Thursday, November 6, 2008

The paradox resolved: Consumer and firm loan growth look healthy on pre-existing lines of credit

The Fed’s statistics on both Consumer and Commercial and Industrial (C&I) credit are not consistent with the results of the Fed’s Senior Loan Officer Survey on Bank Lending Practices: there appears to be healthy lending in spite of record tightness of lending standards. The newest Senior Loan Officer Survey provides some insight to this paradox. Loan growth is seemingly healthy, but the lending is mostly being done on revolving lines of credit.

Exhibit 1: Consumer and C&I loan growth remains healthy

This chart presents monthly consumer and commercial industrial (C&I) loan growth as reported by the Federal Reserve’s H.8 Tables through the end of October 2008. Consumer loan growth rose 1.8% in October and C&I growth surged 3.4%.

Exhibit 2: But Consumer and C&I lending standards have tightened substantially

This chart illustrates the Senior Loan Officer Survey for both consumer and C&I loans through September 2008. Consumer lending standards hit their peak in the second quarter of 2008, falling slightly in the third quarter. However, C&I lending standards continue to rise for small, medium, and large firms.

The paradox: How can loan growth still flow if bank standards are at record highs (tight)?

I argued that consumers were increasingly drawing on their revolving lines of credit, distorting the implications of aggregate consumer loan growth. Consumer loan growth is positive, but only because revolving credit is surging (which too has slowed since then). As credit card debt increases, the risk of a “revolving credit” crunch grows, which would certainly result in a sharp decline in consumer loan growth.

However, the Federal Reserve does not break down the C&I loan data into revolving and non-revolving lines of credit. Finally, the October Senior Loan Officer Survey presents some insight to the surge in C&I loan growth (3.4% in October): "In response to the special questions, significant net fractions of large domestic banks and U.S. branches and agencies of foreign banks reported increases in C&I loans drawn under preexisting commitments. Moderate fractions of all banks, on net, reported increases in C&I loans not drawn under such commitments."

So there you have it: the Federal Reserve’s aggregate growth for both Consumer and Commercial and Industrial credit is being driven by revolving (pre-existing) lines of credit. There is evidence that a credit crunch underway in spite of the surge in bank lending as reported in the H.8 tables, and no paradox exists.

I do believe, though, that with the U.S. government's obvious commitment to “buy” an economic expansion – a second stimulus package (up to $300 billion) early next year and the Fed’s balance sheet expected to reach $3 trillion by the end of the year – will eventually push through to the banking sector, and non-revolving lending will resume in early 2009.

Rebecca Wilder

5 comments:

  1. Did you hear Pelosi's comments - 1st thing was about getting the stimulus package on track - buy jobs and help the economy. Can't wait to hear who gets the Treasury position. Hope it isn't another unemployed Bear-Stearns type. I've found it interesting that my personal credit card interest rate has not changed at all - still 5%. If I were in some peoples situations, I would have to turn to the Card(s) to survive until it all implodes. And, the companies are still pushing for new signups.

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  2. "I do believe, though, that with the U.S. government's obvious commitment to “buy” an economic expansion – a second stimulus package (up to $300 billion) early next year and the Fed’s balance sheet expected to reach $3 trillion by the end of the year – will eventually push through to the banking sector, and non-revolving lending will resume in early 2009."

    Take it from an ex-banker, you'll never get the banks to loosen credit simply by throwing more capital at them. That's a necessary but insufficient condition.

    The other element of the equation is bankers judgement of borrowers capacity to repay. For example in the case of the consumer, does (s)he still have a job? In the case of a public works contractor, does (s)he have any government contracts? In the case of any manufacturer, how does his/her order book look? In the case of new investment, Do the projections and business plan look realistic, or do potential investors even have the courage to make such plans?

    I suppose it's part of the pushing on a string phemenon.

    Anyway, if new loan commitments don't increase, it's obviously not entirely the fault of the banks.

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  3. In short, remember the 3 C's of Credit -
    Character, Collateral, and CAPACITY

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  4. Hi Farrar,

    Thank you for your insightful comments! I agree when you say “The other element of the equation is bankers judgement of borrowers capacity to repay.” This is why credit always becomes scarce during a recession. It would not be a rational decision for bankers to increase lending when the unemployment rate is rising and labor income is falling. Further, the Fed cannot force bankers to lend, which is why – as you say – current Fed policy fits the metaphor of pushing on a string. However, don’t you think that there is a better chance that some of the liquidity will actually flow out to the real economy as the volume of liquidity in the banking sector grows? Perhaps not, but the Fed better be ready to pull back on the reins once bankers are more apt to lend.

    Again, thanks for your insight.

    Rebecca

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  5. Hi Terry,

    Thanks for reading! And thank you for your email.

    In your email, you said this: “Things have changed in the latest report -- I'm no expert, but the 3.4% growth in C&I seems to have been undone (reverted to trend). See charts at http://terrillmoore.typepad.com/ji_bai_zi/2008/11/a-closer-look-a.html.”

    You are totally correct. The chart in my post is monthly data through October, and in November, things started to revert. You can see this in the revesion on the y/y graph in this post: http://www.newsneconomics.com/2008/11/paradox-remains-bank-lending-flows-in.html.

    In your post, the huge decline that you get is presumably two weeks after the October 10th release, http://federalreserve.gov/releases/h8/20081010/. There was a surge in bank lending that was not really a surge – it was simply a transfer of assets from a non-Fed bank to a Fed bank (see the bottom of the release).

    Pretty soon the bank lending data will fall sharply as existing lines of credit run dry (both on the consumer and firm side). I like how you converted the lending series to contributions to total loan growth.

    Rebecca

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