Lending by U.S. banks has plunged by the biggest amount on record in the final two weeks of March prompting analysts to renew warnings of recession and stagflation.
by Tom Ozimek, The Epoch Times, April 11, 2023
The Fed data show that commercial bank lending in the United States fell by $105 billion in the two weeks ending March 29—the largest pullback in the measure on record, which dates back to 1973.
The lending collapse was led by a decrease in real estate loans and commercial and industrial loans, the Fed data showed.
“Horrible credit numbers,” financial analyst Andreas Steno Larsen commented on the Fed’s data release in a post on Twitter. “We are now slow-walking into a recessionary credit crunch.”
Faced with stubbornly high inflation, the Fed a year ago embarked on its fastest pace of interest-rate hikes since the 1980s. The rapid rate increases were a factor in the collapse of Silicon Valley Bank (SVB), which suffered a frenzied run on deposits when it took a $1.8 billion loss on a liquidation of its Treasury holdings, which lost value amid the Fed’s hikes.
Raising the benchmark interest rate that banks use to lend money to each other made consumer and business loans more expensive and harder to get.
“Evidence is gathering that the SVB-fueled banking stress indeed will turn into a recession, but instead of a fast and rapid liquidity-driven recession, we are rather slow-walking into a credit crunch over summer,” Larsen wrote in a note.
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Daniel Lacalle, chief economist at hedge fund Tressis, and an Epoch Times contributor, said that the reason the United States hasn’t yet seen a full-blown recession is due to massive government spending that has propped up economic activity and employment.
“Massive deficit and debt have postponed the recession, but worsened the inflation burden,” he told The Epoch Times. “Recession is inevitable.”
‘System-Wide Credit Will Contract’
While the immediate risk of financial sector contagion from the SVB collapse has abated, the potential for a worse-than-expected credit crunch remains elevated.
Economist Mohamed El-Erian, president of Queens’ College, Cambridge, and adviser to Allianz and Gramercy, wrote in a Sunday op-ed in the Financial Times that “the flashing red light resulting from a speed-of-light run on the U.S. banking system, or what economists broadly refer to as financial contagion, is behind us.”
“Instead, red has become a flashing yellow due to the slower-moving economic contagion whose main transmission channel, that of curtailed credit extension to the economy, increases the risk not just of recession but also of stagflation,” El-Erian warned.
A year of rising interest rates put smaller banks under pressure as they competed for deposits that were flowing into Treasury bonds and money market funds that offered higher rates of return.
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The recent bank failures added to those pressures as depositors withdrew their savings from regional banks in favor of their bigger peers, widely considered “too big to fail” and so more likely to get bailed out in case of trouble.
El-Erian expects that deposit outflows from smaller banks are unlikely to be reversed in the near future. The continued deposit exodus will instead force smaller lenders to pull back, starving small- and medium-sized businesses of credit.
Bigger banks, which are the beneficiaries of the deposit shift, are unlikely to fill the borrowing gap at scale and so, El-Erian believes, “system-wide credit will contract.”
‘Even Trickier Challenge’
There are other factors at play that exacerbate the contractionary impulse on the economy, El-Erian warned.
This includes tighter bank regulatory standards as well as some banks’ operating models now being “a lot more fragile” compared to before the financial crisis of 2008–09 because they got rid of their investment banking arms.
“We are on the cusp of a credit contraction that will play out over the next several quarters, probably reaching its apex toward the end of this year or the beginning of next year,” El-Erian wrote.
He believes the Fed should complete its rate-hiking cycle to get inflation down to reasonable levels before trying to offset the credit crunch with looser monetary policy.
“Failing that, we will be dealing with a higher probability of the even trickier challenge of stagflation.”
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Peter Earle, an economist at the American Institute for Economic Research, told The Epoch Times in an emailed statement that even if the Fed were to hit pause on rate hikes, that wouldn’t necessarily alleviate the risk of a credit squeeze.
“A credit crunch doesn’t require the Fed to continue raising interest rates,” Earle said. “If worries about the health of the banking system continue, spread to commercial real estate, or expand into other sectors, it won’t matter what the Fed does.”
“More problems in financial institutions or other sectors of the economy will eventually result in lending being unavailable or only accessible at exorbitant rates.”
“And that will constitute a credit crunch.”
Small Businesses See Weaker Economy
Growth has become increasingly difficult for business owners since tight credit conditions don’t allow them to expand their operations or hire new employees.
“Self-storage is a cash-intensive investment with stable returns. With skyrocketing material costs, interest rates, and labor prices, it has become more and more difficult to expand,” he said.
Small-business owners’ confidence in the economy declined in the first quarter of 2023 amid persistent inflation concerns, according to the MetLife and U.S. Chamber of Commerce Small Business Index.
Meanwhile, new bankruptcy filings across all major industries saw year-over-year increases for the third month in a row in March, according to data from Epiq Bankruptcy.
