Perhaps because of the egg-linked salmonella outbreak eggs are much on my mind this morning. It may be that the signs posted in my local grocery store announcing that their egg suppliers aren’t implicated in the outbreak might have something to do with it. This morning I encountered in a Wall Street Journal op-ed the same balderdash I’ve been seeing about bank loans for some time:
What’s missing in these times is a strong desire among businesses and consumers to take on new debt, low rates notwithstanding. Corporations can’t even decide what to do with all the surpluses their businesses are generating; they are sitting on vast amounts of cash even though it is earning them minimal investment returns. Because business’s “animal spirits” are suppressed by caution, private-sector hiring is weak, which means the unemployment rate is likely to remain high. As the New York Fed report shows, householders on balance are struggling to pay off the debts piled up during the 2003-2007 credit binge and are building up savings. Consumer spending is relatively flat.
Are the rates low? Or are they merely lower? Unless economics has changed since I was in school as long a good remaining on the market means that the market clearing price has not been reached. To me that would mean that banks are asking too much for loans as much as businesses are reluctant to borrow.
A purchase is a transaction between a buyer and a seller. Attributing a reduction in the number of purchases to buyers alone is promulgating a falsehood by telling only half of the truth. At this point bankers are being paid not to make loans since they can make money with very little risk by borrowing from the Fed, buying Treasury notes, and pocketing the difference between what they pay and what they earn. Why make loans?
In my view a key challenge to righting our economy lies in adjusting our expectations to the new reality at hand. But homeowners continue to believe that their houses are great investments, retailers continue to believe that the glory days of the Aughts will return, bankers continue to believe that they will continue to reap riches beyond the dreams of avarice by the same means that have worked so well for a generation or more, and policy-makers encourage them in those beliefs by pouring money down every available rathole, secure in the conviction that they will be able to uncrack the egg.
I wonder how many businesses are really hording cash. Certainly the large corporations are, but based on my anecdotal experience, most small business are still in survival mode and the ability to horde cash is a problem they’d like to have.
Here’s one explanation of why businesses hoarding cash may be in illusion.
I suspect when we talk about the cost of a loan here, we are not talking about rates, but collateral. And for small businesses that means the owner has to offer up personal stocks or property. And many of these small businesses with outstanding loans were forced to undergo a painful refi when the stock market dropped.
I was talking about unsecured loans. It may be that the banks have tightened up on requirements. I couldn’t say.
However, characterizing the issue as one solely of people being uninterested in borrowing is a canard.
There are several themes at work here, and some hyperbole to boot.
There is no doubt that the Fed/treasury note arbitrage is being utilized to a degree by banks, but that’s not the whole story and it doesn’t follow that the notion of business caution is “balderdash,” or that we should observe “why make loans?”
If “why make loans?” is true all manner of people and institutions would simply seek risk free loans and investments, and we would have no capital markets to speak of. The real answer of course is that there are several factors at work – banks holding excess reserves for fear of additional loan write-downs (facilitated in part by that arbitrage), the easy money arb, and that the market size and demand for risky investments has shrunk. The business caution thingy.
To make a distinction, and a point, the M&A markets are in full flight right now. Why? Avoidance of looming tax increases, banks kicking out borrowers with debt to cash flow ratios of 4-6 who simply couldn’t get recapitalized before, and pockets of opportunity (for yield). My firm has just completed one buy, has another a month from close, and is selling two companies scheduled for close before the end of September. They are all PE deals, so they are debt financed. I guess the banks find these loans, at least, to be better than Treasuries.
But where is the business caution effect, and loan demand way down? Most C&I volume isn’t acquisition financing, its working capital and construction loans. And as I’ve been saying for almost a year now, if you’ve pulled into your shell you don’t need to increase your LOC or build that new warehouse in Tennessee.
I’ve seen Mish quoted various places, but he really needs to put on some suntan lotion, venture out of the house and speak with some business owners.
Andy- The two small busineses we are selling (one has revenues of about $100MM and the other about $160MM) both paid their revolvers to zero and have accumulated cash. Just one data point.
Unsecured loans are almost solely a creature of large corporate borrowing.
I’m not saying that the assertion of business caution is “balderdash”;I’m saying that fixing the blame on borrowers only, as is clearly the case in the column in question, is balderdash. As I said in the post it takes two to tango and each side in the transaction has its own concerns and the sum of those concerns leads to reduced economic activity and, in the case of the banks, buying Treasury bills (a fact) a legitimate tactic for the cautious.
BTW, I believe that Mish is local here, too, Drew.
Dave –
It woul be interesting – and I bet a rough approximation could be done; Federal reserve banks do these kind of studies – to look at the volume of arb activity and make a rough estimate of diminished loan activity.
Lastly, there must also be an element of rational policy by the bank that the risk adjusted return of some proposed laons is unacceptable in this environment. I’ve listened to business owners for 20 years grouse about how a bank wouldn’t make them a loan for this or that purpose. “They only want to make sure bets!” “Aren’t they here to help us grow?” …they lament. Meanwhile I’m thinking to myself: that’s equity risk you are proposing to take, not senior debt risk, you idiot. Finance it with your own damned money in.
BTW/ the last time I believe this issue came up at OTB, the link given to support the corporate hoarding thesis showed the use of a very broad definition of money. I believe it included semi-liquid assets, and there was a longterm trend of an increasing ratio of “money” to ordinary assets over time. I posited that these trends could reflect increasing use of self insurance and leases of property and equipment.
I can testify to it becoming more difficult to get loans of any sort. We maintain a line of credit to help even out revenue swings. We have had this for over 10 years. This line of credit is for about 5% of annual revenue. The bank is making it difficult for us to renew this.
OTOH, I have seen a number of quotes from big company CEOs lately saying that they can borrow billions if they want, but they already have unused capacity.
Steve