Senior Loan Officer Survey of the Fed indicates economic armageddon

November 3, 2008

In the present scheme of events the most valuable, and reliable data that we posses is the Fed’s senior loan officer survey. Not only does it present a very accurate and recent snapshot of the health of the economy’s circulatory system (the banks, I mean) but also it provides almost infallible guidance to the next three to six months of economic activity, because the core and center of this crisis is the banking system, and without that sector healing, any kind of speculation of an economic recovery can never go beyond being a dream. 


We finally had the October update on this report, and here are the graphics: 






In the first graphic we see the rate at which domestic US banks are increasing the risk premium which they add to their cost of funding before lending to others. As can be seen clearly here, this spread is now at  a third consecutive all time high, and has basically nowhere to increase further, because all the banks in the Fed’s latest survey have been increasing their risk premiums on the loans they offer, in other words, they are lending the funds which they obtain at a  very dear cost already at an even dearer rate to the end user, that is, corporations or consumers, which causes economic activity to contract. In the second graphic we see how this continuing tightening of credit by banks, and higher borrowing costs is leading C&I (commercial and industrial) loan demand to plummet. To be sure, this second phenomenon has other causes, but  the unusual characteristics of the situation are obvious. More importantly, in the second graphic we can see that demand for C&I loans still has a long way to fall, which implies that we’re only about half way through with job cuts and downsizing in the wider economy. Loan demand appears to lag the other indicators here by a few quarters. 





It’s interesting to note here that the government’s assumption of Fanny and Freddie’s obligations appears to have had almost no impact on mortgage availability. There was a slight improvement in the percentage of banks tightening credit standards  on prime residential mortgages, which could well be due to the government actions, but even then, demand in all sectors of the mortgage market contracted in the recent quarter. What does this show us? The consumer cannot be fooled into spending like five year old children, because everyone is nowadays aware of the difficulties of the economy. Even if banks do reduce lending standards a bit, which is highly unlikely, it will be hard to induce the debt-laden and bankrupt US consumer to borrow, and this is the other side of the problem. There’s not only a reluctance to lend, but also a reluctance to borrow. 




We see the same picture here. In the first graphic we can see a slight improvement in the ratio of those banks that tighten credit standards, but in the third graphic we can observe demand for such loans collapsing. These numbers should be sobering for the government.


In general the nature of this crisis can be summarized in


  1. A general contraction in all markets from derivatives, to lean hog, both in the number of actors, and the volume of transactions
  2. Collapse in both supply and demand for credit
  3. and consequently a feedback loop which thrives on panic and pessimism.


A long time ago I wrote hear that the feedback loop was the greatest danger to the global economy. Unfortunately,  the loop is active now, and we’re likely to see massive damage done before the crisis solves itself through mass unemployment and bankruptcies.


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