Monday, July 27, 2009

Lending Slows For Banks, Borrowing Picks Up For Governments

The total amount of loans held by 15 large US banks shrank by 2.8% in the second quarter, according to the WSJ. More than half of the loan volume in April and May came from refinancing mortgages and renewing credit to businesses, not new loans. Government-controlled Fannie and Freddie are propping up the mortgage sector. Without their support, the decline in lending would be far more severe. This news does not bode well for those hoping for a big bounce in the economy in the second half of the year. It points to a weak recovery that is still very heavily subsidized by the government. Furthermore, it reinforces the view that the old trick of offering cheap financing to an economy that was far too leveraged isn't going to work. What good is it to offer businesses or consumers 0% financing when they are already up to their eyeballs in debt?

Nonetheless, the government itself is working very hard to make up for the lack of activity in the private sector. The Treasury plans to flood the market with $200 billion in new debt this week, the busiest weekly schedule since 1985. The auctions include $109 billion in two-year, five-year, and seven-year notes, $90 billion in bills and $6 billion in TIPS. Foreign central banks are expected to be big buyers in order to keep rates nice and low, so the US can continue to borrow and borrow and borrow without any thought as to how we're ever going to pay them back.

Speaking of government borrowing with no regard for repayment, emerging nations are also rushing to issue debt. So if you are unhappy with the super low risk-free rates offered by the US, you can always hop the pond and pick up something with a slightly higher yield. The surge in issuance this year by emerging markets, to its highest point since records began in 1962, "is an encouraging sign for the world economy as activity in emerging market bonds had seized up until a few months ago" says the FT article. Alternatively, it can also be viewed as a bunch of countries with major financial problems realizing they have a small window of opportunity to borrow money while investors are still insane enough to buy emerging market debt, so they'd best take advantage of it. Bond volumes in emerging markets have risen to $352 billion this year, up 45% on the same period in 2007 before the financial crisis. Hungary, which had to receive support from the IMF earlier was able to launch its first bond offering since June 2008. Again, solving a debt crisis with more debt = recipe for disaster. But according to the emerging market strategist at BNP Paribas "From an investor's point of view, it does make sense to buy emerging market bonds because there is a safety net. Since the G20 committed extra money to the IMF in April, it has become clear that governments will not let an emerging market country default." So the notion of "too big to fail" has gone global and investors can now assume that every investment is guaranteed. The problem of risk has been eliminated. You know, just like in 2007, when everyone still believed that risks had been effectively mitigated through derivatives. I'm sure it'll all work out just as well this time too.

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