The Federal Reserve is doing almost everything it can to get commercial banks to start lending again. Just a quick look at the data reveals what is happening in the banking system where the rubber hits the road. Let’s take a look.
Looking at the figure Total Reserves which is defined as bank reserve balances held at Federal Reserve Banks and vault cash at banks used to satisfy reserve requirements. The year-over-year rate of increase in this figure for February 2009 was 1,538 %. Yes, that’s right, one thousand, five hundred and thirty-eight percent, rounded off! But, this rate of growth is down from the December 2008 year-over-year figure which was 1,823%. Yes, one thousand, eight hundred and twenty-three percent!
In August 2008, before the financial tsunami hit, the year-over-year rate of increase in Total Reserves was – 1%. Yes, that is a negative one percent! And the rate of increase throughout 2008 up to August was modest, at best.
Let’s move up to a larger measure, the Monetary Base, defined primarily as Total Reserves and Clearing Balances at Banks plus the currency component of the Money Stock measures. In February 2009, the year-over-year rate of increase in the Monetary Base was 88%, rounded off. That is, the Monetary Base increased by a little less than two times over the twelve month period ending February 2009. In December 2008, the year-over-year rate of increase was 99%, rounded off.
Going back to August 2008, the year-over-year increase in the Monetary Base was about 2%. Again, the rate of increase in this measure throughout 2008 up to this time was around this magnitude, give or take a percentage point or two.
How did this increase in reserve measures get translated into the Money Stock figures? Well, in the case of the narrow measure of the Money Stock, M1, the year-over-year rate of increase for February 2009 was 13.5%, down from 17.2% in December. In August 2008, the year-over-year growth in the M1 Money Stock was a little less that 2%. The rate of growth of this measure for the earlier part of 2008 was slightly negative to slightly positive.
In terms of the components of the M1 Money Stock, what contributed to this increase in growth? First of all, the Demand Deposit component rose by about 35% on a year-over-year basis in February, but this was down from a little over 59% in December. The interesting thing is that the year-over-year rate of growth of the currency component of the M1 Money Stock was relatively constant through the end of 2008 into February of 2009. For example, the currency component grew at around a 7% rate of growth in December 2008 but grew at a 10% rate in February.
The conclusion one can draw from this is that people and businesses are holding more of their wealth in currency and in demand deposits! That is, the funds that the Federal Reserve is pumping into the banking system are staying in the banking system or going into cash or very liquid transactions balance in the banking system.
One could argue that the public is not spending these cash and transactions balance accounts any more than they have to and are keeping them on hand to meet their uncertain needs for living and conducting business. That is, these holdings are for security in treacherous times.
Just one additional note on Demand Deposit growth and Currency growth: in August 2008, the year-over-year rate of growth in Demand Deposits was essentially zero and the year-over-year rate of growth of currency was slightly over 2%. That is, in August 2008 almost all the growth in the M1 Money Stock measure was coming from the growth in the currency component.
Now, what about the rate of increase in the M2 Money Stock measure? In February 2009 the growth over February 2008 was just less than 10%. This growth rate was exactly the same as the growth in this measure in December 2008. In August, the year-over-year growth rate in the M2 Money Stock was approximately 6%.
The conclusion that one can draw from this is that individuals, families, and businesses are keeping funds in very safe and easily accessible form. Growth in deposit measures or credit measures beyond cash and demand deposits is almost non-existent. People and businesses are attempting to protect themselves, they are not borrowing more than necessary, and they are not spending more than necessary. One guesses that this is not going to change much in the near future.
From the non-bank side of the equation, why should people and businesses be borrowing if they can avoid it? Unemployment jumped to 8.5% in March, and this weekend economists were talking that this number would reach at least 10% before this economic downturn is over.
Furthermore, bankruptcies were up, almost 4% in March and up almost 40% over a year earlier. This measure, too, is expected to rise throughout 2009 and into 2010. And then, housing prices continue to fall. One measure used to judge where housing prices are relative to (estimated) rental payments was reported by John Authers in the Financial Times on last Thursday. He wrote that the ratio of housing prices to rents which had risen by 44% from 2002 to its peak through the credit bubble has returned to about its 2002 level. However, Authers argues that even though it returned to the 2002 level this ratio could still fall another 20% to reach levels of a decade or so earlier.
And, why should the banks lend? For one, they still have a ton of questionable assets on their balance sheets. And, if these banks are worried about their solvency, they need to work these assets out and not add more and more new assets to their balance sheet. Their focus needs to be on regaining financial health now, not expanding their balance sheet and reducing capital ratios further.
And, we still have the commercial real estate problems to go through, as well as the problem implied in the credit card area due to the rising delinquencies in that sector. Furthermore, there are two kinds of mortgage loans that are going to reprice over the next 15 months or so. Analysts are afraid of what this might do to foreclosures and bankruptcies given the rise in unemployment and the decline in household incomes. Also, there are the surfacing problems connected with state and local government finance. This has not really gathered much attention to date.
The Federal Reserve has been pushing about as hard as it can. Yet, the monetary stimulus is not working its way through the banking system. This is obviously a problem. But, banks in the condition described above don’t really want to lend, and consumers and businesses are in the process of consolidating and strengthening their balance sheets and have little incentive to re-leverage themselves at this point.
The Keynesian solution to this dilemma is, of course, government spending, the more the better. The intent of this spending is to get the banking system unclogged. Whether or not this government spending can actually accomplish this is still to be determined? So, we still are faced with enormous amounts of uncertainty. And, this uncertainty, in my mind, is not going to go away soon.