YOU DECIDE: When will bank lending bounce back?

Media Contact: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

At talks I give all across the state, one of the most frequent complaints I hear is about bank lending. Many business people think banks have money, but they’re just not making loans. They think banks are content to keep the money in their vaults rather than put it to work in the community.

This is important because existing businesses need loans to expand, and new businesses need loans to start. And if businesses aren’t growing, then jobs aren’t being created.

So is bank lending — or the lack of lending — really a problem? Let’s go to the statistics for an answer. In 2009 banks made almost $300 billion of new loans to businesses. This year the value of new loans is running slightly lower, at an annual rate of $270 billion.

But in 2008 new bank business loans totaled $370 billion, and in both 2006 and 2007, the annual business loan total was $325 billion. You have to go back to 2003 to find new bank loans lower than they are today.

So banks are lending; they’re just not lending as much as they were before the recession began in late 2007. The big question is, why?

There are at least three reasons. One is simply that the number of businesses wanting loans is down. With unemployment near 10 percent, consumers tighter with their spending and production from our factories and offices still below pre-recessionary levels, the number of businesses seeking loans — and the amount of those loans — is not what it was a few years ago. In economics lingo, the demand for loans is lower than it used to be.

Another reason is related to the crash of the housing market. Average home values have fallen 30 percent since the peak in prices before the recession. While this has certainly hurt homeowners, it’s also been a drag on businesses.

How so? Business owners, especially small business owners, use their home equity (the value of the home minus any outstanding mortgage) as collateral for loans. So if home values — and therefore loan collateral — are down, then so too will be business loans.

The third reason is a byproduct of the Federal Reserve’s efforts to stabilize the banking system. The Fed has made loans available to banks at very low interest rates. The Fed will also pay interest on money invested by banks back to the Fed.

Both of these tactics were designed to support banks financially during the recession and give them greater ability to make loans. But instead of making business loans, what many banks have done is invest their funds in safe U.S. government bonds or simply turn around and invest with the Fed.

Some observers have recommended that a solution to this last issue would be for the Fed to charge an interest rate for the bank loans and reduce the interest rate paid to the banks if banks invest with the Fed. The thinking is that this would motivate banks to seek higher returns on their money by investing in businesses and other private opportunities.

However, some economists think this remedy wouldn’t work. They argue the current level of bank lending is the new normal, while the higher pre-recessionary levels were abnormal. Lending was only higher between 2003 and 2008 as a result of the housing boom. And now that housing values have come back to earth so too has lending.

Indeed, an amazing $6.5 trillion of housing wealth has been lost since 2006, and experts think it will be years — perhaps a decade — before this wealth is recovered. During the housing boom of 2003 to 2008, when housing wealth surged by $7 trillion, the gains fueled a jump in consumer spending that, in turn, motivated a boom in business loans and expansion.

But now that the housing boom has turned into a housing bust, and wealth has decreased rather than increased, the argument is that the size of today’s economy simply can’t support the levels of business spending and business borrowing that we saw from 2003 to 2008.

Interestingly, the level of real estate wealth today is about what it was in 2003. Perhaps not coincidently, the number of jobs today (130 million) is the same as it was in 2003. So is today the new reality rather than a temporary low? You decide!

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Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The Department of Communication Services provides his You Decide column every two weeks.

Related audio files are at http://www.ncsu.edu/waldenradio/