Banking is the great octane booster of the engines of economy. It can make many people feel rich. Albert deposits $100 in the First National Bank. Bertrand borrows $100 from the First National Bank and deposits the funds in the Second National Bank. Clyde borrows $100 from the Second National Bank ... and so on ad infinitum. Everyone has $100 in their bank accounts at the same time! There is a lot more spendable funds now than if Albert had just kept his $100 under the mattress. A whole lot more. Whee!
This sort of dementia has been going on for a couple hundred years and has reached a fevered pitch in the last ten or so. How could this go on so long without it all crashing down like the house of cards that it is? That is the marvel of economic growth. As long as the economy, and consequently income, keeps growing in the aggregate, there will be plenty of funds to keep all those plates spinning.
When banking goes into reverse though, it is deadly. Sufficient losses on loans cause banks to become unprofitable. Unprofitable banks have to pull the loss out of their equity and shrink lending, because loans cannot exceed a regulated ratio of bank equity. Roughly $10 of lending has to be cut for every $1 of losses. When lending is cut, borrowers have to pay back loans (if they can) instead of rolling them over. When they can't pay the loans back, the banks have further losses, and must restrict lending even more.
It gets worse. When borrowers have to pay back loans they have to cut other spending. If their income is falling, this causes their spending to fall disproportionately. One person's spending is another's income, so income tends to fall. When income falls, debt becomes harder to pay back, and many borrowers default, causing more loan losses for banks, and more restrictions on lending.
Around and around this destruction goes, and where it stops nobody knows. The entire World's economy is wildly indebted. Households, businesses, and governments have never been so in debt as they are now. What goes up, must come down. The bottom could be shockingly low.
Showing posts with label loan. Show all posts
Showing posts with label loan. Show all posts
Sunday, December 13, 2009
Saturday, November 14, 2009
The Big Bank Problem No One Talks About
Consumer credit in the USA is falling, falling, falling. Whatever numbers you pick, there's no massaging the data to make it look innocent. This all is well known, as is the concern that lack of consumer borrowing will be a drag on the consumer portion of the economy.
Something else about this situation seems to be slipping through the cracks of public awareness, however. Once upon a time, maybe twenty years ago, when lenders cared a lot more about credit quality, it was well known that subprime could never work as a profitable lending model. Too many companies had come and gone promising to be profitable lending to high-risk customers. Their seeming profitability was a trick of accounting legerdemain: a growing book makes loss ratios look lower than they actually are since ageing loans are more likely to sour than fresh ones.
In the huge, recent credit bubble when almost everyone (and sometimes their pets) were receiving credit offers, loan books were growing smartly and loss ratios were low. Now that credit is contracting, people who can pay back their loans tend to be doing so. And those who can't (but are not yet to the point of defaulting) are just trying to keep them rolling over. The net result is that the overall quality of bank's loan books is deteriorating rapidly.
Banks are becoming less solvent over time, not more so, in spite of their efforts to improve their condition. Banks efforts to reign in credit by jacking up interest rates and cutting credit lines will actually backfire because better borrowers will simply pay off their loans. Borrowers who accept the barrage of insults are in such poor condition financially they can only subject themselves to usury.
In conclusion, the end state of this process will likely be the Federal Government (having had to bail out the banks and then the FDIC over and over) holding consumer loan portfolios that have little to no value. Cost to taxpayer: something like two trillion dollars, and further debauchment of the Dollar. Banks will be kept in business to keep up appearances, and may even book a nominal profit.
Something else about this situation seems to be slipping through the cracks of public awareness, however. Once upon a time, maybe twenty years ago, when lenders cared a lot more about credit quality, it was well known that subprime could never work as a profitable lending model. Too many companies had come and gone promising to be profitable lending to high-risk customers. Their seeming profitability was a trick of accounting legerdemain: a growing book makes loss ratios look lower than they actually are since ageing loans are more likely to sour than fresh ones.
In the huge, recent credit bubble when almost everyone (and sometimes their pets) were receiving credit offers, loan books were growing smartly and loss ratios were low. Now that credit is contracting, people who can pay back their loans tend to be doing so. And those who can't (but are not yet to the point of defaulting) are just trying to keep them rolling over. The net result is that the overall quality of bank's loan books is deteriorating rapidly.
Banks are becoming less solvent over time, not more so, in spite of their efforts to improve their condition. Banks efforts to reign in credit by jacking up interest rates and cutting credit lines will actually backfire because better borrowers will simply pay off their loans. Borrowers who accept the barrage of insults are in such poor condition financially they can only subject themselves to usury.
In conclusion, the end state of this process will likely be the Federal Government (having had to bail out the banks and then the FDIC over and over) holding consumer loan portfolios that have little to no value. Cost to taxpayer: something like two trillion dollars, and further debauchment of the Dollar. Banks will be kept in business to keep up appearances, and may even book a nominal profit.
Sunday, June 7, 2009
June Credit Card Collapse Report
On June 5, the Federal Reserve released its monthly report on consumer credit. The first quarter drop in revolving credit was revised from 60.4 billion to 66 billion. The preliminary April data shows a 3.4 billion drop. So far this year the rate of decline is 7%, or 21% annualised. We expect as April data is revised, this rate will actually be considerably higher.
If the flow of credit is indeed the "life blood of the economy," as Mr. Obama states, then the USA has arterial sclerosis. Our opinion, of course, is entirely the opposite: the economy can be quite fine without consumer credit. The World got along fine for thousands of years without consumer credit and may again.
The flow of credit is only the life blood of banking profits. American households will of necessity become thrifty in the years ahead or face ruin. Banks will be increasingly cut off from the once fat profits of consumer lending. Their rump loan portfolios will soon turn into capital-annihilating loss generators.
It's a little known fact of lending that you can cover up dodgy portfolios by expanding quickly. Since loans sour as they age, if you keep a loan portfolio new (by always adding more and more accounts), your percentage of delinquent loans will seem low. If your growth stops, or even reverses, your deadbeats can't be hidden so neatly.
The result of that phenomenon as it applies to the current situation is that bank losses on their consumer credit book should begin to really mushroom over the next few months. Don't buy the media announcement of 'unexpected' increases in credit card delinquencies. The banks know its coming, but you read it here first.
If the flow of credit is indeed the "life blood of the economy," as Mr. Obama states, then the USA has arterial sclerosis. Our opinion, of course, is entirely the opposite: the economy can be quite fine without consumer credit. The World got along fine for thousands of years without consumer credit and may again.
The flow of credit is only the life blood of banking profits. American households will of necessity become thrifty in the years ahead or face ruin. Banks will be increasingly cut off from the once fat profits of consumer lending. Their rump loan portfolios will soon turn into capital-annihilating loss generators.
It's a little known fact of lending that you can cover up dodgy portfolios by expanding quickly. Since loans sour as they age, if you keep a loan portfolio new (by always adding more and more accounts), your percentage of delinquent loans will seem low. If your growth stops, or even reverses, your deadbeats can't be hidden so neatly.
The result of that phenomenon as it applies to the current situation is that bank losses on their consumer credit book should begin to really mushroom over the next few months. Don't buy the media announcement of 'unexpected' increases in credit card delinquencies. The banks know its coming, but you read it here first.
Saturday, May 30, 2009
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.
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.
Wednesday, December 17, 2008
Where's the Bottom?
It is now pretty much universally acknowledged that the world's economy is in decline. Even a leader of the stature of Canada's Prime Minister without a Parliament, Mr. Harper, concedes a depression might be possible (source).
Thus, collectively society begins to leave the denial phase and move towards anger. One can expect to see more riots as in Greece and China; more factory occupations as in the U.S. and China; vendettas against banksters such as Mr. Madoff; and who knows what else.
After anger comes bargaining, depression, and finally acceptance. Whether this takes months or years remains to be seen. Even when everyone accepts the fact of the 2007 Depression, it doesn't mean that the economy has hit bottom.
The bottom will be found when failed and failing enterprises and institutions cease to be a drag on society's resources. At that point resources can be applied to meeting people's needs, and the economy can begin resuming more or less healthy functioning.
Generalities aside, what will the bottom look like? Probably half or more of the population will not be working full time, but getting by with a combination of self-employment, odd-jobs, informal work (much of it for barter), and so on. Large numbers will be jobless, homeless, and otherwise restive. There will likely be many disruptions to important services such as utilities, government, retail and banking. There may be many grand gestures by governments to turn things around, but likely they will be mostly for show.
What will turn things around is when people draw on their inner resources to become entrepreneurial - to spot opportunities to meet people's needs, learn new skills, and make new connections. New and surviving institutions will of necessity be extremely frugal and resourceful.
This is a very long way from where society is now. All the way down, people will be clamoring for bailouts, job programs, loans, and whatever else they imagine will remove from them the burden of responsibility to create their own means of living. You, Reader, would be wise to become entrepreneurial or align yourselves with such persons, if you are not already. Affiliation with dying enterprises and institutions may be maintained, but only if you are building up self-reliance on the side.
Thus, collectively society begins to leave the denial phase and move towards anger. One can expect to see more riots as in Greece and China; more factory occupations as in the U.S. and China; vendettas against banksters such as Mr. Madoff; and who knows what else.
After anger comes bargaining, depression, and finally acceptance. Whether this takes months or years remains to be seen. Even when everyone accepts the fact of the 2007 Depression, it doesn't mean that the economy has hit bottom.
The bottom will be found when failed and failing enterprises and institutions cease to be a drag on society's resources. At that point resources can be applied to meeting people's needs, and the economy can begin resuming more or less healthy functioning.
Generalities aside, what will the bottom look like? Probably half or more of the population will not be working full time, but getting by with a combination of self-employment, odd-jobs, informal work (much of it for barter), and so on. Large numbers will be jobless, homeless, and otherwise restive. There will likely be many disruptions to important services such as utilities, government, retail and banking. There may be many grand gestures by governments to turn things around, but likely they will be mostly for show.
What will turn things around is when people draw on their inner resources to become entrepreneurial - to spot opportunities to meet people's needs, learn new skills, and make new connections. New and surviving institutions will of necessity be extremely frugal and resourceful.
This is a very long way from where society is now. All the way down, people will be clamoring for bailouts, job programs, loans, and whatever else they imagine will remove from them the burden of responsibility to create their own means of living. You, Reader, would be wise to become entrepreneurial or align yourselves with such persons, if you are not already. Affiliation with dying enterprises and institutions may be maintained, but only if you are building up self-reliance on the side.
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