Nary a day goes by when we don't hear about banks' unwillingness to lend. We hear about the huge cash positions among banks and we hear about tight (actually traditional and prudent) lending standards. What we don't hear is the consumer demand for credit is soft.
It is true that there are people (and businesses) desperate for credit, but these are impaired borrowers. They are already over-leveraged and often upside down with their home mortgages (they owe more than the home is worth).Truthfully, it is probably impossible to save many of these unfortunate people. It probably isn't smart either (when demand for a commodity falls prices must fall until new demand is kindled).
However, there is another, much larger group of people. These are people who may be able to obtain credit, but do not desire credit. The lack of desire stems from several factors. There are jobs concerns. As we will probably see tomorrow, the employment situation in the U.S. remains troubled. There is also a move toward financial responsibility. Many people have seen the consequences of over-borrowing and do not want to meet a similar fate. Then there is the cost factor. Lenders want to know you can actually repay the loan (as do the investors who provide the capital banks lend to consumers). This requires proof of employment and income, as well as down payment.Consumers have become accustomed to little or no money down loans. Many cannot source the required down payment. In the rare instance of a low documentation, no down payment loan can be written, the interest rate is punitively high to compensate the lender / investor for their increased risk.
I do not consider these lending standards to be tight. These are the lending standards our parents and grandparents faced. Some consumers will be able and willing to borrow in this environment, others will not. This will keep the demand for credit low.
If these lending standards are "normal" why all the fuss? The concern is that for the past two decades the high level of economic activity to which we have become accustomed has been due to ever lower interest rates and ever easier lending standards. The party is over folks. This is your grandfathers economy.
So how will Granddad's economy affect the markets. Growth will be more gradual and measured. Booms and busts will be much more muted. Business which had relied on high volume sales (auto industry) will either suffer or they will become leaner and more efficient (Ford is doing just that).
This also means that we will see more consolidation. Large balance sheet cash positions and the desire to become more cost-efficient will encourage corporate mergers. Although this will help corporate profitability and viability undoubtedly, there will be job cuts, at least among the merging companies.
All is not negative here. Once trimmed down and consolidated, stronger companies will be in place. Stronger companies mean that the jobs which remain are on more solid footing. Workers who feel more secure in their positions are more likely to spend and borrow, albeit more responsibly than in the recent past.
This is good news for all markets. Investors should be optimistic, but they should also manage their expectations. It is unlikely we will see our 401Ks double every year, two or three as to what had become accustomed. However, gains of 3% to 6% are possible.
Gradual growth and recovery (combined with greater dysfunction than our own in Europe) should result in modestly rising treasury yields with a mild bear flattening of the curve beginning later this year. This should result in tighter credit spreads between corporate bonds / preferred securities and treasuries. Typically, this results in rising corporate bond and preferred prices, but this time could be different. The credit markets have recovered significantly since the depths of the depths of the crisis in late 2008. Absolute borrowing yields for corporations are historically low. I believe the most likely scenario is for treasury yields to rise toward corporate borrowing yields. This will result in corporate bond and preferred prices being little changed in the near future. LIBOR-based floating rate preferred shares have probably had their run. With prices of some of these securities above 23, price gain potential is too small to sit with coupons which will be stuck at their 3.50% to 4.00% floors for at least the next year and may not rise much above their floors during this economical cycle.
I'll be back in a few days to discuss Non-farm Payrolls.
2 comments:
I have also heard the banks are satisfied merely buying Treasuries, which are guaranteed, as opposed to loaning to any person/business, which is decidedly more risky.
Should the rate that banks can borrow from the Fed rise above the T-bill rate, more money will likely be offered for loans.
In theory yes, but banks have another problem. They will not lend money to risky borrowers if they have to hold those risky loans on their books.
In years past, banks would securitize those loans and sell the resulting bonds to investors. This time around, investors either do not wish to purchase such bonds or will do so only if the interest rates are very high to compensate them for the risk. Too much focus has been place on one side of the problem. That being the attractiveness of treasury rates (which are historically low). It is not that treasury rates are attractive, but that they are attractive on a risk / reward basis.
If the Fed raise the Fed Funds rate and the carry trade became less attractive, bank lending would rise marginally. To compensate for lower revenue from the carry trade bank fees would rise and the banks would cut jobs.
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