An Ominous Shift in Bank Lending

 | Nov 19, 2013 | 5:00 PM EST
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A few weeks ago, I wrote about the shift in lending activity at JPMorgan (JPM), away from commercial and industrial (C&I) loans and toward mortgages and other consumer loan products.

In this column, I'll deal with the pattern of shifting lending activity over the course of the past two quarters at all of the money centers and within the banking system overall. In that previous column, I believe I left too positive a conclusion about what the shift may be indicating. I'll deal first with the C&I loans and secondly with auto and consumer loans.

As I've said on numerous occasions, the money centers' shift into making C&I loans almost exclusively since the 2008 crisis, as a means of making up for the lack of lending in all other areas, has been very troubling.

C&I loans have historically been used for immediate expansion plans by the strongest and largest corporate bank clients, and these loans have typically been evidence of an expanding economy that would lead to job growth. This hasn't happened. The C&I loans since 2008-2009 have principally been used by companies for two new purposes: technology investment and upgrades of existing facilities in order to increase productivity and to put on carry trades into other asset classes.

Neither of these purposes helps job growth in the aggregate, even though they do cause profits at banks and technology companies to increase.

This is not exclusively good or bad for the economy overall; it's a double-edged sword. The investment in technology allows growth at the companies that supply the technology, but at the expense of labor at the companies and industries that purchase the technology to be used to replace human labor.

The demand for computer programmers and software engineers increases as a result of this activity, along with the pay allocated to them, but at the expense of hardware engineers and other human labor across the spectrum of employment.

The net result is fewer jobs, as reflected in the employment, unemployment and labor participation rates as I discussed last week in the column "A Structural Problem."

But that is OK. It's a part of how economies advance, as long as it is not a permanent issue, and it does eventually lead to a broader economy in which the aggregate income generated may be dispersed among more economic sectors and lead to job growth in them.

That, however, is not happening, and this where the nascent shift in bank lending becomes troubling.

The shift away from C&I loans is not occurring simultaneously with a shift toward more productive lending. It is occurring with a shift toward more consumer lending.

Productive loan categories, such as commercial real estate and construction and development, are still stagnating, while loans for consumption, such as auto loans, credit cards and other loans for individuals, are where the concentration of lending is occurring.

The shift into these areas is less about responding to increasing demand as the result of an expanding economy than it is about the re-emergence of degraded underwriting standards in these areas, which has again allowed the potential borrower base to expand.

There has also been an increase in lending for the construction of multi-family residential properties (apartments and condominiums), but that's because the demand for rentals and cheaper, smaller living spaces is increasing faster than it is for single-family dwellings, because more people lack the income necessary to support a mortgage.

All this appears to indicate that the economy is not functioning properly, like a four-cylinder engine running on three cylinders, or a song where sections are skipped.

The macro economy is about fluidity. It is analog logic, not choreographed and exactly repeatable from one business cycle to another, but it has a general circular continuity that can be anticipated, even as the underlying makeup of employment is always shifting.

That's not happening

Forty years ago, the U.S. economy was roughly two-thirds manufacturing reliant and one-third service-sector related. Over the past 40 years, that relationship has flipped but done so rather steadily. 

Right now, the expansion in lending for technology purposes and the employment gains in sectors associated with technology is shifting toward lending for consumption by the individuals who have gained as a result of participation in technology. This has had little positive impact on the parts of the private economy that are not directly related to technology.

More to the point for the immediate term is that the reduction in C&I lending may indicate a cyclical top in technology investment by companies. So employment growth in that sector would begin to fall, even as employment growth in other sectors has not recovered.

If that is what is happening, the declining rate of unemployment will soon reverse and begin rising again, along with a net reduction in the growth of aggregate economic activity as companies concentrate on maximizing the productivity potential of the technology in which they have aggressively invested over the past several years.

If that is the case, then technology companies will show slower earnings growth, and investors will shift away from Nasdaq issues and toward more defensive and broader issues in the S&P 500 and Dow Jones Industrial Average, along with a general shift from equities to bonds. It may also indicate an imminent recession.

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