When Will Banks Begin Lending Again?

Commercial banks have always played and, as far as I can see, will always play a role in the health of the economy. Commercial banks represent a kind of fulcrum of economic activity. If commercial banks are not lending at all or are not moving toward an acceleration of lending…then one can bet that the economy will not be moving ahead in the near future. If commercial banks are lending modestly or are accelerating their lending…then it can be anticipated that the economy will be expanding or even over-heating.

Right now, the commercial banks are not lending…and there doesn’t seem to be much reason to believe that they will pick up their lending any time soon.

The Federal Reserve is doing all that it can to infuse liquidity into short term and long term financial markets, but the banks are doing little or nothing in the way of expanding credit. There are two major reasons for this: first, the quality of the assets the banks are holding; and, second, the quality of potential borrowers.

In the first case, I am not convinced that banks have finally gotten their hands around the quality of their assets. There is still too much uncertainty in financial markets…as well as real markets…for banks to fully understand their position. Some financial assets, still, cannot be valued. Assets in foreclosure present an uncertain asset value to the banks. Credit card losses are mounting. Auto loan losses are mounting. And, so on and so on…

We continue to receive news that does not bode well for the value of the assets of banks. For example, the front page article in the New York Times trumpets on page one, ”As Vacant Office Space Grows, So Does Lender’s Crisis” (see http://www.nytimes.com/2009/01/05/business/05real.html?_r=1&hp). We have not yet seen the bankruptcies that will follow the miserable holiday season and this will lead to vacancies in the major malls as well as in strip malls. This will lead to further foreclosures and financial stress in real estate where there are already a lot of empty stores. We still have a wave or two to go through in the residential real estate market as the various ‘no doc-no down payment” loans re-price. And, although unemployment began to rise throughout the fall, many expect this trend to accelerate early in 2009 as the business failures and cutbacks start to add up. These movements and others not mentioned will only exacerbate the uncertainty surrounding the value of the asset portfolios of banks.

Banks will continue to be reluctant to lend if they don’t have a good idea of what the asset side of their balance sheet looks like.

As far as potential borrowers. There used to be a saying in the banking community that banks will not lend to anyone unless they don’t need to borrow any money.

My guess is that this will be the major lending rule that most financial institutions will follow in the near and intermediate future. On the upside, financial institutions stretch and stretch their lending standards to earn extra basis points returns so as to outdo their competition. On the downside, banks focus on the quality of credit because charge-offs dominate bank performance. In the past, banks have not moved into riskier borrowers until other banks have moved and it becomes necessary to compete in lesser credits in order to maintain a competitive position. Here the question becomes…who wants to move first?

My answer is that bankers feel very defensive about their behavior in the recent past…they will not want to be the leader in a new round of stupidity!

And, what of the Obama administration and the new plans for fiscal stimulus?

First of all there are rumors that any stimulus package proposed will not be enacted by January 20, 2009 let alone early in the spring. The Obama team has already responded to this by proposing, as a part of any stimulus program, a substantial package of tax cuts. The reasoning behind this is that it will draw bi-partisan support of the Republicans in Congress, something felt to be desirable to help achieve as much effectiveness for the economic program as possible.

An economic stimulus package, however, will not result in an immediate stimulation of bank lending. So, on top of when the economic program is passed…partially or in full…banks must still solve their own difficulties, as described above, before much real lending takes place.

Secondly, there is the international situation. The world economy is worse than anyone thought it was and is declining from there. The United States is part of this world economy…it cannot act independently of what is going on elsewhere in the world. Almost all of the nations of the world face similar situations and each faces the uncertainties mentioned above. But, how much is the rest of the world going to suffer from the continued decline in the United States economy and how much the United States is going to suffer from the decline in the rest of the world is unknown. The Obama administration must act more responsibly toward the rest of the world than did the administration that left office earlier this past fall.

And, we now have another uncertainty…the events in the Middle East present us with another unknown. War is uncertainty itself! What impact this will have on the rest of the world and how it will work itself out cannot be predicted with any degree of precision. But, it is in the mix now and must be taken into consideration is our potential scenarios for the year.

To summarize these comments: the economy will not begin to turn around until the banks are in a position to start lending again. My expectation for this turnaround is beyond the middle of 2009. And, this might be delayed even further if there is a rash of bank failures during the year. There are still too many uncertainties to be more definite and, as a consequence, the prediction for financial markets will still be…a downward drift…with lots and lots of volatility!

BRIC is for real!

The world has changed. The change was coming anyway…the United States just helped it along.
Globalization was going to happen. The United States pushed it along for its own benefit…and now the United States is, itself, seeing what globalization is going to mean...for everyone.

Brazil is now riding high…like other emerging countries, commodities are driving the engine. But, Brazil is just one among several.
· BRIC…Brazil, Russia, India, and China...a group of dynamically emerging countries.
· Sovereign wealth funds; Brazil is joining China and Middle Eastern oil states.
· Canada and a few other countries are being recognized as the ‘next wave’ of countries that are emerging economically.

This is the world of the future. It is a world in which the United States is still the super power, but it is a world that cannot be dominated by the one and only super power. And, these people are talking with one another. For example, the countries that make up BRIC are meeting this weekend in Russia. They are “taking awareness of (their) own influence in world affairs.” And, it is expected that this talking will continue and spread.

But, this is a world in which the United States cannot just do as it wants as it pretty much has tried to do over the past seven and one-half years, economically as well as in foreign affairs. The United States is going to have to consider itself as a member of the world community and learn to work with others as well as encourage and help others if it is going to be respected and listened to.

The United Nations is outdated and unrepresentative; the leadership of the World Bank and the International Monetary Fund is too ‘Western’; and the G-7 or whatever does not contain some important players. The world is in transition and the United States is going to have to be an integral partner in the transition. In the past seven and one-half years, in too many areas, the United States has taken the position that if it didn’t like what was going on, it just removed itself from the picture. As a consequence of such action, the United States lost any ability it might have had to influence outcomes. Also, in the process, other countries learned how to ‘go it alone’ and work out the best solution they could. The United States lost respect while other nations gained in wealth and confidence and the knowledge that they did not need the ‘big guy’ around. They would like the ‘big guy’ there, but their work continued without that input.

Economically and financially, the United States is going to have to become a full member of the world community once again. This administration will not do it…they have neither the time nor the will to do it…but the next administration should. Most of all, the United States must start talking with these nations, not as their superior but as their partner. The United States must not be selfish in this partnership, it must help the emerging powers to become strong, but it must do so while strongly advocating its own position.

Where does this process start? The United States must begin the process by bringing under control its monetary and fiscal policy. It must play by the same rules that the rest of the world plays by.

Why is Brazil considered a part of BRIC? It paid the price of bringing its inflation and its economy under control. Brazilian president da Silva ‘bit the bullet’ and made the central bank independent and let it bring inflation under control. Its economy improved, productivity increased, and, financially, Brazilian debt has been rewarded with an “investment grade” rating. It was not easy, but it was done. Now Brazil is riding the crest of the commodities boom and is trying to make good use of the funds coming into the country: hence the formation of a Sovereign Wealth Fund. And, in the last two years or so, the Real, the Brazilian currency, has even outperformed the Euro relative to the dollar. But, Brazil needs the United States to be strong financially…it needs the United States to be a partner.

Brazil is not the only country that has gone through this cycle. Most major nations, as well as many of the emerging nations have made their central banks’ independent and allowed them to contain inflation. And, this does not help the value of the dollar, given the current stance of the United States with respect to its monetary and fiscal policy.

Hear the stern words of Mervyn King, the governor of the Bank of England, at a news conference on Wednesday: England is “traveling along a bumpy road as the economy rebalances. Monetary policy shouldn’t try to prevent that adjustment.” He further stated that inflation is expected to accelerate and the central bank must continue to combat this inflation and this means that the Bank of England will not make further cuts in interest rates. This, of course, does not help the position of the United States and the value of the dollar. But, the Bank of England does not stand alone in taking this stance.

The world has gotten to where it is faster than it otherwise would have. The United States has contributed to this accelerated pace by creating large fiscal deficits underwritten by extremely low interest rates. The mountains of debt, both public debt as well as private debt, that have resulted have been spread throughout the world. The fact that the United States has no energy policy has also played its part in the changing world and has helped along the explosion in commodity prices. Before these events, the world was globalizing…these events just sped the effort along.

Where does this leave the United States economically and financially? It leaves us in a position in which we must stop pointing at others and placing the blame on them. As Steven Covey wrote…”if you think the problem is out there…that is the problem!”

When there is dislocation and dysfunction, behavior must be adjusted to re-establish some form of unity and wholeness. Most often, dislocation and dysfunction come about due to the strict adherence of ‘ideology’. The United States, once one of the more realistically pragmatic countries in the world, has been compromised by a rigid pursuit of an ideology that has had little connection with the real world. It cannot afford to continue behaving in this way.

BRIC is real. The wealth and power of a dozen other countries is real. And, this change is going to continue. If the United States doesn’t accept this fact, and what it means for its own behavior, disruption and volatility will continue in world markets and may even increase. How one constructs an investment strategy for the future depends upon how one sees this situation working itself out.