Wednesday, 28 May 2008

Can you see the crunch?

Sometimes, the credit crunch is very hard to see in the data. Of course, it is there, but one needs to look very closely at the data to find it.

Take for example, the high street banks and their recent lending activity. Data for April shows a recovery, particularly compared to the autumn. So have the banks gained a degree of confidence and started to lend again?

It is hard to say. Around half of this new lending went to "other financial institutions."

Personally, I have never been sure what are these "other institutions." They occupy that grey area behind the normal banking system. They are non-deposit taking institutions and therefore subjected to less stringent regulation from the FSA. What is certain, however, is that these institutions have become an increasingly important mechanism to off-load risk from the mainstream banking sector.

Take this lending to other financial institutions away from the aggregate lending data, and things look very different. Lending actually falls dramatically, illustrating dramatically that banks are beginning to reduce their lending to other sectors of the economy.

We find a similar data conundrum when we look at real estate lending. On the face of it, lending activity is holding up rather well. However, most of this new lending activity is due to remortgaging rather than genuinely new lending activity.

Increasingly, the data points to two conclusions. First, the credit crunch is centred on the housing market, and lending to individuals. This is where the big risks are for banks. Second, banks are also engaged in some rather obscure lending activity that tends to obscure the full impact of the credit crunch.

(data source: British Bankers Association, which covers activity from the main high street banks)


aSteve said...

I've always assumed that "other financial institutions" are synonymous with hedge funds.

Hedge funds, however, don't spend the money they borrow, they invest (if you're forgiving) or speculate with it. I strongly suspect that hedge funds have been frantic since mid-last-year... speculating on tangible assets in the hope of making profits as the global housing and credit bubble collapses and governments are forced to ease interest rates and accept inflation... or so the gamble goes.

My hunch is that, Alice, you're wrong in suggesting that the big risk is lending to individuals... I think the bigger risk is in lending to small business... and that is why I anticipate unemployment will rise over the coming months. Small businesses especially at risk might include boutiques and other retail outlets; small auto-traders; small builders & landscapers; DIY resellers - etc. As these companies fail to make month-on-month profits, they will pose a very real risk of default... and a bankrupt business can't be squeezed... so, I expect, banks will prefer to move too early than too late - hence exacerbating the situation.

Alice Cook said...

Asteve, I recognize the risks you mention. However, lending to individuals is much bigger in sterling terms than lending to small businesses. Here banks are insufficiently diversified. So when default rates go up, (and they will), the risks to banks are greater.


London estate agent said...

It seems to me that housing lending is holding up surprisingly well. I don't see too much basis for doom and gloom here.

The market is very similar to 2005. Interest rates went up, things slowed slightly, then the bank of england cut rates and things returned to normal. I expect things to quiet this year, with a major pick up in activity in early 2009.

Sweep the streets said...

Those lending numbers look very odd! Why the peak in January and April?

aSteve said...

Alice, I also recognise your perspective... the situation we face is complex... I did not want to suggest that lending to individuals was not the big-one, rather to say that we shouldn't overlook commercial lending simply because the principles are smaller. It is my belief that lending to businesses and individuals has been affected by the same financial bubble - and that we shouldn't overlook interactions between finances reported separately in the statistics. The reason that the commercial lending is so relevant is that those with UK mortgages earn their incomes to keep up payments in the UK too. With constrained business finance, it is far less likely that we will see wage inflation save reckless punters' bacon - but rather the converse... as millions face the possibility of redundancy over the next couple of years.

London EA, if you can't see reason for gloom and doom in UK credit markets, I guess this blinkered optimism suits your day job. All the best with that... I hope you earn by doing marketing irrespective of sales.

Roy said...

Interesting, housing leads the credit crunch. What about credit card debt?

CWS said...

I think we need to see a serious decline in GDP before we see any credit lines being cut for SMES. It might happen, but not for a while yet.

Vodka drinker said...

Alice - when are you going to post something on the road tax?

aSteve said...

Nice question, Roy...

I'm not aware of any authoritative source for tracking credit card debt statistics... My suspicion is that it has been rising sharply.

FT's Alpaville blog is making some interesting noises about securitisation of credit card debt... which suggests clearly to me that investors still want to buy credit card debt.. even though defaults are rising.

Just visiting said...

Credit card debt is keeping the UK economy afloat.

aSteve said...

LOL @ Just visiting!