The San Francisco Fed Lucidly Explains Why Low Levels Of Bank Lending Aren't The Real Problem


Photo: San Francisco Fed

The San Francisco Fed has jumped on board the balance sheet recession meme, ditching the belief that it’s a hike in bank lending standards holding back the economy, according to new research.The research shows that counties in the U.S. with high amounts of household debt are seeing lackluster growth in employment, auto sales, and residential investment, compared to their more debt free neighbours.

In fact, the Fed goes so far as to conclude that it is the debt holding the American economy back.

From the San Francisco Fed:

The evidence is more consistent with the view that problems related to household balance sheets and house prices are the primary culprits of the weak economic recovery…Our view is that the depth and length of the current recession relative to previous recessions is closely linked to the tremendous rise in household debt that preceded it.

If bank lending were the problem, incredibly low rates would have spurred on growth. But banks don’t have any reason to lend to clients in weak counties where growth is not certain, and indebted potential clients have no reason to take on more debt when they aren’t confident in future economic prospects.

In this view, for a variety of reasons, banks that were embroiled in the crisis are not lending even to businesses that have strong investment opportunities. But it is hard to imagine that businesses in high debt counties have many good investment opportunities when residential investment and durable consumption remain 40% to 60% below pre-recession levels.

It seems as if the San Francisco Fed report finally gets the cause and effect straight. It’s not that banks aren’t confident in the recovery, and so the recovery is weak. It’s that consumers have too much debt and don’t want any more, and businesses don’t exactly have great growth prospects if consumers don’t want to take on debt and spend more.

Overall, the county evidence strongly suggests that credit demand is weak because of an over-leveraged household sector. This view is supported by survey evidence that the main worry of businesses is sales, not financing.

Check out the full San Francisco Fed report here >

Now, here’s why Richard Koo thinks the U.S. is in a balance sheet recession >

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