The latest business loans numbers show that bank loans to businesses are still falling. As I have written in recent posts here and here, large banks have systematically shut down their lending to small businesses over the past 2 months, an unintended consequence of the hugely profitable government bailout programs. Basically, today if you can’t sell it to the government don’t bother making the loan.

Bank Loans to Businesses Still Falling

The chart above, from the Federal Reserve Bank of St. Louis, shows commercial and industrial loans from all banks. Banks have loaned approximately -$100 billion to U.S. companies since last fall. Tough to make payroll when you have to pay more to the bank than you get from the bank.

Bank C&I Loans Latest Data

The latest weekly figures, above, show that banks have reduced loans to businesses by $15.8 billion–roughly -$4,000,000,000 per week–in the past month alone. That does not mean there is less borrowing; it means there is negative borrowing. Banks have forced their business customers to actually pay down their loan balances by $4 billion per week. The only way to do that in a small business is to lay off a worker or sell some inventory or other assets at a deep discount.

Essentially all business loans are small business loans–big public companies get their working capital in the commercial paper market. This is a major reason why employment continues to fall.

This is not the end of the world. I wrote a few days ago, in a piece called Time to Think About the Next Story-Inflation, Rising Rates, Commodity Prices, Weak Dollar, that the tsunami of bank reserves released by the Fed over the past six months is hugely profitable for banks and will eventually force a reopening of the credit markets. This chart is just to remind you that it is going to take longer to show up in jobs numbers than it has in bank stock prices.

JR

The amount of currency people hold in their pockets and under their mattresses is the single best indicator of the level of fear on main street. Since last summer, when people first got the wind in their nostrils that banks might fail in big numbers, individual depositors have withdrawn roughly $90 billion from their bank accounts “just in case.”

Currency Holdings Have Stopped Rising

To put that number in perspective, the total reserves of the U.S. banking system last summer before people got spooked was $85 billion.

In recent weeks, however, people have stopped taking $100 bills out of their bank accounts. Total currency held by the public was $849.4 billion on May 18, less that it was a month earlier ($850.1 billion on April 20.) I think it is a sign people are beginning to unclench their buttocks and become a little less afraid. That’s a great sign for spending. When people became frightened last August/September they slammed their wallets shut and stopped buying everything. That’s when the economy fell off the table, inventories spiked up and employers began laying off workers in a hurry.

When the public exhales and put their money back in the bank there will be a rebound in spending. There will also be a further $90 billion spike in bank reserves, which will eventually show up as lending. I don’t know about you, but I can’t wait to see this happen.

JR

The new U.S. Financial Data report out today from the St. Louis Fed shows that bank loans to business are still falling. This fits what we hear from entrepreneurs, that large banks have been systematically reducing availability of working capital loans for small companies—likely an unintended consequence of the Treasury bailout programs that make it bad business to make any loans that are not salable to the government.

Bank Loans to Businesses Still Falling

The chart above shows that the lion’s share of the more than $100 billion (left scale) cut in total bank business loans since last fall is attributable to large banks (right scale). Small banks that do not have full access to the Treasury programs are still making loans.

Banks lend money to small companies, not big ones. Job gains (and losses) come from small companies, not big ones. That’s why this chart tells us we are going to see another lousy job report next week. I think we still have several months of job losses ahead of us before employment turns up again.

JR

About like it has been (4 week average is 628K, originally reported as 631K). Economy is starting to firm up a bit but the job numbers are being held down by the recent further tightening in bank credit lines for small businesses. Banks did this in order to focus bank resources on “things they can sell to the government in boatload quantities” that have a huge return for the bank. Banks have frozen working capital lines, home equity lines, personal lines and nonconforming mortgages (jumbos) for even top quality borrowers.  Jobs can’t pick up until small companies can borrow money again.

I wrote a few days ago that the amount of currency held by the public is a very good measure of the public’s level of fear about the stability of the banks and financial system. The numbers are produced weekly by the Research Department of the Federal Reserve Bank of St. Louis.

Increase in Currency Holdings Over Year Ago Levels

The chart above shows that the level of fear is still very high. People have taken about $90 billion of $20 and $100 bills out of their bank accounts to keep at home under the mattress.

Increase in Currency Holdings Over Previous Month

The increase in currency holdings appears to be abating, however, as you can see in the chart above, which measures the increase over month earlier levels. Withdrawals, which had been running $10-$15 billion per month, have now decelerated to less than $5 billion in April.

These numbers bear watching. Whenever people conclude that the all-clear whistle has blown and banks are not going to fail there is going to be a flood of money being re-deposited into banks. That will make bank reserves swell even higher. It will give banks an additional $90 billion of zero cost deposits and the resulting $5-$10 billion of increased earnings, And it will be the signal for the next round of bank stock price increases.

I am heavily invested in financial stocks today for these reasons.

JR

Last week we had reports on both producer prices (PPI) and consumer prices (CPI) for April. The headlines were about flat and falling prices. So why are interest rates going up?

April PPI showed finished goods up 0.3%, 0.1% ex food and energy and -3.7% from 12 months ago. Intermediate goods ex food and energy were -0.9% for the month of April and -10.5% over the last 12 months. Crude goods were -0.6% in April and a stunning -40% from a year earlier.

Consumer goods in April were flat (0.0%), and -0.7% from 12 months earlier. Energy costs were -8.5% over the past 3 months, and -25.2% from year earlier. 

So then why are interest rates going up? Not at the short end where the Fed is keeping fed funds and T-bill rates low, but at the long end as shown in the above chart of the 10 year Treasury yield. Rates have popped up by roughly one percentage point in recent weeks.

You can see the same bump in the 30 year Treasury yield above. Looking at the 30 year yield has fallen out of fashion due to the interruption in supply and thinness of the market compared with the ten year. But I think it is especially important because its duration is much closer to the duration of the stock market, roughly 25-30 years at today’s rate levels. In rough terms that means a one percentage point increase in the long Treasury yield (currently 3.17% for the 10 year and 4.18% for the 30 year) will reduce the intrinsic value (the expected value of free cash flow) of the S&P 500 by 25-30%.

So why are rates rising? Because bond market investors can see the end of the financial crisis that still dominates the headlines and the talk in Washington. They are looking beyond the credit crunch at the inflation implications of the Fed’s unprecedented tsunami increase in bank reserves (roughly +800%) since last September. They are right to do so.

I don’t think many economists would argue with the statement that an 800% increase in bank reserves, if allowed to remain in the market permanently, would increase the price level by about 800% over a few years. To clarify, that means the price of a quart of milk would go from $2 to $16! I don’t think that is going to happen because I believe the Fed and the political system would not allow it to happen. But it does mean that the Fed is going to have to start taking steps very soon to clean up their mess before it hits prices in a big way.

Here is the catch. The guys who are going to be in charge of cleaning up the mess by vacuuming up the 800% bank reserve increase (and an additional $90 billion that will come back onto reserves when consumers finally unclench their buttocks and re-deposit the $90 billion worth of $20 and $100 bills they have taken out of their bank accounts over the last year) are the same guys (the Federal Open Market Committee) that created the mess in the first place by first under-printing reserves in the year before last September, then over-printing reserves since then. The odds that they will handle this mopping up exercise with grace and agility are approximately equal to zero.

I’m not smart enough at this point to write the story of what happens when they try to do so. But I do believe we will see further increases in long rates as we approach the Fed hoover exercise, which could start to take place as early as the end of the year.

This has two implications to me: First, long-term bonds are the riskiest component of people’s portfolios in spite of what all the textbooks say. Second, the strong gains in the stock market caused by the Fed tsunami are real but temporary. There is no surer way to kill a long-term stock market that to increase bond yields.

JR