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May 28, 2010
How "discouraged" are small businesses? Insights from an Atlanta Fed small business lending survey
Roughly half of U.S. workers are employed at firms with fewer than 500 employees, and about 90 percent of U.S. firms have fewer than 20 employees. While estimates vary, small businesses are also credited with creating the lion's share of net new jobs. Small businesses are, in total, a big deal. Thus, it is no surprise that there is congressional debate going on about how to best aid small businesses and promote job growth. Many people have noted the decline in small business lending during the recession, and some have suggested proposals to give incentives to banks to increase their small business portfolios. But is a lack of willingness to lend to small businesses really what's behind the decline in small business lending? Or is it the lack of creditworthy demand resulting from the effects of the recession and housing market distress?
Economists often face such identification dilemmas, situations in which we would like to know whether supply or demand is the driving factor behind changes within a market. Additional data can often help solve the problem. In this case we might want to know about all of the loans applied for by small businesses, whether the loans were granted and at what rates, and specific information on loan quality and collateral. Alas, such data are not available. In fact, the Congressional Oversight Panel in a recent report recommends that the U.S. Treasury and other regulators "establish a rigorous data collection system or survey that examines small business finance" and notes that "the lack of timely and consistent data has significantly hampered efforts to approach and address the crisis."
We at the Federal Reserve Bank of Atlanta have also noted the paucity of data in this area and have begun a series of small business credit surveys. Leveraging the contacts in our Regional Economic Information Network (REIN), we polled 311 small businesses in the states of the Sixth District (Alabama, Florida, Georgia, Louisiana, Mississippi and Tennessee) on their credit experiences and future plans. While the survey is not a stratified random sample and so should not be viewed as a statistical representation of small business firms in the Sixth District, we believe the results are informative.
Indeed, the results of our April 2010 survey suggest that demand-side factors may be the driving force behind lower levels of small business credit. To be sure, when asked about the recent obstacles to accessing credit, some firms (34 firms, or 11 percent of our sample) cited banks' unwillingness to lend, but many more firms cited factors that may reflect low credit quality on the part of prospective borrowers. For example, 32 percent of firms cited a decline in sales over the past two years as an obstacle, 19 percent cited a high level of outstanding business or personal debt, 10 percent cited a less than stellar credit score, and 112 firms (32 percent) report no recent obstacles to credit. Perhaps not surprisingly, outside of the troubled construction and real estate industries, close to half the firms polled (46 percent) do not believe there are any obstacles while only 9 percent report unwillingness on the part of banks.
These opinions are reinforced by responses detailing the firms' decisions to seek or not seek credit and the outcomes of submitted credit applications.
Of the 191 firms that did not seek credit in the past three months, 131 (69 percent) report that they either had sufficient cash on hand, did not have the sales/revenues to warrant additional debt, or did not need credit. (Note the percentages in the chart above reflect multiple responses by firms.) These responses likely reflect both the impact of the recession on the revenues of small firms as well as precautionary/prudent cash management.
The administration has recently sent draft legislation to Congress for a supply-side program—the Small Business Lending Fund (SBLF)—to address the funding needs of small businesses. The congressional oversight report raises a good question about the potential effectiveness of supply-side programs:
"A small business loan is, at its heart, a contract between two parties: a bank that is willing and able to lend, and a business that is creditworthy and in need of a loan. Due to the recession, relatively few small businesses now fit that description. To the extent that contraction in small business lending reflects a shortfall of demand rather than of supply, any supply-side solution will fail to gain traction."
That said, one way that a supply-side program like SBLF would make sense, even if low demand is the force driving lower lending rates, is if there are high-quality borrowers that are not applying for credit merely because they anticipate that they will be denied. We could term these firms "discouraged borrowers," to co-opt a term from labor markets (i.e., discouraged workers).
If a program increased the perceived probability of approval, either by increasing approval rates via a subsidization of small business lending or merely by changing borrower beliefs, more high-quality, productive loans would be made.
Just how many discouraged borrowers are out there? The chart above illustrates that, indeed, 16 percent of all of our responding firms and 21 percent of construction and real estate firms might fall into this category. I add "might" because the anticipation of a denial may well be accurate but based on a lack of creditworthiness and not the irrational or inefficient behavior of banks. Digging into our results, we find that 35 percent of the firms who did not seek credit because of the anticipation of a denial also cited "not enough sales," indicating that a denial would likely have reflected underlying loan quality.
In the labor market, so-called "discouraged workers" flow back into the labor force when they perceive that the probability of finding an acceptable job has increased enough to make searching for work, and working, attractive again. We should expect so-called "discouraged borrowers" to do the same. That's because if they don't, the likely alternatives for them, at some point, would be to sell the business or go out of business. It seems unlikely that, facing such alternatives, a "discouraged" firm would not attempt to access credit. The responses of firms in our sample are consistent with this logic; 55 percent of those who did not seek credit in the past three months because of the anticipation of a denial indicated that they plan to seek credit in the next six months.
Our results also provide some interesting data on an assumption underlying the policy debate: that those small businesses are credit constrained. Of the 117 firms in the survey that that sought credit during the previous three months, the following chart illustrates the extent to which these firms met their financing needs.
Based on firm reports of the credit channel applications submitted in the previous three months, we created a financing index value for each firm. Firms that were denied on all of their credit applications have a financing index equal to 1, while firms that received all of the funding requested have an index level of 5. Index levels between 1 and 5 indicate, from lesser to greater, the extent to which their applications were successful. In the chart we plot data on the financing index levels of all firms in our sample and then split according to whether the firm is in construction and real estate. Among construction and real estate firms, 50 percent of firms had an index below 2.5, suggesting most did not get their financing requests meet. In contrast, the median index value of 4.7 for all other firms suggests that most of these firm were able to obtain all or most of the credit they requested. This difference between real estate–related firms and others is really not surprising given that the housing sector was at the heart of the financial crisis and recession. But it does suggest that more work needs to be done to analyze the industry-specific funding constraints among small businesses.
By Paula Tkac, assistant vice president and senior economist, of the Atlanta Fed
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May 13, 2010
Regulatory reform via resolution: Maybe not sufficient, certainly necessary
This macroblog post is the first of several that will feature the Atlanta Fed's 2010 Financial Markets Conference. Please return for additional information.
On Tuesday and Wednesday the Federal Reserve Bank of Atlanta hosted its annual Financial Markets Conference, titled this year Up From the Ashes: The Financial System After the Crisis. Much of the first day was devoted to conversations about rating agencies and their role in the economy, for better and worse. The second day was absorbed by the issues of too-big-to-fail, macroprudential regulation, and regulatory reform.
One theme that ran throughout the second day's conversations related to the two aspects of regulatory reform highlighted by Chairman Bernanke in his recent congressional testimony on lessons from the failure of Lehman Brothers:
"The Lehman failure provides at least two important lessons. First, we must eliminate the gaps in our financial regulatory framework that allow large, complex, interconnected firms like Lehman to operate without robust consolidated supervision… Second, to avoid having to choose in the future between bailing out a failing, systemically critical firm or allowing its disorderly bankruptcy, we need a new resolution regime, analogous to that already established for failing banks."
Though those two aspects of reform are in no way mutually exclusive, there is, I think, a tendency to lean to one or the other as the first most important contributor to avoiding a repeat of our recent travails. To put it in slightly different terms, there are those that would place greatest emphasis on reducing the probability of systemically important failures and those that would put greatest emphasis on containing the damage when a systemically important failure occurs.
"…the best chance for durable reform is to start with the assumption that failure will happen and construct a strategy for dealing with it when it does…
"In a world with the capacity for rapid innovation, rule-writers have a tendency to perpetually fight the last war…
"I am not arguing that … the 'Volcker rule,' derivative exchanges, trading restrictions, or any of the specific regulatory reform proposals in play are necessarily bad ideas. I am arguing that we should assume that, no matter what proposed safeguards are put in place, failure of some systemically important institution will ultimately occur—somewhere, somehow. And that means priority has to be given to the development of resolution procedures for institutions that are otherwise too big to fail."
At our conference this week, University of Florida professor Mark Flannery expressed concerns that, placed in an international context, a truly robust resolution process for failed institutions may be tough to construct:
"In principle, a non-bankruptcy reorganization channel for SIFIs [systemically important financial institutions] makes a lot of sense. But the complexity of SIFIs' organizational structures introduces some serious problems. Not only do SIFIs operate with a bewildering array of subsidiaries… but they generally operate in many countries. Without very close coordination of resolution decisions across jurisdictions, a U.S. government reorganization would likely set off a scramble for assets of the sort that bankruptcy is meant to avoid. Rapid asset sales could generate downward price spirals… with systemically detrimental effects. Second, supervisors would have to assure that SIFIs maintain the proper sort and quantity of haircut-able liabilities outstanding. Once a firm has been identified as systemically important, this may be a relatively straightforward requirement to impose, but there remains the danger that 'shadow' institutions will become systemically important, before they are properly regulated. (This is not a danger unique to the question of resolution.)
"I conclude that the international coordination required to make prompt resolution feasible for SIFIs is a long way off, if it can be achieved at all."
Not an encouraging note, and the point is very well taken. Flannery concludes that we would be better served by focusing on changes that lie on the "avoiding failure" end of the reform spectrum: standardized derivative contracts, tying supervisory oversight to objective market-based metrics on the health of SIFIs, limitations on risky activities, and higher capital standards.
As I noted above, I am certainly not hostile to these ideas, and the answer to the question "should reform strategies be rules-based or resolution-based?" is surely "all of the above." But even if it will take a long time to develop better resolution procedures to address the types of problems that emerged in the past several years, I strongly argue that development of such procedures are necessary for the long-term, and work on these procedures should begin. And here, I have a relatively modest proposal, returning to my remarks:
"…there is a pretty obvious way to vet proposals that are offered. We have a couple of real-world case studies—Bear Stearns, Lehman, AIG. One test for any proposed resolution process would be to illustrate how that plan would have been implemented in each of those cases. This set of experiments can't be started too soon, and I think should move it to the top of our reform priorities."
Whether it be the specific provisions of reform bills winding their way through Congress or the "living will" idea championed this week by the Federal Deposit Insurance Corporation, I think we would do well to let the stress testing of those proposals begin.
By Dave Altig, senior vice president and research director at the Atlanta Fed
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April 29, 2010
Consumer credit: More than meets the eye
A lot has been made (here, for a recent example) of the idea that banks have shown a surprising amount of reluctance to extend credit and to start making loans again. Indeed, the Fed's consumer credit report, which shows the aggregate amount of credit extended to individuals (excluding loans secured by real estate), has been on a steady downward trend since the fall of 2008.
Importantly, that report also provides a breakdown that shows how much credit the different types of institutions hold on their books. Commercial banks, which are the single largest category, accounted for about a third of the total stock in consumer credit in 2009. The two other largest categories—finance companies and securitized assets—accounted for a combined 45 percent. While commercial banks have been the biggest source of credit, they have not been the biggest direct source of the decline.
The chart above highlights a somewhat divergent pattern among the big three credit holders. This pattern mainly indicates that credit from finance companies and securitized assets has been on a relatively steady decline since the fall of 2008 while credit from commercial banks has shown more of a leveling off. These details highlight a potential misconception that commercial banks are the primary driver behind the recent reduction in credit going to consumers (however, lending surveys certainly indicate that standards for credit have tightened).
To put a scale on these declines, the aggregate measure of consumer credit has declined by a total of 5.7 percent since its peak in December 2008 through February 2010. Over this same time period, credit from finance companies and securitizations declined by 16.2 percent and 12.4 percent, respectively, while commercial bank credit declined by 5.5 percent. Admittedly, securitization and off-balance sheet financing are a big part of banks' activity as they facilitate consumers' access to credit. The decline in securitized assets might not be that surprising given that the market started to freeze in 2007 and deteriorated further in 2008 as many investors fled the market. Including banks' securitized assets that are off the balance sheet would show a steeper decline in banks' holdings of consumer credit.
A significant factor in evaluating consumer credit is the pace of charge-offs, which can overstate the decline in underlying loan activity (charge-offs are loans that are not expected to be paid back and are removed from the books). Some (here and here) have made the point that the declines in credit card debt, for example, reflect increasing rates of charge-offs rather than consumers paying down their balances.
How much are charge-offs affecting the consumer credit data? Unfortunately, the Fed's consumer credit statistics don't include charge-offs. However, we can look at a different dataset that includes quarterly data on charge-offs for commercial banks to get an approximation. We can think of the change in consumer loan balances roughly as new loans minus loans repaid minus net loans charged off:
Change in Consumer Loans = [New Loans – Loan Repayments] – Net Charge-Offs
Adding net charge-offs to the change in consumer loans should give a cleaner estimate of underlying loan activity:
If the adjusted series is negative, loan repayments should be greater than new loans extended, which would lend support to the idea that loans are declining because consumers are paying down their debt balances. If the adjusted series is positive, new loans extended should be greater than loan repayments and adds support to the hypothesis that part of the decline in the as-reported loans data is from banks removing the debt from their books because of doubtful collection. Both the as-reported and adjusted consumer loan series are plotted here:
Notably, year-over-year growth in consumer loans adjusted for charge-offs has remained positive, which contrasts the negative growth in the as-reported series. That is, the net growth in new loans and loan repayments shows a positive (albeit slowing) growth rate once charge-offs are factored in. Over 2009, this estimate of charge-offs totaled about $27 billion while banks' average consumer loan balances declined by about $25 billion. Thus, a significant portion of the recent decline in consumer loan balances is the result of charge-offs.
Nevertheless, in an expanding economy, little or no credit growth implies a declining share of consumption financed through credit. Adjusting consumer loans for charge-offs suggests that the degree of consumer deleveraging across nonmortgage debt is somewhat less substantial than indicated by the headline numbers.
All in all, the consumer credit picture is a bit more complicated than it appears on the surface. A more detailed look suggests that banks haven't cut their consumer loan portfolios as drastically as sometimes assumed. The large run-up in charge-offs has also masked the underlying dynamics for loan creation and repayment. Factoring in charge-offs provides some evidence that a nontrivial part of consumer deleveraging is coming through charge-offs.
By Michael Hammill, economic policy analysis specialist in the Atlanta Fed's research department
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April 06, 2010
Breaking up big banks: As usual, benefits come with a side of costs
Probably the least controversial proposition among an otherwise very controversial set of propositions on which financial reform proposals are based is that institutions deemed "too big to fail" (TBTF) are a real problem. As Fed Chairman Bernanke declared not too long ago:
As the crisis has shown, one of the greatest threats to the diversity and efficiency of our financial system is the pernicious problem of financial institutions that are deemed "too big to fail."
The next question, of course, is how to deal with that threat. At this point the debate gets contentious. One popular suggestion for dealing with the TBTF problem is to just make sure that no bank is "too big." Two scholars leading that charge are Simon Johnson and
James Kwak (who are among other things the proprietors at The Baseline Scenario blog). They make their case in the New York Times' Economix feature:
Since last fall, many leading central bankers including Mervyn King, Paul Volcker, Richard Fisher and Thomas Hoenig have come out in favor of either breaking up large banks or constraining their activities in ways that reduce taxpayers' exposure to potential failures. Senators Bernard Sanders and Ted Kaufman have also called for cutting large banks down to a size where they no longer pose a systemic threat to the financial system and the economy.
…We think that increased capital requirements are an important and valuable step toward ensuring a safer financial system. We just don't think they are enough. Nor are they the central issue…
We think the better solution is the "dumber" one: avoid having banks that are too big (or too complex) to fail in the first place.
Paul Krugman has noted one big potential problem with this line of attack:
As I argued in my last column, while the problem of "too big to fail" has gotten most of the attention—and while big banks deserve all the opprobrium they're getting—the core problem with our financial system isn't the size of the largest financial institutions. It is, instead, the fact that the current system doesn't limit risky behavior by "shadow banks," institutions—like Lehman Brothers—that carry out banking functions, that are perfectly capable of creating a banking crisis, but, because they issue debt rather than taking deposits, face minimal oversight.
In addition to that observation—which is the basis of calls for a systemic regulator that spans the financial system, and not just specific classes of financial institutions—there is another, very basic, economic question: Why are banks big?
To that question, there seems to be an answer: We have big banks because there are efficiencies associated with getting bigger—economies of scale. David Wheelock and Paul Wilson, of the Federal Reserve Bank of St. Louis and Clemson University, respectively, sum up what they and other economists know about economies of scale in banking:
…our findings are consistent with other recent studies that find evidence of significant scale economies for large bank holding companies, as well as with the view that industry consolidation has been driven, at least in part, by scale economies. Further, our results have implications for policies intended to limit the size of banks to ensure competitive markets, to reduce the number of banks deemed "too-big-to-fail," or for other purposes. Although there may be benefits to imposing limits on the size of banks, our research points out potential costs of such intervention.
Writing at the National Review Online, the Cato Institute's Arnold Kling acknowledges the efficiency angle, and then dismisses it:
There's a long debate to be had about the maximum size to which a bank should be allowed to grow, and about how to go about breaking up banks that become too large. But I want to focus instead on the general objections to large banks.
The question can be examined from three perspectives. First, how much economic efficiency would be sacrificed by limiting the size of financial institutions? Second, how would such a policy affect systemic risk? Third, what would be the political economy of limiting banks' size?
It is the political economy that most concerns me…
If we had a free market in banking, very large banks would constitute evidence that there are commensurate economies of scale in the industry. But the reality is that our present large financial institutions probably owe their scale more to government policy than to economic advantages associated with their vast size.
I added the emphasis to the "probably" qualifier.
The Wheelock-Wilson evidence does not disprove the Kling assertion, as the estimates of scale economies are obtained using banks' cost structures, which certainly are impacted by the nature of government policy. But if economies of scale are in some way intrinsic to at least some aspects of banking—and not just political economy artifacts—the costs of placing restrictions on bank size could introduce risks that go beyond reducing the efficiency of the targeted financial institutions. If some banks are large for good economic reasons, the forces that move them to become big would likely emerge with force in the shadow banking system, exacerbating the very problem noted by Krugman.
I think it bears noting that the argument for something like constraining the size of particular banks implicitly assumes that it is not possible, for reasons that are either technical or political, to actually let failing large institutions fail. Maybe it is so, as Robert Reich asserts in a Huffington Post item today. And maybe it is in fact the case that big is not beautiful when it comes to financial institutions. But in evaluating the benefits of busting up the big guys, we shouldn't lose sight of the possibility that this is also a strategy that could carry very real costs.
By Dave Altig, senior vice president and research director at the Atlanta Fed
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March 10, 2010
Consumer credit, credit availability and The Credit CARD Act
Total consumer credit outstanding expanded by $5 billion in January after contracting 15 of the previous 17 months. Consumer credit outstanding includes revolving and nonrevolving credit. Revolving credit is mostly credit card debt, and nonrevolving credit includes loans for items such as vacations, autos, and boats. Even with the slight increase in January, total consumer credit (after adjusting for inflation) has contracted nearly 6 percent since the recession began in December 2007. This number might seem like a huge contraction but compared with three of the past four recessions, it actually looks rather typical. Consumer credit contracted 9 percent in the 1973–75 recession, 11 percent in the 1980 and 1981–82 recessions (treated as one recession here), and 8 percent in the 1990–91 recession.
However, once the current recession is separated into revolving and nonrevolving credit, the relationship to past recessions changes. Typically in a recession, nonrevolving credit shrinks considerably while revolving credit shrinks little if at all. The trend so far in this recession has been the exact opposite; nonrevolving credit essentially has remained unchanged while revolving credit has shrunk 11 percent.
Is the decline in consumer credit the result of supply- or demand-side forces? Perhaps the answer is both.
According to the Federal Reserve's Senior Loan Officer Survey, demand for all types of consumer loans (revolving and nonrevolving combined) has fallen since the first quarter of 2009. A decrease in demand for consumer loans is plausible because consumers tend to delay big purchases such as cars and vacations when uncertainty about future income increases. Because future income is affected by job prospects, consumer credit demand lags the recession much like employment does.
The chart below shows banks reporting an increase in willingness to make consumer loans. In fact, the fourth quarter of 2009 marked the first time in nearly three years that more banks reported increased willingness to supply consumer installment loans than have reported decreased willingness.
Even if banks are more willing to make consumer loans, their lending standards have gotten tougher. Increased credit standards have moderated in recent months, but on average banks are still reporting tightening rather than easing based on the January Senior Loan Officer Survey. This tightening is particularly evident for consumers seeking revolving credit. In fact in the fourth quarter of 2009 banks on average reported increased tightening for credit limits of revolving credit compared with the previous three months. This development came as little surprise since a special question on the Senior Loan Officer Survey in October revealed that banks would tighten a wide range of their credit card policies following the enactment of the Credit CARD Act.
Looking ahead, it will be interesting to see to what extent the tightening of standards for revolving credit impacts overall lending and to see if the Credit CARD Act ends up impacting revolving credit availability in the long run.
By Ellyn Terry, senior economic research analyst at the Atlanta Fed
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February 19, 2010
Should the Fed stay in regulation?
One of the central issues in the postcrisis effort to reform our regulatory infrastructure is who should do the regulating. The answer to some in Congress is none of the above:
"… under consideration is a consolidated bank regulator, one aide [to Alabama Senator Richard Shelby] said. The idea is supported by [Connecticut Senator Christopher] Dodd, who proposed eliminating the Office of Thrift Supervision and Office of the Comptroller of the Currency, and moving their powers, along with the bank-supervision powers of the Federal Reserve and the Federal Deposit Insurance Corp., to the new agency.
"Negotiators are still deciding how to monitor firms for systemic risk, including how to define and measure it, what authorities to give a regulator and which agency is best suited to get the power, a Shelby aide said."
As reported in The New York Times:
"The Senate and the Obama administration are nearing agreement on forming a council of regulators, led by the Treasury secretary, to identify systemic risk to the nation's financial system, officials said Wednesday…"
Though the idea of a council to provide regulatory and supervisory oversight is still contentious (the Times article offers multiple opinions from Federal Reserve officials) the formation of a council is not necessarily the same thing as removing the central bank from boots-on-the-ground, or operational, supervisory responsibility. In other words, there is still the question of how to monitor systemic risk and which agency is best suited to get the power.
Earlier this week I made note of a new International Monetary Fund (IMF) paper by Olivier Blanchard, Giovanni Dell'Aricca, and Paulo Mauro, taking some issue with the proposal that central banks consider raising their long-run inflation objectives. Though that part of the paper seemed to attract almost all of the attention in the media and blogosphere, the discussion in the IMF article expanded well beyond that inflation target issue. Included among the many proposals of Blanchard et al. was this, on systemic risk regulation and the role of the central bank:
"If one accepts the notion that, together, monetary policy and regulation provide a large set of cyclical tools, this raises the issue of how coordination is achieved between the monetary and the regulatory authorities, or whether the central bank should be in charge of both.
"The increasing trend toward separation of the two may well have to be reversed. Central banks are an obvious candidate as macroprudential regulators. They are ideally positioned to monitor macroeconomic developments, and in several countries they already regulate the banks. 'Communication' debacles during the crisis (for example on the occasion of the bailout of Northern Rock) point to the problems involved in coordinating the actions of two separate agencies. And the potential implications of monetary policy decisions for leverage and risk taking also favor the centralization of macroprudential responsibilities within the central bank."
Consistent with the even-handedness of the Blanchard et al. paper, the authors did not come to this conclusion without noting the legitimate issues of those who would separate regulatory authority from the central bank:
"Against this solution, two arguments were given in the past against giving such power to the central bank. The first was that the central bank would take a 'softer' stance against inflation, since interest rate hikes may have a detrimental effect on bank balance sheets. The second was that the central bank would have a more complex mandate, and thus be less easily accountable. Both arguments have merit and, at a minimum, imply a need for further transparency if the central bank is given responsibility for regulation."
But, they conclude:
I wonder, then: Would a regulatory council of which the Federal Reserve is a member, combined with operational supervisory responsibilities housed within the central bank, be a tolerably good response to Blanchard's and his colleagues' admonitions?
"The alternative, that is, separate monetary and regulatory authorities, seems worse."
By Dave Altig, senior vice president and director of research at the Atlanta Fed
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February 09, 2010
If your economic forecast for the coming year embeds something like robust growth in consumer spending, last Friday's Federal Reserve report on consumer credit should probably give you pause.
At least some folks look at that picture and see a slow slog ahead. Calculated Risk sums up the concern:
"Consumer credit has declined for a record 11 straight months—and declined for 14 of the last 15 months and is now 4.8% below the peak in July 2008. It is difficult to get a robust recovery without an expansion of consumer credit—unless the recovery is built on business investment and exports (seems unlikely to be robust)."
At Angry Bear, the question is a little more pointed:
"Remind me again why all those banks were 'bailed out?' Wasn't it supposed to be to kick-start the economy again?"
Well, here's the thing. That consumer credit picture embeds both the supply of credit and the demand for credit. Though both tighter credit standards and weak loan demand are certainly at play, it is does seem that, at the moment, weak demand is the factor most responsible for slow loan growth in the United States. Recall, for example, this information from the Federal Reserve's January Senior Loan Officer Survey:
"The January survey indicated that commercial banks generally ceased tightening standards on many loan types in the fourth quarter of last year but have yet to unwind the considerable tightening that has occurred over the past two years. The net percentages of banks reporting tighter loan terms continued to trend lower. Banks reported that loan demand from both businesses and households weakened further, on net, over the survey period."
As regular readers of macroblog know, our own Atlanta Fed surveys (here and here) are indicating that soft customer demand, not credit access, is a significant story in business capital expenditure and expansion plans.
Of course, we don't really know whether credit availability will become a more significant problem when demand begins to recover. This uncertainty is behind what is the real back story at this critical point of the recovery. As we peer ahead, we essentially have two competing, and contradictory, economic histories as our guides. First, there is the statistical regularity that deep recessions in the United States have in the post-WWII period been reliably followed by rapid recoveries. But second, there is the Reinhart-Rogoff statistical regularity that recoveries from financial crises are slow and difficult.
A Wall Street Journal interview with Carmen Reinhart provides reasonable arguments as to why slow and painful is a sensible bet. On the other hand, one could argue that the advance fourth quarter gross domestic product figure is consistent with the sharp bounce-back scenario. (If you are looking for that argument, Brian Wesbury and Robert Stein oblige.)
One thing is certain. At least one history is going to be revised.
By Dave Altig, senior vice president and director of research at the Atlanta Fed
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January 13, 2010
The demand and supply of bank credit: A small business snapshot from the Southeast
In his recent speech, Federal Reserve Bank of Atlanta President Dennis Lockhart highlighted concerns about the linkage between commercial real estate loan problems at banks and small business financing during the economic recovery:
"The overall commercial real estate debt in the financial system is smaller than residential, but it is disproportionately concentrated in small and regional banks. Smaller banks are a significant source of credit for small businesses, and in most recoveries we look to small businesses to generate a significant number of jobs."
President Lockhart also referenced the results of a survey of small business finances the Atlanta Fed conducted late last year.
"A recent small business survey performed by the Atlanta Fed suggested that business loan demand was down primarily because of weak sales and modest revenue prospects. The credit availability picture was mixed. No surprise, construction-related firms and manufacturers had the most trouble obtaining credit during the last six months. But others did well in having their credit needs met. Of more than 200 respondents, nearly half did not look for credit at all, mostly citing weak sales or sufficient cash reserves."
The survey President Lockhart was referencing was conducted in early December and included responses from 206 small businesses across the Sixth Federal Reserve District (the states of Alabama, Florida, Georgia, Louisiana, Mississippi, and Tennessee) regarding their access to credit. The intent of the survey was to include some additional small business perspectives to supplement our other monetary policy information-gathering efforts.
The firms in the survey were contacts established through our Regional Economic Information Network. In that sense, the survey is not based on a pure random sample of firms. However, the industry distribution of respondent businesses was reasonably representative of the industry mix of the Sixth District (see the chart). The average firm size in the survey was about 22 employees, with around 40 percent of respondents having between one and nine employees.
So, how did businesses surveyed respond? Slightly more than half the respondents said that they had sought to obtain a loan or line of credit from a bank in the last six months. The primary reasons given by those seeking credit were to replace an existing loan (cited by 50 percent of those respondents) and/or to obtain additional working capital (cited by 45 percent of those respondents).
The degree of difficulty firms felt they had in obtaining credit was mixed, with about 60 percent of respondents saying they were able to obtain all or most of the bank credit they sought. The small size of the survey (206 respondents) limits the accuracy of any sector-by-sector comparisons. However, it is interesting to note that construction firms stood out as the business type that had the greatest difficulty having their demand for financing satisfied, with 70 percent of them saying they were unable to obtain the funding they sought. That percentage compares with 50 percent of small manufacturers surveyed and 25 percent of retailers responding they were unable to obtain the funding they desired.
Of those businesses that had not sought credit during the last six months, the dominant reason given was poor sales/revenue (cited by 55 percent of those respondents). Other reasons for not seeking additional credit included sufficient cash reserves.
Slightly less than half of respondents expected to try to obtain a loan or line of credit from a bank during the next six months. The reasons given for seeking credit (businesses could give more than one reason) included the need to replace an existing loan (cited by 43 percent of those respondents), the need for additional working capital (cited by 44 percent of those respondents), and the need to purchase equipment (cited by 21 percent of respondents). Among firm types, construction firms anticipated a higher demand for credit than others.
For respondents who were not expecting to seek credit over the next six months, the anticipation of poor sales growth was the most frequently cited reason (cited by 49 percent of those respondents).
There are plenty of caveats that should be applied to these results. For example, the survey respondents represent established, relatively successful firms. We could not, with this effort, capture the experience of firms that have recently failed (perhaps for lack of credit). Nor can we ascertain the businesses that were never formed because they could not obtain start-up funding.
Still, we believe the results of our survey are instructive. To the extent that the firms in our survey are representative, it appears most going concerns have been able to obtain all or most of the credit they need. What they don't have are customers.
Of course, this is a snapshot of current conditions, and things may change as the economy picks up, demand expands, and credit needs grow. And it would be very useful to know what the story is with those firms that have failed or were never created. We are consequently planning to conduct a follow-up survey as 2010 progresses. We'll keep you posted.
By John Robertson, vice president in the Atlanta Fed's research department
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December 03, 2009
Jobs and the potential commercial real estate problem: Still keeping us up at night
In the season of good cheer, it is certainly gratifying to know that some in the economic forecasting business are actually feeling cheerier:
Reaffirming last month's call that the Great Recession is over, NABE [National Association for Business Economics] panelists have marked up their predictions for economic growth in 2010 and expect performance to exceed its long-term trend. "While the recovery has been jobless so far, that should soon change. Within the next few months, companies should be adding instead of cutting jobs," said NABE President Lynn Reaser, chief economist at Point Loma Nazarene University.
While we at the Atlanta Fed agree that the recession has likely ended, we wish we could feel as optimistic about the current jobs outlook. We've catalogued those concerns before—here, for example—but we continue to look for reasons to believe that our pessimism is unwarranted.
As was noted in a recent speech by Federal Reserve Chairman Ben Bernanke, weak bank lending remains one potentially significant headwind impeding the jobs recovery:
"… reduced bank lending may well slow the recovery by damping consumer spending, especially on durable goods, and by restricting the ability of some firms to finance their operations."
Among the factors restricting lending, "… with loan losses still high and difficult to predict in the current environment, and with further uncertainty attending how regulatory capital standards may change, banks are being especially conservative in taking on more risk," Chairman Bernanke said.
One area where bank loan losses are potentially high and uncertain is commercial real estate (CRE). As highlighted in a macroblog post from October, if the CRE problem falls disproportionately on financial institutions that also finance small business activity, we will be all the more worried that "the post-recession employment boost [small] firms typically provide may be less robust than in previous recoveries."
In fact, as Atlanta Fed President Lockhart noted in a speech last month, as of mid-2009 the banks with high exposure to CRE (relative to tier 1 capital) accounted for about 40 percent of commercial and industrial (C&I) loans to small businesses.
Underneath that statistic are a couple of additional facts that also have our attention:
Over time, CRE loans have become increasingly concentrated in those banks whose CRE lending activity is high relative to their available capital. As of June 2009, banks with CRE loan books more than three times their Tier 1 capital level accounted for 52 percent of the $1.6 trillion of CRE loans in bank portfolios. Though this is lower than the 2008 peak of 59 percent, it compares to just 17 percent in 1993.
Small businesses that rely on bank loans for credit are much more likely to be affected by a bank's CRE exposure than in the past. In 1993, banks with CRE loan books more than three times their Tier 1 capital accounted for just 11 percent of total small business C&I loans. But this share increased to 42 percent in 2008 and stood at 38 percent in June 2009 (of a total of $281 billion of C&I loans to small businesses).
The following chart summarizes these two observations.
Thus, both commercial real estate loans and small business C&I loans are much more concentrated in banks with relatively lower levels of capital than has been the case in the past. Combined with our previous observation that a relatively high fraction of small business loans sit in banks with significant exposures to commercial real estate, these facts do not strike us as a case for optimism regarding the near-term outlook for growth in small business borrowing.
Perhaps today's job summit will result in additional ideas to counter what we see as a serious drag on job creation in the near term. And, of course, tomorrow's employment report could show signs of improvement in labor markets. That would be good news.
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November 12, 2009
Small businesses, small banks, big problems?
In a speech on Tuesday, Federal Reserve Bank of Atlanta President Dennis Lockhart drew some connections between the current commercial real estate (CRE) problems and the prospects for a small business-led recovery.
The starting point was an observation made in an earlier macroblog post that identified the important role small businesses have traditionally played in job creation in the economy and how they had been disproportionately negatively affected in this recession.
What are the connections between CRE and small business? An obvious direct link running from small businesses to CRE is that small businesses are an important source of demand for many types of commercial space. A link from CRE to small businesses is that CRE problems in banks could potentially affect credit availability for small businesses.
The problems currently facing the CRE industry have been building for some time for both property owners and the holders of CRE debt:
- The income generated by nonresidential/nonowner-occupied CRE has generally been falling as vacancy rates on commercial space rose, and capitalization rates–the ratio of income to valuation–have climbed sharply.
- The decline in CRE valuations has created a significant amount of "rollover risk" when CRE loans and mortgages mature and need to be refinanced (about $340 billion in CRE debt is estimated to mature in 2010 and 2011). At the same time, delinquency rates on CRE loans have been increasing sharply, especially for CRE lending for residential construction and development purposes.
Small business lending
Banks have already responded to the generally weakened economic conditions and reduced creditworthiness of borrowers by raising credit standards for all types of lending, including commercial loans, credit cards, and home equity. But there is a risk that additional bank problems, such as the realization of substantial CRE losses, could further constrain bank lending right at the time when credit is needed to support economic growth.
President Lockhart draws the connection between further bank problems and the prospects for small business-led recovery by observing that small businesses depend significantly on the banking sector as a source of financing. (A 2003 Federal Reserve survey of financial services used by small business showed over 50 percent of small businesses had a credit line or bank loan. In addition about half of small businesses use a personal or business credit card.)
The dependence of small businesses on banks is particularly problematic if the banks facing the most severe CRE problems also are a significant source of loans to small businesses.
It turns out that much of the CRE exposure is concentrated among the set of 6,880 or so smaller banking institutions (banks with total assets under $10 billion). Based on the June 2009 Bank Call Report data, these banks represented 20 percent of total commercial bank assets in the United States but hold almost half of the CRE loans.
It seems reasonable to assume that the banks with high exposure to CRE (say, those with CRE exposure as measured by a CRE loan book that is more than three times their tier one capital) are likely to take a conservative approach toward additional loan growth. The bad news is that the banks with the highest CRE exposure also account for about 40 percent of all commercial loans under $1 million–the types of loans most likely used by small businesses.
It is important to recognize that this analysis does not automatically imply small businesses will not be able to get needed funding when demand increases. For instance, even if banks with high CRE exposure are unable to expand lending as demand increases, it is possible that other banks that are less constrained will be able to step in to provide the needed financing. Also, small businesses depend a lot on other sources of financing, such as credit cards, and the large card issuers tend to have low CRE exposure.
Today, the number one challenge for small businesses remains poor sales rather than access to credit. But tomorrow, it will be important that small businesses also have access to funding if they are going to play their traditional role as an engine of growth.
By John Robertson, a vice president in the Atlanta Fed’s research department
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