Banks Are Lending, but to Whom?

A recurring concern we have heard since the financial crisis erupted is that banks are simply not lending, and that this is holding back economic activity.  If only banks would lend, the economy would grow.  As usual, the truth is a little more complex. 

Unlike in the Great Depression, and despite about 300 bank failures, the balance sheets and deposits of insured commercial banks and thrifts has been steady, if slowly, expanding throughout the financial crisis and recess.  Banks have continued lending during this time; however, they have changed who they are lending to.  Over the last two years we have witnessed a massive shift from lending to the private sector to lending to the public.

The chart below shows banking business lending and bank holdings of U.S. government securities.   The chart suggests that the approximately $500 billion increase in bank lending to Uncle Sam came at the expense of a $400 billion decline in lending to private business.  If one assumes that bank balance sheets have either been stable or increased slightly, then a loan to the government must off-set a loan otherwise made somewhere else.

While its hard to exactly measure the job impact of this reduced business lending, some estimates have been made on the impact of SBA lending.  According to one study, every $41,600 in new small business loans is associated with 1 new job created.   While this number should be taken with a grain of salt, it implies that the $400 billion reduction in business lending has cost over 9 million jobs.  Of course, one might argue that the half-trillion in lending to the govt has created or "saved" some jobs.  Accepting the difficulty of coming up with a reliable estimate, I think its fair to say that on net a few million jobs have been lost due to this shift of lending from the private to the public sector.

Also of interest is that since the financial crisis, and despite the failures of Fannie and Freddie, commercial banks and thrifts have increased their holdings of Fannie/Freddie/Ginnie securities by over $300 billion.

Textbook economics usually teaches that government crowding out of private investment only really occurs when we are near full-employment.  Yet looking at the balance sheets of our commercial banks and thrifts, would suggest that U.S. Treasuries and Agency securities have crowded out significant lending that would otherwise go to the private sector.   But this should come as no surprise, since banks can borrow for close to zero and invest risk-free in government debt, earning a nice spread of 3 to 4 percentage points.