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Banks Have Hoarding Affliction
The extension of credit is said to be the lifeblood for a thriving economy. Knowing this, data from the Federal Reserve make it clear that the U.S. economy is in desperate need of a transfusion.
Banks are not lending and consumers are not borrowing -- at least not in the manner they used to.
What banks are doing is hoarding massive amounts of cash. What consumers are doing is hoarding the little cash they have left after taking care of their essential needs. This hoarding is happening, though, for different reasons.
Banks are hoarding cash because the Fed has made it all too enticing to earn a risk-free return. Consumers are hoarding cash because they have to pay down their debts, save for retirement, and build up their own reserves in the face of a weak job market.
In Excess
Excess reserve levels at commercial banks are stunning. At the end of September, they stood at just over $860 billion on a not seasonally adjusted basis. That compares to $60 billion during the Lehman Bros. bankruptcy ordeal in September 2008 and a paltry $1.7 billion in September 2007.
The massive ramp in reserves is why the chart below looks incomplete; however, it is complete.
The scale on the vertical axis is so expansive that the excess reserve levels from September 2007 to August 2008 are indecipherable. It also goes to show just how challenging the Fed's task will be in preventing a big pickup in inflation when the banks decide to start lending those excess reserves.
So, why aren't banks lending out these excess reserves?
For most, they just don't want to take the risk given that they are still dealing with the ramifications of ill-advised loan decisions in recent years. They don't need to either considering the Fed is paying interest on those reserves and Treasuries provide an additional risk-free investment outlet.
Incidentally, the holdings of Treasuries and agencies by commercial banks have increased by approximately $300 billion on a seasonally-adjusted basis since the beginning of 2008 while the level of deposits in commercial banks has risen by approximately $900 billion.
Turnover the Tortoise
Money isn't turning over in this economy, because it isn't being lent out in loose fashion. The velocity of money today, in fact, is running more like the tortoise than the hare.
We understand the concern that it could quickly transform into the hare, but the chart below provides a telling snapshot as to why we haven't seen a multiplier effect stoke inflationary pressures yet despite the huge boost in the money supply.
The turnover is expressed as a ratio, which we have computed by taking nominal GDP and dividing it by the quarterly average of M2. Note that the slowdown in the velocity of money accelerated at about the same time commercial banks' excess reserves and holdings of Treasury securities and agencies started to ramp.
Not surprisingly, the peak in loans and leases also occurred in the third quarter 2008 or when Lehman Bros. filed for bankruptcy.
Walking With Crutches
We suspect the Fed is OK, too, with banks not lending that money eagerly given the concern the Fed has expressed in the past about the excessive risks taken on by banks and household balance sheets being overleveraged.
The Fed, of course, needs to express its desire to see the economy grow to its potential publicly, yet knowing the Fed continues to pay interest on excess reserves strikes us as a tacit acknowledgment by the Fed that it is still uncomfortable with capital levels at the banks.
In brief, the Fed isn't sold on the idea that the banking sector has its house in order despite several banks repaying TARP funds and others extolling the improvement in Tier 1 Capital ratios.
A deteriorating commercial real estate market, a weak housing market, and a prolonged period of higher unemployment/underemployment, which will interfere with debt repayment capabilities, are no doubt playing into the Fed's concerns.
At the least, the Fed is cognizant that the U.S. economy hasn't shown it is ready to get rid of its government-issued crutches and stand on its own two feet.
A Weak Pulse
There has been much ado lately about whether the Fed will change the language in its policy directive in some way that will convey to the market its desire to stay ahead of inflation.
We think the Fed will change its language with the directive on November 4, but we're not expecting the Fed to change its ways with the fed funds rate anytime soon.
Notwithstanding the 3.5% increase registered in the advance Q3 GDP report, the economy isn't as strong as it would seem on that headline.
Government stimulus, and other government spending, accounted for nearly 2/3 of the increase in real GDP while the change in private inventories accounted for about 1/4 of the increase.
The bottom line, as seen in the charts above, is that the only expansion effort banks are embracing right now is risk-free lending. Until that view changes, economic performance will remain sub-par and policy rates will remain low for an extended period.
The U.S. economy has a pulse fortunately, yet it's a long way still from having a strong heartbeat because it has such low blood pressure.
Feeds!