Monday, 28 July 2008

Signs of Debt Deflation in Commercial Lending

A while back I said that one of the things to watch for was contraction of commercial and trade credit as that would signal the contagion of the financial crisis from the financial economy to the real economy. Here is more evidence that it is going to be ugly out there - and definitely deflationary in due course:

U.S. banks sharply reduce business loans
By Peter S. Goodman, International Herald Tribune

Banks struggling to recover from multibillion-dollar losses on real estate are curtailing loans to American businesses, depriving even healthy companies of money for expansion and hiring.

Two vital forms of credit used by companies — commercial and industrial loans from banks, and short-term "commercial paper" not backed by collateral — collectively dropped almost 3 percent over the last year, to $3.27 trillion from $3.36 trillion, according to Federal Reserve data. That is the largest annual decline since the credit tightening that began with the last recession, in 2001.

The scarcity of credit has intensified the strains on the economy by withholding capital from many companies, just as joblessness grows and consumers pull back from spending in the face of high gas prices, plummeting home values and mounting debt.

I'll be writing more about Irving Fisher's theory of debt deflation as causing the Great Depression in my Friday RGE blog, which I'll cross-post here. Fisher was marginalised and neglected by the Chicago School free marketers, but is well worth reappraising given the way history is repeating itself.


NC Jim said...

On another blog, Wachovia was reported as turning down almost all loan applications. However Wachovia is aggressively marketing CD's on local TV and I assume elsewhere in NC - we are just a coastal backwater.

There appears a strong drive to deleverage.


suecris said...

I'm confused about corporate debt - high levels are seen by the Wall Street sharks as a *good* thing, for reasons I can't fathom. I live in St. Louis and our local paper covered the InBev takeover of Busch as if it really was almost Busch's own fault for not having been aggressive enough in buying up other companies. A-B's lack of much debt made it too tempting a target, apparently.

Seems reminiscent of blaming rape victims for wearing too-revealing clothes. Next we'll be hearing that the little old lady down the street with no mortgage was irresponsible for not having debt, which made her a too-tempting victim for an asset-stripping shyster.

Sorry for the pretty much off-topic rant.


London Banker said...

@ nc jim
What you say about Wachovia reminds me of the run up to the thrift crisis. Thrifts were competing to offer the highest rates on CDs to attract funds, and then failing because it turned out they were using the new money to hang on by their fingernails.

@ suecris
For a long time Wall Street played the game of getting tax breaks for debt, then telling managements they were stupid not to have debt when it was so tax-efficient and allowed them to leverage their way to rapid growth. It's like telling working class Americans that the government wants you to have a huge mortgage so you can have a huge tax break, so it's stupid not to buy more house than you can afford . . .

Hush, I think I hear another shoe dropping.

jill said...

Robert Higgs posting on the Beacon
claims there is no credit crunch:

"Perhaps someone can enlighten me. I simply don’t understand how we can have a “credit crunch” without substantial increases in real interest rates across the board."

senna said...

Interest rates are the usual arbitor of decision making in obtaining credit. Taking backseat now. With artificial interest rates held down by Fed and large gap-spread agreed upon by colluding (er...competing) banks, the new first principle is three C's. Creditworthiness, collateral, character. Short supply of those, there. Plus as added insurance banks are increasing points, decreasing debt-to-equity ratios, and in general making terms much more credit unfriendly. Credit crunch comes from fearful banks restricting lending becausing prior commitments have precedence, and over-self-protective terms lead borrowers to take a pass. Those desperate for funds cannot make the new threshholds and therefore are left to remedy their situations by other means or BK out.

Anonymous said...

I would like to hear your take on inflation given the run up and run down of the commodity markets at present. Do you see yet another run up in the very near future?

My particular interest lies in the ag segment, where i am looking into purchasing farmland.


clark said...


Testimony of Michael Greenberger Law School Professor University of Maryland School of Law Before the United States Senate Committee Regarding Energy Market Manipulation and Federal Enforcement Regimes Tuesday, June 3, 2008 10:00 a.m.

This perhaps explains what's happening in the commodity markets paricularly oil.

Believe me. Quite stunning.

Best, Clark

NB. (P.16) Those who have blamed speculation as a material factor in the rise of energy prices have estimated, for example, that up to $90 of the present price of the barrel of crude oil has nothing to do with supply/demand, but, instead, is caused by unpoliced trader malpractices.

clark said...

I'll try again.

London Banker said...

Thanks Clark, for the Enron Loophole testimony. I'm not sure there is a way to put the US markets hegemony genie back in the bottle. Markets are moving to other jurisdictions, and it's hard to argue that oil is better priced in New York than in Dubai. It's also hard to argue that the CFTC would provide better market supervision than the FSA or DFSA given its highly politicised history.

I know it's hard for the US to allow the rest of the world a role in the pricing and supervision of markets for commodities they produce and/or consume too. When you don't control the pitch or the umpire, it's easy to shout "Rigged" and "We was robbed!" I'm unconvinced.

Sure manipulation and speculation are a huge factor in current commodity pricing. But I think they would be just as huge if the markets were in the USA, just that the direction of the rigging would be against the interests of commodity producers - as it has been for the past 65 years.

clark said...

London Banker .. not to be testy, which I hope I am not, I think Goldman and Morgan Stanley according to this testimony have been using the "Enron Loophole" to avoid reveling their trading positions to the US authorities. Of course, they can trade these contracts in the Gulf or London or Asia and who would know?