Commentary

Behind The Scenes Of Imprudent Bank Loans

“Bank Lending Keeps Dropping,” according to a recent front-page Wall Street Journal headline. But the Treasury Department statistics used in that article did not measure total bank lending. Instead, the figures include only $231.4 billion of monthly “loan originations” at 21 of the nation’s 8,300 banks — namely, those that received the biggest “capital infusions” (loans) from the TARP program.

Two of those “banks” with the biggest percentage drop in lending were Goldman Sachs and Morgan Stanley. But regardless of their nominal conversion to bank-holding companies Goldman Sachs and Morgan Stanley still make investments, not loans. And even among the commercial banks, the largest “loan originations” were not new loans but refinancing of old mortgages.

Debt does not allow people to live beyond their means.”

To see what is actually happening to bank lending in general, we have to look at Federal Reserve release H-8. The graph shows what has happened to the three core categories of bank loans and leases since the recession began (omitting such miscellany as securities loans and interbank loans). Lending for real estate this March was 45% commercial and 39% residential, with home equity loans accounting for the rest. Credit cards made up 44% of consumer lending with the remainder for big-ticket items like cars and furniture. Commercial and industrial loans are labeled “business” for simplicity.

All three categories of bank loans increased steadily through November, but business and real estate lending has been relatively flat since then. The October 2008 spike in business borrowing was not because of TARP (which wasn’t launched until the end of that month), but because panic in the market for commercial paper in the wake of the bungled Lehman bankruptcy made it prudent to draw down lines of bank credit.

U.S. Bank Loans

It may sound paradoxical, but the fact that banks had no more loans on the books in March than they did in October does not show they haven’t been making new loans. Thanks to the record defaults on credit cards, auto loans, student loans, business loans and commercial and residential mortgages, banks must have been making many new loans to offset such massive write-offs of older loans. Making prudent new loans has not been easy, since the pool of credit-worthy borrowers shrunk dramatically with the surge of personal and business delinquencies, defaults and bankruptcies.

Speaking in Trinidad-Tobago, President Obama nonetheless complained, “Banks still are not lending at previous levels.” So what? Why would anyone expect banks to lend as much while the economy was shrinking as they did when it was growing? When people buy fewer cars and houses, they don’t need as many auto loans and mortgages. When retail businesses and car dealers are raising cash by liquidating inventories, they don’t need to borrow to buy more inventories.

When households and firms borrow sensibly, they are borrowing against expected future earnings or against accumulated wealth (assets minus debts). Debt does not allow people to live beyond their means. On the contrary, heavily indebted consumers actually acquire fewer goods over time, because so much of their budget is wasted on interest payments.

One of the surest ways for businesses or households to increase future earnings and wealth is to reduce their debts — to borrow less, not more. That should be particularly obvious at times like these, when so many businesses, banks and homeowners are suffering painful hangovers from a multi-year orgy of foolhardy borrowing.

Annual Growth of Debt (Percent)

Nonfinancial Business

Financial Business

Home Mortgage

Consumer Credit

2002

2.6

9.6

13.3

5.7

2003

2.5

10.6

14.2

5.2

2004

6.2

8.9

13.6

5.5

2005

8.7

9.4

13.2

4.3

2006

10.5

10.0

11.2

4.5

2007

13.1

12.4

6.8

5.5

2008

4.8

6.4

-0.4

1.7

Source: http://www.federalreserve.gov/releases/z1/Current/z1r-2.pdf

The table shows the annual growth of debt for nonfinancial and financial businesses, as well as home mortgages and consumer credit. Nearly everyone now realizes that the financial sector borrowed far too much in recent years, as did many homeowners. The rapid escalation in debt among nonfinancial firms in 2005 to 2007 has largely avoided such intense scrutiny. Yet the cost of servicing corporate debts has certainly helped turn profits into losses, requiring layoffs and other cost-cutting measures. Could anyone really believe that General Motors needs more debt or that people with zero equity in their homes need bigger mortgages?

The Obama administration has repeatedly frightened bank stockholders with threats of quasi-nationalization, putting taxpayers at risk for trillions of dollars in the process, ostensibly because of a quixotic crusade to get banks to lend “at previous levels.” If so — that is, if the intent of the TARP plan was to induce banks to hand out loans at a faster pace than before last November — then the program has evidently been useless, if not harmful. Yet increased bank lending couldn’t possibly have been the real goal, since much of the federal loot went to investment banks that never wanted any part of this scheme. After all, nobody goes to Goldman Sachs or Morgan Stanley looking for a loan.

The deeper purpose of the Treasury’s “capital purchase plan” appears to have been quite different — namely, to ensure that big financial firms will now be managed according to the principles of politics rather than economics. And that can also explain why the administration is so suspiciously reluctant to allow TARP supplicants pay back the loans.

Alan Reynolds is a senior fellow with the Cato Institute and the author of Income and Wealth.