Reply #3: Another View from "Market Watch!"--"Banks Cut Back on Loans to Businesses."

[KoKo]

Capitol Report

Oct. 9, 2009, 6:00 a.m. EDT
Banks cutting back on loans to businesses
Credit squeeze on entrepreneurs threatens to derail recovery

By Rex Nutting, MarketWatch

WASHINGTON (MarketWatch) -- U.S. banks are reducing their lending at the fastest rate on record, tightening the credit squeeze and threatening to leave many otherwise viable businesses unable to borrow money to expand their businesses, meet their payroll or refinance their maturing debts.

According to weekly figures provided by the Federal Reserve, total loans at commercial banks have fallen at a 19% annual rate over the past three months, while loans to businesses have dropped at a 28% annualized pace.

Last autumn, bank lending temporarily expanded when other sources of funding from the shadow banking system dried up after the collapse of Lehman Bros. Since then, however, total outstanding bank loans have dropped at an accelerating pace. See the data.

The decline in bank lending mostly affects smaller businesses. Larger corporations have alternative sources of funding, including retained earnings, corporate bonds, securitized loans and new equity. Those other sources of capital have increased in recent months, but not enough to offset the decline in bank lending.

In the first and second quarters, the U.S. private sector consumed more capital than it raised for the first time in more than 60 years. Negative net investment is "the hallmark of depression and difficult to reverse," said economist Leigh Skene of Lombard Street Research.

The big drop in credit also shows up as slower money growth. In the past 13 weeks, the money supply has fallen 0.3%. Most new money is created by borrowing, as banks credit the borrower's account with the proceeds of a loan. Conversely, the money supply is reduced when debts are paid off or written off. Deflation is not a threat -- it's already here.

The question is whether the decline in lending will be reversed soon.

If the drop-off in lending is mainly due to weak demand by businesses, then there's some hope that the recent upward momentum in industrial output and sales could lead to more optimistic business sentiment, greater demand for capital, and more lending by banks.

But if the decline is mainly due to weak banks unable or unwilling to lend, then a turnaround in credit creation may have to wait until banks' balance sheets are repaired, a process that could be delayed by further expected defaults in consumer loans, mortgages and commercial real-estate loans.
Running on fumes

The credit squeeze on small businesses remains a major hurdle for the economy to overcome.

Despite more than a trillion dollars from the Fed and from the Troubled Asset Relief Program, "the banking system has still not fully recovered," New York Fed President Bill Dudley said in a speech this week.

The biggest banks raised billions in new capital, as ordered by Washington after the stress tests, but "banks are still capital constrained and hesitant to expand their lending," Dudley said.

"Most importantly, some significant classes of borrowers -- namely commercial real estate and small business -- are almost wholly dependent on the banking sector for funds, and those funds are not easily forthcoming," he said.

Dudley said the credit squeeze is the most important factor that will "inhibit the pace of the economic recovery." Read the speech.

Businesses with fewer than 50 employees have been responsible for about one-third of job creation over the past few decades. In the 2001 recession, these small businesses were remarkably well-shielded, accounting for just 9% of job losses, said Melinda Pitts, an economist for the Atlanta Fed, writing on Macroblog. Read more.

In the early part of this recession, however, small businesses have accounted for 45% of job losses. If small businesses can't get financing, "then the post-recession employment boost these firms typically provide may be less robust than in previous recoveries," Pitts said.

"The economy is running on fumes," said Brian Bethune, U.S. financial economist for IHS Global Insight. Although the Fed and the Congress have been trying to buy time for the economy while waiting for the banking system to recapitalize itself, Bethune worries that the support won't be strong enough or will be shut off too quickly.

"We need a longer bridge," he said. "There's a lot of risk in the first half" of 2010.
More write-downs, weak demand

The decline in bank lending reflects several factors.

First, banks are writing off more bad loans, which directly reduces the amount of outstanding loans. Data for third-quarter write-offs are not yet available, but in the second quarter, they surged to a record $44.5 billion, nearly matching the total write-offs in the six years from 2002 to 2007. For commercial and industrial loans, write-offs rose to $7.8 billion for the quarter, according to bank data reported to the Fed.

Weaker demand and constrained supply are also factors in the decline in lending. According to the Fed's quarterly survey of bank lending officers, banks have tightened their standards for commercial and industrial loans at the same time that demand has fallen for such loans.

According to the banks, the main reason for the decline in lending to businesses has been weaker demand. Reduced creditworthiness of the borrowers ranked as the second-most important reason.

The banks also complain that tighter regulation and a special assessment to replenish the Federal Deposit Insurance Corp. are hurting their ability to lend.

The need for capital has dried up as the recession worsened.

Many companies see little need to invest right now. About one-third of total manufacturing capacity in the country is sitting idle. Spare capacity is also rising in commercial real estate, especially in apartments, retail, offices and hotels. Fewer small businesses are planning to expand, invest or hire than at any time in more than 30 years, according to the National Federation of Independent Business.

Still, many businesses need credit to keep their operations going, or to expand into markets being abandoned by other, less nimble companies.

Many companies also need to roll over their debt because corporate loans tend to have short maturities. About $3 trillion in commercial real-estate loans mature in the next three years, Skene said. About half of those loans came from banks. Most of the $1.3 trillion outstanding in leveraged loans will also need to be rolled over in the next few years, he said.

"This is why the Fed hasn't flinched," Bethune said. The most recent Fed statement said the recovery would likely be subdued. The Fed and Congress have "lots of things in place to get us out" of the credit squeeze, he said. But he warns, "it will take us years."


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