Bearish battalions

Font Size

Print

Feedback

Email

Discuss

Reserve which show that loans made by banks (their assets, in the jargon) have fallen over the past three months.

This tightening in credit has taken so long to show up in the numbers because of the way that banks were operating before the summer of 2007. First, they had pushed much of their lending business off-balance-sheet, so that loans were bought by specialist entities like structured-investment vehicles (SIVs) and conduits. When the market for subprime loans collapsed, a lot of these loans came back on to the banks’ balance-sheets. Second, banks had made back-up commitments to businesses to lend money if needed. With the collapse in other debt markets (such as asset-backed commercial paper), corporate borrowers cashed in those chips. Much as they would have wished otherwise, banks found their loan books expanding.

Now, chastened by the huge amounts of capital they have had to raise to strengthen their balance-sheets, banks are being more careful. According to Ian Harnett of Absolute Strategy Research, a consultancy, the availability of credit in Europe for both consumers and companies is now at its lowest level since 2003.

The problem for financial markets is that the virtuous circle which pushed asset prices higher in the middle of this decade may be turning vicious. Banks lend money against the collateral of assets, most notably in the form of housing. As house prices increase, the collateral rises in value and the banks are willing to lend more. That enables buyers to bid up prices even further.

But when banks stop lending, buyers are unable to purchase assets. Some investors are forced to sell to pay off loans. The value of collateral falls, making banks even more reluctant to lend. Markets freeze up, as neither buyers nor sellers have the confidence to do business.

As house prices fall in America, Britain, Ireland and Spain, the wealth effect kicks in. George Magnus, a strategist at UBS, cites the examples of Finland and Sweden in the early 1990s.

As house prices fell, personal-savings rates jumped by 12-14 percentage points. A similar move in America or Britain would have a devastating effect on consumer demand, and thus on GDP growth over the next couple of years. As yet, there has been more of an effect on consumer sentiment than actual retail sales, although individual retailers (such as Britain’s Marks & Spencer) are suffering.