not advocate a peevish fixation---really an perverted obsession---with inflation. It ain't that important.

Aks yourself this: How do you know when we have obtained exactly zero inflation in a world of rapidly evolving goods and services?

If deflation and inflation are theft, then we must target exactly zero---even as businesses and consumers constantly migrate to better technologies. We must tighten the money supply every time horse shoes go up in price.

Better we target prosperity. I like boom times. Bring 'em on.

Junkyard_hawg1985 said...


Money replaces barter to make life easier in making transactions. To meet the replacement need for barter, it has three basic requirements:

1) Storable - i.e. metal good, milk bad.
2) Divisible - i.e. metal is good, houses are bad.
3) Store of wealth - i.e. metal is good, depreciating currency is bad.

I'm for having money that is a store of wealth. Prices for individual items can rise and fall at will based on supply and demand. What our federal reserve is currently doing is depreciating the currency by monetizing federal spending. This allows the government to buy stuff out of thin air by stealing fractional parts of people's money. Monetizinng debt in no way, form, or fashion brings about prosperity. When the states had their own money during the Articles of Confederation days, they loved to monetize spending. That practice led to econominc hardships, not prosperity. When the Constitution was written, it fixed the value of the dollar to a standard weight of silver because the founders saw the folly in monetizing debt. This is when America's economic growth really began. We have forgotten the lessons from history.