Bank Loans Declining Despite TARP: News May Not Be So Bad

Newspapers are reporting declining loan volumes outstanding at some of the banks that took the TARP capital funds.  (articles in Wall Street Journal, Market Watch, Seattle Times, San Francisco Chronicle)

The conclusion that banks are not using their TARP money as planned is premature–but possibly true.

Here's why the judgment may be premature.  Large banks have for many years sold a service called a standby line of credit.  Corporations that normally borrow in the commercial paper market pay a small fee to a bank for the right to borrow from the bank if the commercial paper market dries up.  Usually the banks collect the fee without having to do a thing–easy money.  But when commercial paper markets dried up last summer, banks had to make loans.  They probably did not want to make many of the loans that they actually made, but they had contractual obligations.  Lately the commercial paper market has re-opened a bit, and some of the standby agreements have expired.  So the decline in bank lending may reflect the run off of loans that banks never wanted to make in the firs place.

The second reason why it may be premature is the normal cyclical pattern of bank loans. Here's what  bank loans to business look like over time:

(Thanks to the Fed of St. Louis for data access and graphics.)

Loan volumes always decline in recessions (the shaded areas on the chart).  So did it make sense to try to stimulate lending at a time when lending always falls?  It's possible that lending fell by less than it otherwise would have thanks to TARP.  We don't know that is the case, but it's possible.

There's a reason to be skeptical about TARP, though.  As I noted in an earlier post, bank examiners at the local level are singing a different tune than their leadership in Washington DC.  The agency heads say that they want banks to lend, but the examiner walking into a Main Street bank to review its condition emphasizes liquidity and preservation of capital, which means "don't make loans."  I'll be nervous until all the regulatory agencies get their field staff in line with their leadership.

My take: I think that credit availability outside of real estate development is at the very tight end of the normal range, or perhaps a bit tighter than the tight end of normal.  Many Main Street businesses that had credit lines last year still have their lines.  However, it's a lousy time to have to change banks, and it's not a great time to ask your current bank for an increase in your line.  And that is negative for the economy overall.