Follow-Up on Loan Delinquency

The FDIC is reporting delinquent bank loans are 7.75% of all loans. While this is not yet as bad as mortgage delinquency which we discussed in yesterday's post, it is still capital-annihilating (since most of these deadbeat loans will have to be written off).

With their capital evaporating, banks must shrink lending. It is no wonder that so many businesses and individuals are seeing their credit lines cut or cancelled. As those who have the means to pay off said lines of credit race to do so, they will not be investing or spending money. This will have a dampening effect on economic activity, to say the least.

If the nationalised, yet insolvent Freddie Mac and Fannie Mae being ordered to expand their books to keep mortgage loans flowing were a precedent, we would anticipate an imminent, very large bank nationalisation instigated in order to have banks under political control and follow the directive to grow loans, no matter the ultimate cost. (The hurried, and ill-conceived TARP investments do little to give the Federal Government adequate policy leverage over the banks).

We think it wiser to let banks gradually expire. In the post peak-oil, resource-constricted world, there will likely be no further economic growth. In the aggregate, borrowing and lending will become much riskier propositions since loans will tend to impoverish, rather than enrich borrowers. There will always be room for lending to promising enterprises, but this will be a small niche.

It will be very shocking to witness much of the 20% or so of the US economy that is the banking and financial sector just go away. But there is no way around it. Like house building and automobile manufacturing, it is a sector whose preeminence has come and gone.