The Feder
al Reserve recently released the results of its latest survey of senior bank officers. Like the economy—not coincidentally—the bankers' attitudes were mixed. Things have improved over the past year. Bankers on balance have shown a greater willingness to extend credit. But still, they remain very cautious. This lingering reluctance to lend, understandable after the losses of 2008-09, offers yet another reason why the economy's recovery has proceeded so slowly and will likely continue to do so for some time to come. Still, there are tentative signs that the environment is easing, certainly enough to support a recovery of sorts.
This caution among bankers has for some time thwarted the Fed's efforts to push the economy forward. To accelerate the recovery, monetary policy makers have given the system ample financial resources for years now. From August 2008, at the beginning of the crisis, to the present, near zero short-term interest rates and two quantitative easing programs have expanded the Fed's balance sheet hugely and poured liquidity into the financial system. Bank reserves, a key liquidity metric, expanded during this time an astronomical 3,428%, 281.4% a year on average. The monetary base, another liquidity measure that counts currency in circulation along with bank reserves, expanded at a rapid 39.2% annual rate during the same time. But because the banks have shown such a reluctance to lend, little of this massive infusion of liquidity has reached the general economy.
Initially, bankers' fears almost entirely thwarted the Fed. While policy turned the flow of Fed-provided liquidity into a tidal wave, banker reluctance kept it from getting through to businesses and consumers. Lending overall, already down substantially during the recession, continued to fall, dropping an additional 8.3% annual rate in 2009 and 2010 and remaining stagnant during the first half of 2011. Banker reluctance has kept the Fed's liquidity flow so bottled up that even today a disproportionate 94.2% of total reserves stand in excess of what banks need to support their existing loan and deposit levels.
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But even in the face of continued banker caution, this latest Fed survey, coupled with recent modest expansions in lending, suggest that matters are beginning to change, although slowly. The Fed's regular surveys in 2010 and 2011 showed a moderate movement by bankers in favor of lending, but late last year, fears emanating out of Europe kept banks cautious. Of the 56 major banks surveyed by the Fed during 2011's last quarter, 53 reported no further easing in lending criteria, while three said that they had "tightened somewhat." With the source of this recent turn to caution easing, especially as the European Central Bank (ECB) begins to take a hand supporting European financial markets, American banks going forward should resume and perhaps accelerate the incipient easing trend that had developed.
What is perhaps most important to this equation is that lending has shown signs of advancing. The first signs appeared in earnest last summer. Between last June and January, the most recent period for which data are available, total loans and leases extended by U.S. banks increased at an annual rate of 4.5%. As 2011 turned into 2012, the pace slowed modestly, no doubt reflecting the caution bankers alluded to in the latest Fed survey, but the expansion has nonetheless continued at an annual rate approaching 3%.
The most significant and most encouraging aspect of the picture, at least where the economy is concerned, is the rise in commercial and industrial lending. From June through January, it expanded at an annual rate of over 12%, indicating not just a greater willingness to extend credit among bankers but a greater demand for funds among businesses. Because such lending mostly supports the medium and small-sized businesses that also do most of the hiring in this economy, this trend, however tentative, stands as particularly significant.
The dark side of the lending picture, not surprisingly, remains real estate. Overall, such lending fell at a 1.2% annual rate between last June and year-end 2011, a welcome relief from the near free fall of earlier years but a decline nonetheless. A modest 0.3% uptick in January's real estate lending (3.6% at an annual rate) offers the hint of a turn, but one month does not a trend make.
Even with all the caveats and pauses, the admittedly modest turn in lending gives reason to look for the economy at last to show a more thorough response to the Fed-provided liquidity of past years. Money growth offers one sign of that turn. While the liquidity remained bottled up and unable to reach depositors and borrowers, money growth remained modest. For instance, from mid-2009 to the end of 2010, the Fed's broad, M2 money measure expanded at barely over a 2.6% annual rate. But in the last six months, as bank lending has increased, it has expanded at almost a 12% annual rate. Likewise the Fed's narrower M1 definition of money (restricted to currency in circulation and checking accounts) shows a 23.5% annual rate of advance over the last six months and grew at almost a 10% annual rate over the last three months.
This recent movement of liquidity from reserves into the economy signals that past Fed efforts should at last begin to have the broader effect going forward that the Fed has long sought. Perhaps, as this change becomes more evident and secure, Fed Chairman Ben Bernanke and his fellow policy makers will see less need for a third quantitative easing.
Milton Ezrati is senior economist and market strategist for Lord Abbett & Co. and an affiliate of the Center for the Study of Human Capital and Economic Growth at the State University of New York at Buffalo. See more of his economic pieces here.
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