Although it has been drowned out by all the excited reports of massive GDP growth in the fourth quarter of 2009, the economic situation continues to worsen in the eyes of those who are focused on much more important variables, such as the amount of credit in the system. The most recent Fed report, for the week of January 20th, shows that commercial bank loans and leases have reached a new low since 2008, $37.6 billion less than the revised October 21, 2009 low. Bank loans have contracted nearly 9% from the October 2008 peak and are already down 0.42% in the first three weeks of 2010. At the present rate, bank loans will contract another 7.67% in 2010, exceeding last year’s record credit contraction of 7.05%.
To put this in perspective, the only reason the chart goes back to 1973 rather than 1947 is that the lowest rate of credit growth from 1947 through 1972 was 2.65% in 1949. It’s not just that two straight years of credit contraction has only happened once before in the post-war era, it’s that the magnitude of it is completely without precedent. And this is all without the banks being forced to take write-downs for the bad loans that they made and securitized off their books. As the Market Ticker has been pointing out since April 2007, selling on bad loans to investors does not take a bank off the hook when, as was very often the case with subprime and Alt-A loans, there is a fraudulent element in the mortgage such as overstated income.
S&P put out a report the other day in which it essentially said “if the banks have to eat the reduced value now they’re all insolvent.” We in fact have fixed none of the underlying issues that brought down Fannie, Freddie, AIG, Bear and Lehman. The only reason we have seen supposed “improvement” in the markets is that the government has given permission to lie to financial institutions in the exact same form and fashion (that is, hiding actual liabilities and probable losses) that brought down ENRON. But the underlying loss is still real, still present, and still out there. Refusing to recognize it doesn’t make it go away. It just sweeps it under the carpet with the hope (wish really) that the institution will be able to screw you, the consumer, out of enough money to cover the shortfalls before they’re forced to recognize the already-occurred losses and thus declare bankruptcy.
If the mortgage security put-back issue comes to the fore, my linear projection of 7.67% bank loan contraction almost surely be overly optimistic, just as my forecast for 2009 deposit failures in RGD was. If we are still in the early stages of debt-deflation, then we must still be in the early stages of economic contraction. Paul Krugman likes to write about demand gaps, but even his most negative calculations are dwarfed by the size of the credit gap between the pre-2009 8.37% average annual credit growth and the 2009-2010 -7.5% annual contraction.
Debt is always the core of the problem. Witness how the imminent debt implosion in Greece makes the previously unthinkable prospect of sovereign defaults and the eventual disintegration of the Euro and the European Union look increasingly more likely:
The EC has no data on public debt beyond 2008, when the figure was €237bn, or 99.2pc of GDP. A surging budget deficit of 13pc of GDP has pushed the figure much higher since then. Brussels expects the debt to reach 125pc this year, and 135pc in 2011 unless spending is slashed. If auditors discover a fresh chunk of hidden debts, this would test Greek financial credibility to the limits. “If there is anything too this, it is the final straw,” said one banker.