In one sense, this comment is very true. And hopefully without reaching for melodrama, the microcosm of data to review in this discussion has enormously much broader implications for the macro cycle of the moment in which we find ourselves. To be honest, it really has global implications when you also invite Japan and Europe to the proverbial party of the moment. The most recent Fed sponsored bank loan officer survey that hit the Street not quite a month back now starts one of the most important clocks of which we can conceive in terms of ultimately revealing the character of the current economic cycle. And that clock is the potential death of Keynesianism, or maybe more importantly the perceptions such a potential “death” will engender. When talking about macro themes, this cycle is a balance sheet recession that is different than anything domestically experienced for the last half century at least. We all know that up through the present, one of the major stumbling blocks for US economic recovery has been the lack of lending by banks. Especially important to an economy that has certainly been driven and supported by macro credit acceleration for decades and one now devoid of shadow banking asset backed credit expansion. You remember, these banks are the same folks that have been on the receiving end of Fed largesse from almost start to finish over the past three years. And yes, these are the folks that are sitting on a massive amount of excess reserves, courtesy of Fed money printing, that have not been lent back into the economy itself. But this comment or perception of lack of lending is only partially true. When analysts look at year over year bank lending, they are looking at net numbers, so to speak. They are looking at both lending and asset contraction within those singular numbers. Yes there has been gross lending, but there has also been plenty of writeoffs/loan defaults offsetting any type of net lending expansion.
Anyway, the proverbial Keynesian economic cycle clock should now start running in earnest for one very simple reason. Virtually across the board in almost all formal lending categories, the now sunshiny in outlook senior bank lending officers are apparently no longer tightening their lending standards. We've hit the important point of change for the current cycle. In fact, they are modestly easing requirements relative to recent history. Although this gentleman shall go nameless for obvious reasons, I recently personally heard the head honcho from a major San Francisco based banking institution remark that his bank simply can’t find credit worthy borrowers. That’s the reason their lending growth has not been accelerating. Of course this same institution was a major HELOC lender on the West Coast not so long ago. I guess then it was easy to find creditworthy borrowers, huh?
Anyway, as we look back across historical experience, aggregate demand for loans from the banking system, at least according to the bank officer survey, in each economic recovery cycle really began to accelerate upward when banks actually began to ease lending standards for each cycle. So now that we have hit that point of easing credit standards as per bank responses in the most recent Fed report, the important issue (although this has been the case for some time now really) now becomes loan demand. This is the proverbial Keynesian turning point, if you will. Key question of course being, will the demand for borrowing increase? Of course this is now occurring at the exact point our wonderful heroes at the Fed plan to buy more US Treasuries in the interest of keeping macro interest rate levels low. What Keynesian could ask for more, right? Banks softening lending standards AND interest rates at generational lows. We’re now all kids in a potential leverage opportunity of a lifetime candy store, no? The answer to this question will determine Keynesian vitality, or otherwise, dead ahead. Just what will the Keynesian crowd do if loan demand continues to remain tepid at best, plan their next vacation in Austria?
You’ve probably seen this data before so let's make it quick as the graphs tell the story. First up is bank lending to large companies. Credit standards have softened and loan demand actually peeked its proverbial head just barely into positive territory in the latest report. As you can see, and as is the case with the charts yet to come, drawn in with dark lines for each cycle at the point where bank credit standards went into easing mode–the turning point, if you will. As mentioned above, once this happened, up went the demand for borrowing. Will it be so again? That is now the key question of the moment.
Very quickly, I personally discount a good bit of what we see with bank lending to large companies because most truly large companies have access to the capital markets. Banks largely lost this book of business decades ago as the corporate bond market both blossomed and matured. And in today’s world of generationally low corporate bonds yields, why would any large company deal with a bank for meaningful lending needs. They wouldn’t and they don’t. Credit lines? Sure. Meaningful longer term borrowing? No way as the capital markets are the cheaper venue.
Next up is bank lending to smaller companies. This I believe is more representative of larger and smaller bank market share in terms of corporate lending (to those with often limited or actually no access to the corporate fixed income markets). The banks have now crossed the divide into the land of credit standards easing, but the demand for borrowed funds from the smaller business community has not yet found its way into positive territory. I won't drag you through this again as I've discussed small business credit within the context of the NFIB small business optimism survey too many times this year. Credit is not their key issue. Demand/Sales is the issue. But as we look ahead, it's only common sense that small businesses will borrow if they see demand/sales growth reaccelerating. If indeed the Keynesian moment is to pass quietly, I'd expect demand for loans by the small business community to accelerate very noticeably over the next few quarters. Stay tuned, but that's certainly not the case quite yet.
It's no mystery at all that commercial real estate remains very weak. This is one of the key problem areas for the banks at present, with special emphasis on the regional and community banks who are heavily exposed. A meaningful domestic macro economic slowdown and further QE ahead is moving into mainstream consciousness/consensus thinking as we speak. Depending on magnitude of economic slowing to come, CRE could indeed be destined for the proverbial double dip, for lack of a better characterization. Is that what the more than noticeable weakness in banks stocks as of late is telling us? We'll see, but it's a real possibility. No wonder these folks "can't find any creditworthy borrowers", right? For now banks are not easing credit standards for CRE. That says two things. First, it says banks indeed do see the potential for further price/collateral value weakness ahead in the land of CRE assets. And secondly, it says they are still bleeding CRE problem blood behind the opaque band-aid of non-mark to market accounting. In like manner at present, the banks are telling us they do not see positive demand for CRE loans. Good thing the question to these senior loan officers for CRE involves new loans and not refis when it comes to CRE, right? Demand for refis in CRE land is off the charts, but there is so much underwater loan values that they will never be done. CRE refi’s are not going to happen gracefully anytime soon and that remains the key issue for CRE outcomes over the near term.
Enough babbling on my part. You get it. One last issue not shown is that banks have eased lending standards for consumer loans incredibly meaningfully in recent quarters. But just look at the consumer credit numbers to get a picture of demand, or lack there of to be more correct in characterization. In summation, the Keynesian, per se, moment has arrived. Generationally low interest rates coupled with banks easing lending standards. Just what the stimulative doctor ordered? And of course the important issue is we're going to find out just how stimulative vis-à-vis loan demand dead ahead. Can we assume that at this point the year over year bank lending numbers should now reflect the true character of demand and not necessarily reflect what has been lack of lending supply up to this point? History tells us the cyclical turning point for bank lending/credit expansion has arrived. Now it's time to directly witness the quality and character of bank lending ahead. Importantly, watching the banks is critical in that the former shadow banking system that was the asset backed securities world continues to contract. If loan demand fails to materialize in meaningful fashion, as has exactly been the case in the current cycle to this point, just what will the Fed now intent on driving Treasury rates even lower accomplish outside of possibly increasing bank and Wall Street investment bank spreads for a while and simultaneously distorting what would otherwise be the true functioning and message of capital markets? The answer lies directly in front of us. The moment of Keynesian "truth" has now arrived. Of course the important question is, will it be truth? Or consequences?
A few quick last perspectives on the whole issue of bank lending. Very simply, we now find ourselves a little over one year into a theoretical economic recovery as per the headline GDP numbers and now with the blessing of the NBER. What does history have to say about the character of prior cycle recoveries in bank lending that "speak" about broad historical macroeconomic character? Just have a look.
We have indeed seen two other periods of relatively extended bank lending weakness post the 1974 and 1990 recessions. You'll remember that in the early 1990's we also saw the dramatic demise of the S&L industry along with meaningful banking system problems associated with high yield/junk debt assets. Very much a financially stressful period requiring what were at the time extraordinary Fed monetary policy measures (little did we know what extraordinary would ultimately mean). And we all know that 1974-5 saw a very deep recession, probably the only in post Depression history that even came near rivaling our most recent. But again, our most recent is differentiated as a balance sheet recession, not an economic shock (first oil crisis) driven and business led recession. Yes, the current environment now sets new historic precedent, but as explained above, the moment of truth has now arrived so we at least need to keep open minds.
Switching gears just a bit, we know many a commentator and Street strategist as of late has been heartened by the fact that stated headline inflation remains very low at present. But an important question in light of historical precedent becomes, is that necessarily a good thing for bank lending and credit expansion in aggregate? Although maybe it's too simplistic, macro or systemic inflation academically acts to support the collateral value of assets against which banks lend. Duh. So before we cheer low inflation as far as the eye can see per recent headline CPI trends, we simply need to keep in mind the relationship in the chart below that is the year over year change in both the CPI and bank lending.
Is there a certain directional correlation here? As you can see, coincidental directional movement is most pronounced over the 2000 to present period. Does the recent rate of change drop in the CPI foreshadow yet another year over year contraction in bank lending yet to come? We'll just have to see. That would certainly make sense in some type of a double dip environment, but again too early to pinpoint or call at present.
Finally, a quick peek at the relationship between the rhythm of bank lending and that of equity prices. Below is a quick look at the year over year change in bank lending and coincidental year over year change in the S&P 500. At least over the past decade, the year over year change in equity prices (the S&P 500) has bottomed and peaked prior to the peaks and troughs in the rate of change in bank lending. What does the recent year over year change in equity prices portend regarding the rhythm of bank lending looking ahead? Of course the correct answer is we're going to find out. By the way, the SPX is priced at 1145 for the current yr/yr reading below.
I suggest we all watch banking system loans and leases outstanding quite closely ahead for very obvious and important reasons regarding cycle characterization. Can the markets remain irrational longer than we can remain solvent? Or can we remain solvent longer than the markets can remain irrational? Mr. Keynes, your move. And quickly, sir, okay?
