I am reading an outlook for the US Economy from a well known forecaster, and he claims that one of the reasons for the ongoing contraction in private sector bank lending (and therefore M2 growth) is that “there are $176 billion of commercial real estate loans of questionable value on banks’ books”. Thus, the banks fear they might not be adequately capitalized should they need to write these loans off down the road, and as a result they are reluctant to extend credit.
While I agree completely with this analysis, it comes as a surprise to me that he only cites the extent of the CRE problem. So the question is: Did this author forget to mention all the other toxic stuff that was supposedly on the banks’ books (“securities held to maturity” to avoid the write-offs) or was it all erased by one of the many bailouts we’ve had in the last couple of years (and which institution is left holding the bag in that case) ?
“All the other toxic stuff” is things like:
- Non-performing/Delinquent Residential RE Mortgades
- Agency RMBS
- CDOs
- CDS
This came in by email overnight from reader Rodrigo. I’m no specialist where banks and bank balance sheets are concerned, so I can’t address what banks are holding or not holding at this point. I can, however, address things from a couple of perspectives.
First, from the headlines and stories I’ve read, the folks at the Fed seem to be more concerned with what the commercial real estate sector could do to put pressure on the banks than much else, so the newsletter author in question isn’t the only one with that concern. That is no doubt a factor in the rapid decline in Commercial and Industrial loans.
As for the “other toxic stuff”, keep one very big thing in mind. Both the Fed and Freddie and Fannie have been very active in the mortgage market. The agencies have bought up a lot of loans, many of them troublesome, while the Fed now owns about $1.2 trillion worth of MBS paper. Those activities have done a considerable amount to stablize the market, both in terms of the underlying mortgages and the securities. Obviously, we still have a fair amount of foreclosure activity, but it seems like the banks have that at least mostly factored in to things.
Here’s a look at what money supply has been doing of late courtesy of shadowstats.com. Notice how the M3 growth rate (light blue line)Â went negative in the latter part of 2009. That’s an indication of contracting credit and lending in the economy.
Note, M3 is no longer published by the Fed. Shadow Stats has carried on the calculation using their own methods, which is what you see above.
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About the Author
John Forman, author of this blog, has traded for more than 20 years, is a professional market analyst, and authored The Essentials of Trading. He is an active participant in trading forums, consults for trading related businesses, as published literally dozens of trading articles, and has been quoted in a number of books and in the media.
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