Five Things: The Credit Cycle Begins Again
Banks aren't lending, but the question is why?
Going through morning readings from a number of credit market experts this week, there are a few things going on that those bearish stocks and Treasuries need to be aware of as we continue to work through the debt unwind.
Here are two charts from the St. Louis Federal Reserve that have received plenty of attention over the past week. The first is the annualized rate of change for M2 showing the deceleration, despite Federal Reserve attempts to stimulate it.
The second chart, showing the annualized rate of change of Total Bank Credit really explains the first chart because banks are not lending.
The restrictive monetary conditions illustrated by M2, compared to the expansionary monetary policy the Fed has embarked on, indicates that banks aren't letting credit make its way into the economy, instead preferring to use it to repair their balance sheets via the carry trade, where they borrow short-term money and invest it in longer-term Treasuries.
This is something the Bloomberg article about the disconnect between gold buyers (posted on the Daily Feed this morning) missed. "Demand for gold is increasing as US government debt reaches record levels and the Federal Reserve keeps interest rates near 0%," Bloomberg reported. But the demand for Treasuries by banks was fueled even further by the Federal Reserve's declaration following the September meeting that the Fed Funds rate will remain exceptionally low for "an extended period."
2. Banks Aren't Lending, But Why?
But back to the restrictive monetary conditions illustrated by M2 for a moment. Why aren't banks making new loans? On the consumer side, there's a definitive lack of demand. But on the corporate side, as we've seen with bond issuance and the need to repair balance sheets, demand for credit remains very high.
Last year, during the peak of the credit crunch, companies were forced to draw down lines of credit from banks, in some cases just to function.
Keep in mind, during credit booms, banks don't really pay much attention to these credit lines; for one thing, they're relatively small, or at least they appear that way during good times, and in most cases companies rarely tap them. On a personal level, think of them as a "line of credit" attached to your checking account in case of an overdraft.
While overdraft protection is very expensive for most individuals, this kind of credit is basically a teaser offered at very low cost to companies by banks in order to get the lion's share of a company's larger, more profitable credit demands.
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