Category: Stephanie Pomboy

Credit contraction for the ages

Several weeks ago we listened to Jan Hatzius, economist at Goldman Sachs, make a case for the total credit losses within the US banking system and related credit contraction. Further work was introduced by Rob Parentau over at Dresdner Bank where his firm called for $500-750 billion in credit losses and approximately $4 trillion in total credit contraction. Finally, we have a few figures from Stephanie Pomboy over at MacroMavens who quantifies her work from the most recent contraction post dot com bust.

After the dot com bust banks were forced to add $12 billion to their loan loss reserves over the following 18 months. Small as it seemed at the time, resultant lending activity declined by over $450 billion-a multiplier of 40X! Today some of the experts, including the individuals above, foresee a total of $300-500 billion in losses so using a conservative 10X multiplier total credit contraction may approach $3-5 trillion!

Putting this in perspective was the latest from Doug Noland who after parsing the Feds Flow of Funds data indicates $600 billion in nominal GDP last year after increasing credit by $2 trillion. Needless to say the US economy is much more dependent on credit stimulation today vs past several decades.

Not to mention the banks exposure to real estate today, roughly 62%, vs a third back in 2000-2001. Finally, loan loss reserves are near 31 year lows at a paltry $87 billion so how do the banks address this tsunami?

Assuming the banking system can spread the pain over 5 years, plugging the $213-413 billion hole would require setting aside $42-82 billion per year. Using the conservative 10X multiplier gives us $420-820 billion in lost annual lending. Doesn’t this all but guarantee a long overdue consumer recession?

My Comments: In a world completely dependent on sequential credit expansion the ramifications from today’s present unwind will be one for the record books. Maybe Abby Cohen should spend less time on CNBC while reading more from her employer’s top economist.

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