U.S. Bank Credit and 2Q 2011 Household Debt Payments
(September 29, 2011)
Dear Subscribers and Readers,
With the lack of practical tools at the Fed's disposal, and with the banks' reluctance to lend, the U.S. financial liquidity remains mixed, and thus insufficient to prevent a further market correction. From a domestic standpoint, both the Fed and U.S. commercial banks need to play a big role to revive bank lending and economic growth. Over the intermediate to long run, bank lending needs to revive for a sustained uptrend in asset prices and economic growth. Following is a monthly chart showing the state of U.S. bank lending—i.e. the year-over-year change in loans and leases by held by U.S. commercial banks for the period January 1950 to September 2011 (updated to September 14, 2011):
While the decline in bank lending in 2009 was unprecedented (the Great Depression notwithstanding, when one-third of all US banks failed), it has steadied in the last 15 months. Bank lending growth is now slightly positive on a year-over-year basis (up 0.1%, compared to -0.3% in August). Moreover, the absolute amount of bank loans and leases outstanding (seasonally adjusted) rose by $31.4 billion (to $6.80 trillion) from the end of December 2010 to September 14, 2011. That said, this liquidity creation within the U.S. commercial banking system would not much improve the stock market's short-term outlook.
Let us now discuss one of our long-term themes—that of deleveraging in U.S. households. We discussed this in our recent commentary from a U.S. balance sheet standpoint (“2011 2Q Flow of Funds Update – Feds Need to Pay Attention to Housing”). We argued that more deleveraging was needed—preferably until U.S. households' asset-to-liability ratio rises to 5.50 or higher—and that until that occurs, the Federal Reserve will not tighten. While we don't know whether it's voluntary or forced (likely a bit of both), the fact of the matter is that U.S. households are saving more, spending less, and paying out less interest payments as a percentage of their disposable income. On a disposable income basis, however, the deleveraging process is further into the game—although this has more to do with lower interest rates. From this perspective, the trend of deleveraging U.S. households is evident in the declining proportion of U.S. disposable income dedicated to debt payments. As I mentioned, US households' balance sheets will continue its deleveraging process (as consumers adopt a more frugal lifestyle; and as banks and credit card companies restrict lending). Sometime over the next several years, the inevitability of Schumpeterian growth (as well as old-fashioned population growth) will allow U.S. economic growth to normalize again. The combination of this Schumpeterian growth and relatively clean U.S. household balance sheets will drive the next secular bull market in U.S. stocks. I expect the next secular bull market to begin sometime in the 2013 to 2015 timeframe. While the ongoing deleveraging isn't as clear in the 2Q 2011 Flow of Funds data, there is obvious evidence that U.S. households are saving and paying down their debts. This is clear in the most recent trends in US households' financial obligation ratios (ratios of debt payments to disposable incomes), as illustrated in the following chart:
The financial obligation ratio for all U.S. Households' declined during 2Q 2011 and is now at its lowest level since 4Q 1993! Note that one reason would be that many households simply stopped paying their debts. Despite these relatively benign numbers, the deleveraging in the broader US economy should continue, although we have likely finished the most painful adjustments. Going forward, I expect U.S. households to deleverage through a combination of higher disposable incomes (the unemployment rate has peaked), higher savings, and as lenders work through its backlogs of foreclosures and loan defaults (although I expect U.S. housing prices to remain in the doldrums for years to come). Furthermore, as U.S. households pay down more of their debts and become more productive through technological innovation, “workforce re-education” and starting new businesses, we should experience an improvement in the long-term health of the U.S. economy and society. The “Black Swan” risks remain in Europe, where there will likely be a substantial “regime” change (e.g. a restructuring of the entitlement system, sovereign of peripheral nations, etc.) over the next 6 to 12 months.
Henry To, CFA, CAIA