A remarkable rise in US bank lending may hold the key to the outlook for the US economy, but it could be either very good or very bad news.
Lending for commercial and industrial purposes rose at a 26.4 per cent seasonally adjusted annual rate in February, according to Federal Reserve data, the biggest such spike since the 2008 fall of Lehman Brothers. As is so often the case, it is hard to know if this represents the first rays of dawn or simply an oncoming train.
If companies are taking out loans to make investments and hire new workers, we may finally have fulfilled one of the missing pre-conditions of a sustainable recovery. On the other hand, banks often draw down existing loans during times of stress, either to fund working capital needs or because, as was the case in 2008, they fear being denied funds either by banks or capital markets.
The lack of capital investment by corporations — despite high profit margins — is one of the principal puzzles of the last several years of muted growth. Capitalists being presumed to like making profits, the expectation has been that high profit margins will lead to high investment.
But despite record corporate profits, rather than investment, which often involves borrowing, we’ve instead been treated to the spectacle of corporations piling up cash, sometimes offshore with a view to tax arbitrage, or investing not in new capacity but in buying back their own shares.
To be sure, debt has continued to increase as a percentage of economic output, but the growth has been in government debt and in consumer debt, often taken out to fund education as a means of riding out what now feels like a permanent employment slump.
So anything that indicated that banks and customers are willing to take the risk and engage in a wave of new commercial lending has the capacity to be an excellent sign.
It is also certainly true that after years of concentrating on margins, corporate assets are looking a bit frayed, a situation ripe for a new investment wave. Equipment owned by corporations is as old as it has been since 1995. Intellectual property, even in this age in which IP is supposedly short-lived and easily supplanted by ‘disruptive’ new ideas, is as old as it has been since 1983, a point in time, I will remind you, when the war between Beta and VHS format videotape (young people, ask your parents) was not yet settled.
But signs this investment boom is actually happening are thin on the ground. A new survey of company chief financial officers by Deloitte, showed plans are for slightly less capital investment in the coming year compared to plans a year ago. Hiring expectations were also subdued, with plans for domestic hiring to expand just 1 per cent in the coming year.
This leaves us with the other possibility, that companies are taking out loans, usually existing committed facilities, at a faster pace as a defensive manoeuvre. Even though there are clear precedents from 2008, 2007 and the late 1990s when something similar happened, this is still a puzzling move.
Capital markets remain not just open, but when it comes to riskier borrowers, buoyant. Indeed terms and conditions are generally loose and getting looser, a development watched by central bankers and other regulators with some concern. The most recent Federal Reserve survey of senior bank loan officers showed that, at least for mid-sized and large firms, borrowing was getting easier and spreads and other terms and conditions more attractive for borrowers.
The other possibility is that we are seeing a number of firms all having to finance unexpectedly high levels of inventory at the same time. If sales don’t come through as expected, perhaps because of the exceptionally cold weather or perhaps because of the beginnings of a slowdown, companies will draw on existing loans to tide them over until demand picks up again.
That phenomenon, that bank lending can grow in a recession, is supported by the Fed itself, which published in December a short piece explaining its thinking as it relates to bank stress-testing. The clear implication is that banks see their loans rise more than they would expect based on demand in the economy, meaning they have larger loan books which suffer more losses.
That implies the need for more capital. It is, of course, unclear what is happening.
If, however, we are seeing a pick-up in lending due to a sudden slowdown in demand, the clear implication is not just tougher times for banks, companies and stock markets, but for the economy as a whole.
