Credit Won't Lead The Recovery

A question I've often wondered during this recession is -- what will lead us out? With unemployment above 10%, it probably won't be consumers. That leaves business. Yet, some news out from the Federal Reserve makes that hope look a little bit grim as well. In the Fed's "October 2009 Senior Loan Officer Opinion Survey on Bank Lending Practices," trends for banks' credit practices are revealed. In short, credit likely won't be leading us out of the recession either.

The Fed asks senior loan officers various questions in the survey. The one I found the most interesting was how their underwriting requirements have changed over the past three months for commercial and industrial loans. Exactly zero say that they've eased standards. Here are the results for loans to large and middle-market firms and small firms:

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Indeed, more than 14% have actually tightened underwriting standards. Here's what this survey's results look like from a more historical standpoint:

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Clearly, businesses will find that direction a positive trend, but they probably still don't like that it's well above zero. Moreover, in the past 20 years we haven't seen so steep a climb in tightening credit standards -- and they aren't loosening; they just aren't tightening as much. As long as banks keep clenching their wallets as businesses beg for loans, the recovery will be stunted.

Of course, this news might not be all that surprising. This isn't exactly a healthy time for business, particularly new business. As a result, battered banks aren't crazy about the idea of using their precious capital to bet on seemingly risky business endeavors. With 9% of all commercial real estate loans delinquent, I can't say I really blame them. This piece from Real Time Economics today confirms this attitude -- banks are increasingly choosing Treasury and agency securities over commercial and industrial loans. Check out the graph it includes:

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But without credit, how will business drive growth and new employment? The only other option is equity. Investors need to be willing to put cash to work to keep U.S. businesses strong and help it to expand. If the stock market hitting a 52-week high today is any indication, then that's exactly what we're seeing. This investment needs to extend beyond just the stock market, however, and also include smaller and start-up firms.

I've said before that business must lead us out of the recession, but I think these observations make it easy to refine this statement further: equity investment in business must lead us out of the recession. After all neither consumers nor credit appear positioned to be of much help.