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Can Financial Conglomerates Even Lend to Us or Businesses?

Are financial conglomerates in a position to increase lending?  Do they still have too many “toxic assets” on the books plus a lot of their own debt on the books which in turn is causing them to not be able to provide any no loans?  Are we (households) in a position to incur more debt?  If the trillions of dollars that Federal Reserve and Treasury pumped into the financial system to keep interest rates low is not jump starting new lending, did we just waste trillions of dollars?  These are the questions that came to mind after reading this Bloomberg article and the Federal Reserve Bank’s April 2009 Senior Loan Officer Opinion Survey.

The Fed and Treasury have pumped an estimated $12.8 trillion into the financial system to increase liquidity.  In part, the theory was that flushing the market with cash would 1) keep interest rates low and 2) provide an avenue or market for financial conglomerates to securitize any new loans.  This strategy worked in keeping interest rates low, at least in the short term, and provided a “thaw” in the credit markets (remember credit markets were frozen).  Several indicators, such as the Libor-OIS spread which is assumed to a be a measure of the health of banks because it reflects what banks believe is the risk of default associated with lending to other banks, have shown improvement recently. 

Libor-OIS, which indicates banks’ reluctance to lend, fell to 0.45 percentage point today, the lowest level since February 2008. Still, futures indicate the measure is about two years away from shrinking to 0.25 percentage point. That’s the level former Fed Chairman Alan Greenspan has said would be considered “normal.”

So, what is the problem?  How about this:

“A lot of banks are just trying to hold on to what they have and not really make loans.”

If banks are not willing to lend to one another does that mean they are even less likely to lend to businesses or us.  According to April 2009 Senior Loan Officer Opinion Survey it doesn’t appear that banks are willing to loosen those purse strings despite receiving trillions of dollars from Fed and Treasury:

Commercial and industrial lending. On net, about 40 percent of domestic respondents, compared with around 65 percent in the January survey, reported having tightened their credit standards on commercial and industrial (C&I) loans to firms of all sizes over the previous three months. On balance, domestic banks have reported tightening their credit standards on C&I loans to large and middle-market firms for eight consecutive surveys and to small firms for ten consecutive surveys.

Commercial real estate lending. About 65 percent of domestic banks, on net, reported tightening their lending standards on commercial real estate (CRE) loans over the previous three months, compared with about 80 percent in the January survey. On balance, domestic banks have been tightening credit standards on CRE loans for 14 consecutive surveys, and the April survey marks the first time since October 2007 that the net proportion of banks reporting such tightening fell below 70 percent.

Residential real estate lending.  In the April survey, somewhat larger fractions of domestic respondents than in the January survey reported having tightened their lending standards on prime and nontraditional residential mortgages. About 50 percent of domestic respondents indicated that they had tightened their lending standards on prime mortgages over the previous three months, and about 65 percent of the 25 banks that originated nontraditional residential mortgage loans over the survey period reported having tightened their lending standards on such loans.

Consumer lending. Large percentages of domestic banks again reported a tightening of standards and terms on both credit card loans and other consumer loans over the previous three months. Nearly 60 percent of respondents indicated that they had tightened lending standards on credit card loans, about the same proportion as in the January survey. About 50 percent of respondents, down from 60 percent in the January survey, reported tightening standards on other consumer loans. About 50 percent of respondents reported having reduced the extent to which credit card accounts were granted to customers who did not meet their bank’s credit-scoring thresholds, and a similar fraction reported pulling back from granting other kinds of consumer loans to such customers.

Despite the credit “thaw” could it be that financial conglomerates cannot produce more loans because their balance sheets - loan portfolios and debt obligations - are still too risky. 

There is another side to this equation: the demand side for credit/debt.  According to the April 2009 Senior Loan Officer Opinion Survey, there is some demand for new residential and consumer loans is there:

Residential real estate lendingAbout 35 percent of domestic respondents saw stronger demand, on net, for prime residential mortgage loans over the previous three months, a substantial change from the roughly 10 percent that reported weaker demand in the January survey. About 10 percent of respondents reported having experienced weaker demand for nontraditional mortgage loans over the previous three months-a substantially lower proportion than in the January survey.

Consumer Lending.Regarding demand, about 20 percent of respondents, on net, indicated that they had experienced weaker demand for consumer loans of all types over the previous three months-substantially less that the percentage so reporting in the January survey.

It appears that financial conglomerates are tightening credit.  Does this defeat the purpose of $12.8 trillion barrel dump that Fed and Treasury did for the financial sector?  According to Alan Greespan (I am uncomfortable quoting him):

“There is still a very large unfunded capital requirement in the commercial banking system in the United States and that’s got to be funded,”

Wow, we still have the potential of having zombie banks.  The Fed and Treasury have done nothing to address the potential insolvency of some of the financial conglomerates.  If this lack of capital means that financial conglomerates will not lend to us or businesses then they will continue to a drag on our economy.

Has the Fed and Treasury wasted $12.8 trillion?  It maybe too early to tell but things don’t look good: 1) home prices continue to drop; 2) mortgage foreclosure rates are not improving; 2) inventory (on the market) for existing homes is still too high; and 2) unemployment is not improving and possibly getting worse.

It is time to break-up the zombie financial conglomerates.