Another crazy US banking chart.

Have US banks made sufficient loss provisioning to cover their loans? This chart tells us that they haven't.

First, a warning, this is a difficult chart to explain and understand. However, it is well worth the effort to see what it is telling us about the US banking system.

So here goes....

The US Federal Financial Institutions Examination Council assesses whether banks make sufficient allowances for losses. In the bank supervisory reporting system, this number is called the "allowance for loan and lease losses" or the ALLL.

In order to make this assessment, the FFIEC looks at each bank and divides the ALLL by non-performing loans. If the ratio is greater than one, then the bank has things covered. If it is less than one, the bank has insufficient provisioning.

Here it gets a little more complicated. There are big banks and there are little ones. This chart takes account of that rather obvious fact. It separates those banks that have a ratio greater than one from the under-provisioning banks. It then takes the sum of all assets held in those good banks and divides it by the total assets of the banking system.

So what is this chart telling us? Currently, only 19 percent of assets are held in banks that have a ratio greater than one. In other words, the US banking system as a whole has insufficient allowance for losses.

This is why US banks are scrambling to increase their loss provisioning. In turn, provisioning is costly, and this is going to keep the US banking system severely depressed for a long time to come.

No green shoots here

In April, the US trade balance increased slightly. At the time, optimists pointed to this data, and suggested that the worst of the recession might be over. The idea was that consumers were buying more imports, confidence was returning, and if the trend continued, economic growth might resume.

The April data also had an international dimension. During the boom years, the huge US current account deficit was engine of world growth. On the back of the US consumer, and her insatiable appetite for cheap goods, China enjoyed double digit growth rates.

The optimism of April was killed by the reality of May. The US trade deficit slipped back, erasing the increase recorded the previous months.

No green shoots here.

Three decades of debt

In my most recent post, I proudly declared my zero tolerance for debt. Afterwards I received the following anonymous comment:

"Alice, your sentiment is good and your self-discipline excellent.

However, you still have to find rental payments and you're attempting to store your wealth in the form of paper tickets (pounds) with very questionable long-term value. For somebody like you who is expecting inflation this strategy doesn't make sense."

The first point is easily handled. A mortgage holder rents the money; a renter rents the house. Only a renter can stop renting anytime she wants. If her salary increases, she trades up to a larger house; if her income falls, she downsizes. A mortgage holder is imprisoned in a world of duplicitous estate agents, rapacious banks, sticky contracts and a highly inflexible market.

The second point, however, is more problematic. What should someone do if there is a widespread expectation of future inflation?

To tell the truth, I don't have a good answer to this problem. In broad terms, buying real assets seems to be the solution. However, what assets should I buy, and when? I have a few answers but I don't feel confident about sharing them.

The comment hints at a deeper issue. If the inflation is likely to rise, then there is perverse incentive at work. It makes sense to stock up on debt and allow inflation to erode its real value. In contrast, savers will pay as the purchasing power of their assets are destroyed.

This is, in fact, the crazy world that New Labour and the Bank of England want to create. Quantitative easing, zero interest rates, and double digit deficits are all policies directed at one objective - inflation. There is a debate about whether these policies will work, and I happen to think they will. Nevertheless, there is complete clarity about what Brown, Darling and King want to achieve. On this point at least, we can't accuse them of dishonesty.

Having said that, I don't think the prospect of double digit inflation is enough to convince me to shackle myself down with a debt that will take me at least three decades to pay off.

I choose freedom

When you look at long term credit data, you begin to understand the revolution in personal finance that took place in the last thirty or so years.

Back in the early 1960s, private credit was less than 16 percent of GDP. By 2007, it was over 170 percent. It is an historically unprecedented increase in personal indebtedness. GDP measurs our national income, which ultimately determines our capacity to repay debt. So this data tells us that our debt burden, which expressed in terms of income, has increased ten-fold.

To put it mildly, the data sems to suggest that we have become a nation of debt serfs. The vast majority of households, it would appear, are totally beholden to the bankers.

But not me. I proudly declare that I have no debts. The relevant number is zero. You won't find me in that chart. I have no credit card debt and no mortgage. Overdrafts are banned in the Cook household. Everything we have belongs to us. We deal in cash, and not credit.

I don't know about the rest of you but I choose freedom over serfdom.

Another beautiful chart

This financial crisis has produced some wonderful charts. Recent numbers either dive to the depths or reach for the sky.

I particularly like this one. It illustrates loan loss reserves of US banks. The reserves are expressed in terms of total loans.

The chart tells us two things. During the boom years, banks ran down the spare cash they put away to cover bad loans. Just before the crisis they were putting away barely one percent of their total loans.

Then, along comes the crisis and banks suddenly realise that they don't have enough reserves. Everything goes into reverse, and banks start accumulating reserves like crazy.

I reckon this number can only go higher. Soon, it will exceed the previous highs in the late 1980s, and hit an all time high.

MPC - there is no end to the madness...

Today, the MPC decided to leave interest rates unchanged. However, the bank will continue to pump out the cash.

The BoE's original money creation ceiling of £125 billion should be reached next month. Today's statement hinted that the Bank might want a further authorization to create even more cash.

In summary, there is no end to the madness.

From the BoE's press release....

The Bank of England’s Monetary Policy Committee today voted to maintain the official Bank Rate paid on commercial bank reserves at 0.5%. The Committee also voted to continue with its programme of asset purchases totalling £125 billion financed by the issuance of central bank reserves.

The Committee expects that the announced programme will take another month to complete. The Committee will review the scale of the programme again at its August meeting, alongside its latest inflation projections.

The race to the bottom

A simple question - have the dramatic cuts in interest rates worked? The evidence in favour is not compelling. The world is in recession.

I know; things would have been much worse if central banks hadn't acted.

Let the dead man speak

Keynesians routinely malign policymakers from the 1930s, charging them with failing to run sufficiently large fiscal deficits to maintain aggregage demand. According to this modern myth, mass unemployment during the interwar years could have been avoided, if only the officials running the Treasury and the Bank of England had been brave enough to spend their way out of recession.

Of course, it is easy to pour abuse on long dead officials. However, the excellent jka online blog produced a wonderful post recently, which goes a long way to counterbalancing this malicious Keynesian myth.

The site published a memo, written in 1931 by Sir Warren Fisher, who was then the permanent Secretary to the Tresuary. The memo outlines the case for responsible fiscal policies during a deep and damaging financial crisis.

Here is rare chance for a long dead Treasury official to put forward the case for low fiscal deficits and sound money. The memo is as valid today as it was back in the 1930s.

"The seriousness of the financial difficulties which are engaging public attention is perhaps not fully realised. It may therefore be useful to set out the elementary facts. The root cause of the "run" on the part of the foreign depositor is the fact of our living beyond our means as evidenced by our ordering from abroad more goods than we could pay for and therefore our owing to other countries more in dollars and francs than they owe to us in sterling.

Closely associated with this fact in the foreign mind is the question of our national Budget. After the war a certain number of countries continued to have difficulties in balancing their budgets and instead of pulling in their belts, resorted to the expedient of meeting deficits by printing innumerable bank or currency notes. Whenever this was done, the national currency lost much or all of its value i.e. purchasing power, and with the corresponding rise in prices, hardship, even hunger, was widespread.

Consequently, when any of these countries subsequently desired financial assistance from other countries before the citizens of the latter could be induced to lend, they insisted on the borrowing country balancing its budget. And no one was more emphatic than ourselves in preaching this doctrine.

A national Budget has thus come to be regarded as a touchstone of a country's financial stability second only in importance to its international balance of trade; and if, as the case at present with us, we are "down" on our balance of trade with other countries, foreigners to whom we owe money automatically turn a microscope on to our Budget. And if the Budget is not really balanced, but is merely dressed up to look as though it were; or again if the national expenditure is of a scope and type such as to involve (by means of taxation) taking people's saved, up capital and spending it as if it were recurrent income, the distrust abroad of our soundness would be intensified.

Any expectation that we might continue on a "rake's progress" would complete the destruction of international confidence and thus result in the final collapse of our greatest asset, i.e. our credit.

The remedy is to reverse the process which has been responsible for the trouble, and this means that instead of living at a level which has entailed ordering abroad more goods than we can pay for, we must relate our orders to our capacity to pay. And unless we can produce and sell abroad more goods (including "services") than we have been doing, we shall be forced to cut down our orders abroad, and our and our standard of living must be reduced accordingly.

If not the epitaph of us English of to-day will be written by historians to come in Shakespeare' words (Richard II , Act 2, Scene l )
­
England, bound in with the triumphant sea,
Whose rocky shore beats back the envious siege of watery Neptune,
Is now bound in with shame, with inky blots and rotten parchment bonds.
That England, that was won’t to conquer others, hath made a shameful conquest of itself".

Green shoots?

From the American Bankers Association:

A record wave of job losses is being cited as a major factor in a record rate of consumer delinquencies in the first quarter of 2009, according to the American Bankers Association’s Consumer Credit Delinquency Bulletin.

More than two million Americans lost their jobs in the first three months of the year with more than 6 million jobs lost since the recession began. The composite ratio, which tracks delinquencies in eight closed-end installment loan categories, rose to 3.23 percent of all accounts (seasonally adjusted) compared to 3.22 percent of all accounts in the previous quarter.

The delinquent balances on those accounts also rose from 3.16 percent to 3.35 percent of total balances due (not seasonally adjusted). The ABA report defines a delinquency as a late payment that is 30 days or more overdue.