U.S. banks loosen up on loans -- for now

WASHINGTON -- After three years of stagnant loan growth, the Peoples Bank in Coldwater, Ohio, has noticed a change. Clients who two years ago would not have qualified for loans now find that they can. One customer who was working for only 35 hours a week two years ago is now working 45 to 50 hours. "That was his reason for coming in: He had steadier income," says Jack Hartings, president of the seven-branch bank. Since the bank's main alternative to lending money is buying Treasury bonds that yield only one to two per cent, Hartings is eager to make new loans.

Across the country, bank lending, which shrank steadily from early 2009, is growing again, thanks to modest employment growth, stabilizing home prices in many regions and the Federal Reserve's Herculean efforts to hold down interest rates.

This is helping. In the fourth quarter, America's economy grew by 2.8 per cent at an annual rate. Much of that was from inventory restocking, which will not be repeated. Still, consumer spending rose at a two per cent annual rate, and house building expanded by 11 per cent, the most since 2004.

Consumption grew faster because households borrowed more and saved less. Saving, which had topped five per cent as a share of disposable income in the wake of the recession, had fallen to 3.5 per cent in November.

This was not sustainable, and indeed the savings rate jumped back to four per cent in December. Are further increases in store? If so, that would hold back consumption, which accounts for roughly two-thirds of gross domestic product. And indeed that is the main reason recoveries after financial crises are usually sluggish: Households and businesses have to hack back the debt they accumulated during the boom years, a process called deleveraging. Households have, as expected, reduced their debt relative to their income. But much of that has come by defaulting on their loans. More such defaults are probably in store. The question is, will consumers also divert more of their income from consumption? That would cause the savings rate to rise further.

A higher savings rate would be much less painful for the economy if it were achieved through increased income rather than lower spending. That could happen. The non-partisan Congressional Budget Office, in its economic outlook released on Jan. 31, calculated that real disposable incomes would grow by three per cent this year, thanks both to faster wage growth and a big drop in inflation.

Plenty could go wrong with this scenario. At the end of 2012, a big threat looms: Taxes will automatically rise and spending will shrink unless Congress votes to override existing legislation. The CBO reckons that would slice the deficit in half, but at the cost of pummelling the economy. For private deleveraging to proceed, public deleveraging may have to wait.

Republished from the Winnipeg Free Press print edition February 9, 2012 A11