Sunday, November 30, 2008

Loan Delinquency Data Suggest Commercial Banks Are Doing OK, Nowhere Close to Great Depression II

The chart above shows delinquency rates for business and agricultural loans at all U.S. commercial banks from 1987:Q1 to 2008:Q3 using recently released Federal Reserve banking data through the third quarter. In both cases, delinquency rates for agricultural and business loans are close to all-time historical lows, and especially for business loans (1.61%) far below the 3.92% peak in the second quarter of 2002 following the last recession and far below the 6% peak during the 1990-1991 recession.

Although delinquency rates will likely rise in the fourth quarter, the low rates of delinquency for non-consumer loans (business and agricultural) through the third quarter 2008 show that we are nowhere close yet to the delinquency rates for business/ag loans during the recessionary conditions of 1990-1991 or 2001. So before we start making comparisons to the Great Depression and the 1930s, maybe we should first be using the last two recessions as our benchmark comparisons.

Of course, as expected, the major weakness for bank loans is in the real estate sector, and delinquency rates for real estate loans through the third quarter reflect that weakness (see chart below). Real estate loan delinquencies are approaching 5%, which is higher than the 2001-2002 peak of 2.2%, but not yet as high as the 7.5% in 1991.

Likewise, the delinquency rate for consumer loans (see chart below) of 3.8% is below the 5% peak in 1991, and below the rates during the peak of the economic expansion of the 1990s.

Bottom Line: Delinquency rates for commercial banks suggest weakness in the real estate sector, but some relative strength and stability in the commercial loan segment for business and agricultural loans. Most importantly, we're nowhere close to the drastic banking conditions of the 1930s, which were so severe that almost 10,000 banks failed in the four-year period between 1930 and 1933, and more banks failed (4,000) in a single year (1933) than the sum total of all bank failures in the 74-year period since 1934 (3,566). Great Depression II? No way.

6 Comments:

At 11/30/2008 2:00 PM, Blogger the buggy professor said...

1) Mark: These are very informative charts, which help all of us to keep a more rounded perspective on what's happening to the financial side of our economy . . . at any rate in the commercial banking system.

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2) Right now, as other posts of yours have shown --- for instance, retail sales up somewhere between 2.2% and 3.0% after Thanksgiving last week --- we would be facing a downturn of a moderate sort, maybe similar to 1990-1991, except for one big problem: there is clearly a credit-squeeze emerging in the US.

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3)Some hard evidence:

The squeeze was shown by an abrupt decline in the money-multiplier in August this summer . . . most likely, to follow the consequences, the cause of the abrupt reaction of the Federal Reserve and the Treasury in mid-September to adopt a variety of ad-hoc measures to try to stave off a major meltdown of our entire credit-system --- not least, short-term purchases of commercial paper that enable both big banks and corporations businesses with good credit ratings to get short-term credit that they need to pay off immediate debts until profits on imminent sales (up to nine months in the future) emerge to pay back the investors in their commercial paper.

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Consider what one analyst noted back on October 3rd:

"What we are now experiencing is something different and deeper than perhaps anyone imagined," says Steven Busby, a consultant with Greenwich, which conducted its survey from September 16 to September 24. "This is a true crisis of liquidity — even the strongest companies are struggling to get short-term financing. It may not be long before companies are forced to curtail operations due to lack of funding and the full consequences of this crisis become evident in the broad economy."

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The same problem, it emerged, was affecting long-term bonds. According to the same article,

Nearly two-thirds (62 percent) of the companies say their ability to issue long-term bonds has been curtailed, including 64 percent of those with more than $5 billion in annual sales. Little surprise, 70 percent of companies say the cost of issuing long-term bonds has increased, including 30 percent whose costs have risen significantly."

Source: click here

And that, mind you, was the financial situation a good two months ago.


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4) Further evidence: this time, the big growth of excess reserves in commercial banks . . . which means that they aren't lending out their money, presumably even to borrowing business firms and households with good credit records.

Specifically, the monetary base that the Federal Reserve directly controls --- currency held by the public and reserves held by banks --- expanded a remarkable, even astonishing, 72% between September 10th and November 16th this year.

Wow!

And yet --- a clear sign of a marked decline in the money multiplier (and hence velocity in the monetarist quantity theory of money MV = PQ where M is the money supply (M1 or M2 or MZM, not clear), and V is velocity, and P is the price level of the economy and Q is growth in economic output) --- and yet the money supply itself grew less than 1%



……….


5) What Follows?

It’s this financial crisis of a systemic sort that makes the current real-economic downturn so worrying. Enter Ben Bernanke’s own impressive studies in depth of the causes of the Great Depression between 1929 and 1933.

It wasn’t just the initial crash on Wall Street, nor the failure of monetary policy that let serious deflation begin between 1929 and 1933 ---along with a major plunge in GDP and an explosion in unemployment from around 3% to over 20%, plus a collapse in international trade and neo-mercantilist policies of competitive devaluation --- that caused and prolonged the Great Depression. It was also that the Federal Reserve did expand the monetary base by 18% (not 72% in two months!), but the money multiplier itself bell by 38% --- and so the money supply actually decreased in that four year period by 28%.


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6) What else follows.?

Well, enter Ben Bernanke’s own impressive, in-depth studies of the Great Depression. His main conclusions were not just that the money supply fell, but that the entire credit-system broke down. As a reaction to the explosive growth in debt during the 1920s boom, there ensued after the stock-market crash a powerful, apparently non-stoppable debt-deflation --- call it deleveraging if your want --- in both the business and household sectors. Farms defaulted by the millions; so did small firms and households.

The result?

It wasn’t just the money supply, it was the crash in the credit-markets and their freezing up that undermined aggregate demand and turned the recession of 1929-1930 into the ferocious Great Depression of the next 3.5 years.

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7) Against this background, the policies of the Federal Reserve --- along with Treasury bailouts and the like --- make a lot more sense.

This is the case despite all the improvisation for such unparalleled financial interventions and prop-ups by the Fed and Treasury to try not just to increase the money supply to hold off deflation (which may have been occurring these last two or three months), but to prevent the system-wide financial crisis from turning into an Arctic-winter over several years in the credit-intermediation functions of our financial institutions.

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So the Fed has pumped tremendous money into the bank reserves; it has even paid about 0.6% interest on them to create a floor under nominal interest rates so they won’t plunge to nominal zero (the limit); it has recapitalized many big banks on the liability side (taking preferred stock in return), just as it has tried to increase liquidity on the assets side by buying (some) toxic assets; it has even begun to buy longer-term assets like housing mortgages and loans to Freddie Mac and the other government-backed mortgage agencies in order to try to reduce long-term interest rates (over which its normal policies have no direct control); it has also --- clearly, despite no proclamation--- switched the two-decade old policy from targeting short-term interest rates (the Federal Funds rate for overnight interbank loans) and the related Taylor rule and toward QE . . . quantitative easing (expansion) of the money supply.


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7) Will these radically innovative monetary policies, backed by the Treasury and now extending outward from commercial and investment banks and insurance companies, work to hold back or reverse deflation and buffer the shocks to the real economy by the financial crisis . . . which, remember, is the first one of a systemic sort and simultaneously on a global basis, since the early- and mid-1930s?

All complicated, remember further, because the US is now a large debtor nation with a far far smaller manufacturing (and hence export-oriented) economy --- the exact opposite of our situation in the 1930s. It’s China that has both enormous over-supply of manufacturing and huge dollar- (and some euro-) denominated assets worth $2 trillion. What will China do? (If it seeks to devalue the Yuan --- the remimbi in foreign-exchange market --- in order to prop up its rapidly falling export-oriented firms, which contribute nearly 40% to China’s GDP and take most investment after residential and office-buildings, then we have to expect the emergence of trade-retaliation by the US and the EU as a distinct possibility sooner or later).

….......


Back to the question then: will the Fed’s and Treasury’s policies work to salvage our financial system and hence stave-off a credit-crunch of a prolonged sort?




The only honesty answer: right now, it’s way too soon to tell. In the meantime, the new Obama administration will be switching to extensive fiscal expansion by funding a variety of programs, mostly in infrastructure to begin with. Note, finally --- relevant to monetary policy --- such fiscal expansion will have a short- and mid-term boosting effect on aggregate demand only if:

• There is a multiplier effect of such expenditures

• There is limited or no crowding out of private investment (which requires --- a very likely continued policy --- monetary accommodation by the Federal Reserve to offset any crowding-out)


• There is no rise in interest rates --- thanks to such monetary accommodation by the Federal Reserve --- that brings in a further flow of capital from Europe and Asia and the Middle East on top of the already safe-haven flight of such capital into the dollar. If there is such a rise in interest rates, then the dollar will further appreciate and hence further reduce exports and increase (to some extent) imports from abroad . . . the exact opposite of what we want from fiscal expansion.


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8) The conclusion?

What we’ve said so far deals with the current financial crisis of a systemic sorts and its fallout on the real economy . . . all on a very intricately intertwined global scale.

Enter the long term. In the long-term, to put it tersely --- over a decade or two, say --- the US, one way or another, will not be able to grow as it has since the early 1980s by consumer-binges (the 1980s and the 2000-Bush era --- the latter dangerously so), soaring federal deficits and hence national debt, and constant financial innovation of an unregulated sort that leads to a marked swing between excessive financial balloons and bursting . . . all accompanied by massive leveraging of debt by households, businesses, and the government.

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Such deleveraging is inevitable. And it will almost certainly be accompanied by far more ambitious financial regulation --- including hedge-funds and derivatives of all sorts --- and far more switches from personal consumption to more savings, with less runaway ballooning and bursting in the stock-market and wider bond-markets. And, one way or another, an ability to make sure that government deficits occur on a countercyclical basis, not in a structural sense as they did in the Reagan-and Bush-Sr and Bush-W eras.


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Michael Gordon, AKA, the buggy professor

 
At 11/30/2008 2:15 PM, Blogger jorod said...

I would suggest you look at debt levels. That's the real test as people have to liquidate assets to pay debt. That's what has been killing stocks, commodities, hedge funds, banks,....

 
At 11/30/2008 6:39 PM, Blogger stilettoheels said...

Yep. The commercial banks are in just fine shape.

Now how many dollars has the Fed and Treasury extended and committed to the financial sector? $3.2 trillion extended and $8.5 trillion committed.

Yep, that was a hecka of a glowing quarterly report issued by the FDIC.

FDIC-insured commercial banks and savings institutions have failed in nominal dollars of assets thus far this year at twice the rate of the S&L failures of a generation ago. And the credit card, auto loan, commercial real estate tsunami of defaults is heading towards shore.

Yep. The commercial banks are in just fine shape.

Bottom line: In Q3.08, the banks are back to the early 1990s recession by most measures. Once the early 1980s are taken out, then it will be the Great Depression II. If your track record about the 2007/8 recession is any indication, methinks you are not in a strong position to make any judgment calls.

Yo buggy, have you heard about academic abstracts or executive summaries.

 
At 11/30/2008 7:01 PM, Blogger the buggy professor said...

"Well, enter Ben Bernanke’s own impressive, in-depth studies of the Great Depression. His main conclusions were not just that the money supply fell, but that the entire credit-system broke down.

"As a reaction to the explosive growth in debt during the 1920s boom, there ensued after the stock-market crash a powerful, apparently non-stoppable debt-deflation --- call it deleveraging if your want --- in both the business and household sectors. Farms defaulted by the millions; so did small firms and households."
---- the buggy professor


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1) Please note the phrase in quotation marks: "debt-deflation" especially.

When, hours after I initially posted the earlier commentary --- pounded out, as usual, at a high-pulsating rate --- I just came back to Mark's site and re-read that paragraph.

As it stands, that italicized phrase is possibly wrong --- at any rate, ambiguous.


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2) The ambiguity --- and possible error --- has to do with two likely distinct phenomena:

* Asset-deflation, in which stocks and bonds and housing among other saleable assets that get over-priced in a long unsustainable boom --- not least owing to easy credit and low margins on buying stocks and bonds and very high liabilities in the financial and household sectors --- will have to come down to more sustainable levels before the real economy's growth can recover to its long-term potential.

That potential is set on the supply-side: inputs of labor, inputs of capital, and technological progress --- the latter meaning advances in knowledge of all sorts, whether embodied in new and better machines or better existing production techniques or better management of firms or even, more contestably, better worker skills. (Some economists think they can proxy improved worker skills numerically and use that proxy to qualify the quantitative inputs of labor . . . a dispute irrelevant here.)

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* Debt-deflation , especially as the great American economist, Irving Fisher --- the real father of modern monetarism --- coined the phrase back in the very early 1930s.

By that he meant how --- in the face of a declining price-level (deflation) --- the nominal debts of households and business firms grow in real terms.

As deflation continues and the price level falls, so, very likely, will nominal wages. In that case, indebted households and businesses find the burdens of payments on the interest and principal increasingly burdensome and are unable to pay their creditors.

Hence the tremendous mortgage failures in farming and elsewhere, along with the freezing up of the financial credit-system and systematic debt-deflation. It was the interaction of all that with a deflationary fall in the price level, so Fisher argued in 1933, that 1) transformed the recession of late 1929 and early 1930 into a Great Depression --- a price level fall of 25%, a crash of GDP of around 30% (and maybe 44%, depending on how you take into account deflation to get to real GDP), and an explosive growth of unemployment of 20% or more --- and 2) prolonged it for the four years he was analyzing.


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3) Against this background, I trust, you can see the problem of distinguishing clearly asset-deflation or debt-deflation. It all depends on what is happening to the price-level of the economy.

Asset-deflation means, in effect, deleveraging the enormous debt of American households and business firms (not all), but in the financial system certainly and in many other key industries. That is inevitable. It will require Americans to pay off large debt, including eventually government national debt --- how much will depend on the growth of productivity and real GDP --- in the future. At most, the path back to sustained potential GDP of the US economy can be reduced in its negative shocks by intelligent (and lucky) monetary policy and fiscal policy.

One way or another, though, Americans will be spending less of their income on consumption in the future, saving more accordingly, and being far more wary of debt. Businesses, especially in the financial system, will have to be rigorously deleveraged from extravagantly dangerous levels of liabilities to overall capital equity, and return to proper credit-analysis. And proper credit-analysis means that they allocate capital by considering the credit-worthiness of any debtor --- household or business --- and take into account the risks involved of future default.

Only in that way will financial institutions do what they are supposed to. No, not make huge sums of money for their managers --- as when, a figure still hard to believe, the leading 24 hedge-fund heads last year earned more than the 500 (very handsomely rewarded) CEO’s of the Fortune 500 firms --- but ensure that they allocate capital efficiently and accountably for a capitalist economy.

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By contrast, debt-deflation is a huge possible danger that Bernanke --- a scholar very much in the mode of Irving Fisher (whose work on the breakdown of the US economy Friedman tended to ignore, focusing instead on the problems of a shrinking money supply in the 1929-1933 period) . . . the two of them, Fisher and Bernanke, aware of how dependent complex modern economies are on the flow of credit to sustain themselves.


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4) There's a somewhat related problem: distinguishing between disinflation and deflation.

Disinflation is generally desirable . . . a slowdown in the rate of annual inflation (usually core CPI for the Federal Reserve, but also general CPI that includes volatile food and energy prices).

What the Federal Reserve has generally been concerned is not to let the nominal inflation rate fall below and annual 2-3%.

When that happens, the specter of a general fall in the price level emerges. And once that happens, debt-deflation looms as a very dangerous, self-sustaining force unless the Federal Reserve can reflate the economy even if nominal interest rates fall toward or to zero . . . exactly as happened in Japan in the mid- and late 1990s and into this decade.

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It took the Japanese central bank about four or five years into its stagnation and occasional falls into deflation and recession before it switched from a zero-interest rate policy to massive quantitative easing.

That QE started in 2001, and it took another 3 years or so before the price level was able to regain growth above zero percent (2004 on).

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Michael Gordon, AKA, the buggy professor

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PS Please note that the buggy prof has drawn on the analysis of Scott Andrew Urban for his comments here. Click here for Urban’s much lengthier, well-documented argument. It also includes an IMF chart on the trends in the Japanese price-levels and efforts by the Japanese central bank to expand the money supply.

 
At 12/03/2008 8:11 PM, Anonymous Ann Heitland said...

Regarding home loan delinquencies, in the early 1990s, we did not have ARMs. The resetting schedule for ARMs over the next 2 years will send a chill down your back if you have any sense.

 
At 12/11/2008 4:06 PM, Anonymous Anonymous said...

Sub-prime arms have mostly re-set (2-28s and 3-27s) with only the three year's made in 2006 to go. Prime arms, mostly tied to LIBOR (or COFI), will mostly re-set down if the interest rates hold.

 

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