Or is the Market Forcing Their Hand?
Ten years ago, the worst recession since the Great Depression was coming to an end, at least according to the NBER who is in charge of recording U.S. recessions. While the NBER officially declared the end of the recession in June 2009, most Americans didn’t feel like the recession was over. The unemployment rate was still climbing, new foreclosures were still appearing, consumer net worth had just bottomed (after seeing a $12 trn loss), credit card delinquencies were still hovering near a record high and consumer confidence was near a record low. In addition, banks continued to tighten lending standards for businesses and credit conditions were still tight.
Most think of the Great Recession and think housing crisis, but it was the accompanying credit crisis that exacerbated the recession and caused a government bailout. Without it, we may have seen the collapse of the U.S. economy. Ten years later we remember the depths of the credit crisis, show what has changed, look at the state of the credit market now and what may be cause for concern.
- Recap ‘08/’09 credit freeze: The structured credit market was a major catalyst for the credit crunch. Skyrocketing foreclosures, the complex collateralized debt market, and banks unsure of their peer’s health or exposure to bad debt caused the lending market to freeze. The LIBOR OIS spread, a warning of stress in the overnight banking system hit a record high and issuance in the debt market came to a near standstill.
- Government regulators intervened and changed the dynamics of how banks earned money. This was to avoid careless use of their balance sheets in the future. We have seen banks clean up their balance sheets and debt at all levels (except the Government) has seen multi-years of deleveraging. Here are some of the things that have changed over 10 years.
- Banks healthier: In accordance with the new Dodd-Frank laws, banks have strengthened their balance sheets by reducing and/or eliminating certain businesses (e.g. proprietary trading) and even holding less inventory of debt against their capital. The average tier one capital ratio of the three largest banks (JPMorgan, BofA and Wells Fargo) has increased from 8.3 (2Q06) to 13.5 (1Q19). While financials always carry a lot of debt compared to their equity, debt to equity has fallen from over 500% to ~150%. In addition, with earnings per share at pre-crisis highs, banks have not only consistently passed the stringent annual Fed stress tests but also increased dividends to shareholders for the past eight consecutive years.
- Consumers healthier: Consumers saw their balance sheets deteriorate after the crisis. However, 10 years later and consumer balance sheets are solid. Household debt service ratios have gone from a record high (4Q07) to historic lows while household debt to disposable income has fallen to a 17 year low. Lastly, household net worth is at a record high ($108 trillion).
- Housing market healthier: The combination of a better economy, more responsible lending standards and healthy consumers has contributed to a more stable housing market. Foreclosures as a percent of total loans has fallen to the lowest level since 1995. Subprime delinquencies have fallen to the lowest level since 1Q07. The inventory overhang has been corrected as the month’s supply of existing homes has averaged 4.4 months over the past five years. This compares to the 8.6 average months’ supply from 2007-2012.What still keeps us up at night: Yes the economy has recovered from the Great Recession and yes the consumer and banks are much healthier than before and in the aftermath of the crisis, but leverage is still a concern. While banks and consumers have reduced debt burdens, the overall debt level in the U.S. (consumer, corporate and government) is at a record high at nearly 270% of nominal GDP. This is because borrowing has simply shifted from one area to another. While consumer liabilities as a percent of nominal GDP has fallen from ~100% to ~75%, corporate liabilities as a percent of nominal GDP has increased from ~80% to 100% and Federal government debt has increased from ~50% to 100% of nominal GDP. Low interest rates have allowed record amounts of borrowing. However, if interest rates go higher, this puts refinancing at risk and the borrowers who have accepted such a low level of return for the risk they are taking may be subject to unsettling losses.