Another of the factors supporting the Model “T” forecast of a “UL” shaped recovery is tight credit (See “What the Model “T” says about the Economic Recovery). To understand the impact of credit on the current economy, we need to go back to September of 2008.
Just a few days before the start of the financial crisis, I was on the phone discussing the transportation market with my friend Tom (a big fan of this blog) who worked for a New York investment firm. Suddenly he became alarmed when one of the commercial paper markets he was following on his computer “stopped working”. I asked him if that was bad. He said he didn’t know, because he had never seen it happen before. We now know just how bad it was.
Much has been written about what was happening in the financial industry when the crisis hit, but not much has been reported on what happened in the manufacturing and small business sectors as a result. Most recessions begin because of decreased business spending as part of the ups and downs of the business cycle. This recession began in December 2007 and appeared fairly typical until the financial crisis hit in mid-September 2008. Before the shock, there were even some indications that the recession might end in 2008.
The financial crisis led to the so-called credit crunch. Suddenly, banks were reluctant to lend money to anyone for anything. Because much of business spending (especially capital equipment and small business) is reliant on credit, companies that were weathering the recession up to that point were forced to stop spending. The sharp, fast, pullback in business investment turned a normal recession into The Great Recession. Industrial orders dried up quickly and companies started laying off workers (both blue and white collar) and people panicked. Consumers then also cut purchases. Once a recession bites significantly into consumer spending, it starts a downward spiral that is difficult to contain and the economy spun out of control.
The government did try to help. Remember the TARP? (Troubled Assets Relief Program) The $700 billon program was done primarily to stabilize the financial system. However, the very important secondary goal of the program was to enable banks to start lending again at pre-crisis levels and to encourage them not to hoard cash to protect against future loan losses. It failed miserably in this regard. For example, one commercial trailer manufacturer had seven large orders at the beginning of December 2008. This was enough to continue production into mid-January 2009. Within two weeks, every one of the orders was cancelled due to lack of financing. Multiply this impact across business sectors and you end up with a -5.4% GDP in Q4, 2008 and a -6.4% in Q1, 2009.
If credit availability of C & I (Commercial & Industrial) loans is a key factor for economic recovery and the TARP failed to remedy this, you might think the government would try something else, a Plan “B” perhaps? No. They moved on to the stimulus, saving the auto industry and healthcare reform, etc.
So what has happened to business credit availability in the last 12 months? IT HAS GOTTEN WORSE! The Fed reported that banks were continuing to tighten their credit standards in October. Almost 90% of banks reported that credit standards were tighter than historical norms. (Barron’s). The National Federation of Independent Business (NFIB) Index of “Credit Difficulty” is very near the historic high that was set a few months ago. C & I loans in Q3 fell 28% from last year. (Market Watch). Outstanding revolving credit (used extensively by small businesses) recently plunged 7.8%, the largest decline on record (Wells Fargo).
What are banks doing with all that TARP money? The Wall Street Journal just reported that the country’s four largest banks are hoarding cash reserves to protect themselves against future losses. This is what the TARP was supposed to discourage, not encourage.
Barron’s is forecasting that credit availability may not improve until the second half of next year and will not return to normal levels until 2011. When businesses can’t borrow there is no business expansion, they have trouble meeting payrolls and they can’t refinance their debt. It is difficult to expect a strong economic recovery if businesses and consumers do not have access to affordable credit.
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