I read a number of comments this morning regarding how bank lending is going to lead us out of recession. Credit growth is absolutely important for an economy to expand but the idea that banks will be rushing out to lend runs counter to recent post-recession experience. As I noted in my previous blog, real estate is where commercial banks lend the most and therein lies the problem. Real estate, either for construction or mortgages or home equity loans, is not exactly the credit a loan officer wants to now load up on. As for commercial and industrial lending, the corporate sector long ago pushed banks into marginal suppliers of short-term capital once direct borrowing from the credit markets became available. Additionally, firms usually fund out of cash at the beginning of a recovery so a big uptick in corporate borrowing is unlikely -- except for lowering average interest costs.
The asset that grows the fastest on bank balance sheets in the first year or so after a recession ends is Government Securities. The charts below illustrate that fact quite clearly. They show credit growth coming out of the past three recession by basing the outstanding loans to each sector at 100 at the end of the recession.
The only surprise here is the continued expression by many that bank credit is going to start flowing and lift the economy. There will certainly be enough credit to support general activity, as opposed to what occurred at the end of last year. What finally gets the private sector going is an acceptable balance sheet and the expectation of higher future income. It is going to take some time to get there, especially for households. Only after that point do banks jump in to finance expanding private sector optimism. It will be interesting to see what type of bank lending is going to grow the fastest. In the meantime, the accumulation of Government securities is raising the credit quality of overall bank assets.