In addition, it's clear from a deeper analysis of the data that the US is in a recession which started at some time in the last quarter of 2007. (If you want to see some really great analysis regarding GDP, read this article from Chris Puplava). That being the case, the economy will need the financial sector to become more active in the loan market in order to get out of its current hole.
But that won't be happening anytime soon. First we've learned that total financial sector losses are now over $500 billion dollars:
Banks' losses from the U.S. subprime crisis and the ensuing credit crunch crossed the $500 billion mark as writedowns spread to more asset types.
The writedowns and credit losses at more than 100 of the world's biggest banks and securities firms rose after UBS AG reported second-quarter earnings today, which included $6 billion of charges on subprime-related assets.
The International Monetary Fund in an April report estimated banks' losses at $510 billion, about half its forecast of $1 trillion for all companies. Predictions have crept up since then, with New York University economist Nouriel Roubini predicting losses to reach $2 trillion.
Now the IMF's estimate of $1 trillion doesn't seem that far-fetched (it's not as though they are the only organization making that estimate. PIMCO recently made the same prediction).
And there's a good reason for that. The latest Quarterly Banking Profile from the FDIC was a wake-up call to anyone who cared to listen:
Deteriorating asset quality concentrated in real estate loan portfolios continued to take a toll on the earnings performance of many insured institutions in first quarter 2008. Higher loss provisions were the primary reason that industry earnings for the quarter totaled only $19.3 billion, compared to $35.6 billion a year earlier. FDIC-insured commercial banks and savings institutions set aside $37.1 billion in loan-loss provisions during the quarter, more than four times the $9.2 billion set aside in first quarter 2007. Provisions absorbed 24 percent of the industry's net operating revenue (net interest income plus total noninterest income) in the quarter, compared to only 6 percent in the first quarter of 2007. The average return on assets (ROA) was 0.59 percent, falling from 1.20 percent in first quarter 2007. The first quarter's ROA is the second-lowest since fourth quarter 1991. The downward trend in profitability was relatively broad: slightly more than half of all insured institutions (50.4 percent) reported year-over-year declines in quarterly earnings. However, the brunt of the earnings decline was borne by larger institutions. Almost two out of every three institutions with more than $10 billion in assets (62.4 percent) reported lower net income in the first quarter, and four large institutions accounted for more than half of the $16.3-billion decline in industry net income.
Looking at that paragraph we see phrases like "deteriorating asset quality...higher loss provisions...losses taking a larger percentage of revenue....lower return on assets...broad-based declines in profitability...phrases all investors want to see about a vitally important sector of the economy.
All of these events -- the increasing losses and writedowns -- have led to an overall credit tightening. When losses increase, loan's are harder to find. Hence the bearish news from the latest loan officer survey:
About 60 percent of domestic banks—a slightly larger fraction than in the April survey—reported having tightened lending standards on commercial and industrial (C&I) loans to large and middle-market firms over the past three months. About 65 percent of those institutions—up notably from roughly 50 percent in the April survey—also indicated that they had tightened their lending standards on C&I loans to small firms over the same period. Significant majorities of domestic respondents indicated that they had tightened selected price terms on C&I loans to firms of all sizes: About 80 percent of banks—up from roughly 70 percent in the April survey—noted that they had increased spreads of loan rates over their cost of funds on C&I loans to large and middle-market firms, and about 70 percent of respondents—a somewhat higher fraction than in the April survey—reported having widened spreads on loans to small firms. In addition, considerable fractions of domestic respondents reported having boosted non-price-related lending terms on C&I loans to firms of all sizes over the survey period, and the fraction of banks that tightened such terms on loans to small firms increased significantly relative to the April survey.
Strong majorities -- as in 60% are increasing the cost of loans to mid-level and higher borrowers. Credit is tightening in a bigger way for small firms as indicated by more banks tightening lending standards to there borrowers. In short, banks are making it harder for the big guys to get loans and more harder (if that's a phrase) for the smaller firms to get a loan.
Here's some more troubling news:
Substantial majorities of domestic institutions that experienced weaker loan demand over the past three months cited a decrease in customers’ needs to finance investment in plant or equipment as well as firms’ decreased need to finance inventories. In addition, about 65 percent of domestic and 70 percent of foreign respondents pointed to a decrease in customers’ needs for merger and acquisition financing as a reason for the lower demand for C&I loans. Regarding future business, small domestic and foreign institutions, on balance, reported that inquiries from potential business borrowers were about unchanged during the survey period. In contrast, about 15 percent of large domestic banks, on net, reported an increase in the number of inquiries from potential business borrowers over the past three months.
The speed of business is slowing down in a big way -- there is less need to finance investment and inventory. There are not good developments for the macro-economy.
And what about the future?
Concerning loans to businesses, about 55 percent of domestic and 45 percent of foreign respondents indicated that they expected their banks to tighten credit standards on C&I loans in the second half of this year, and about 45 percent of domestic and 30 percent of foreign institutions, on net, anticipated tightening their lending standards on these loans in the first half of next year. Regarding commercial real estate loans, about 70 percent of domestic and 45 percent of foreign respondents believed that their institutions would tighten their lending standards on these loans in the second half of 2008, and roughly 50 percent of both domestic and foreign banks anticipated doing so in the first half of 2009.
A majority will tighten C&I loans this year. That pretty much sinks a second half recovery right there. Combine that with a slowdown in investment and inventory building and you've got a recipe for some serious problems. And finally, we're learning the Europe and Japan are slowing down (Japan's economy contracted last quarter). That means exports -- a sole bright spot in the US economy - will probably start decreasing.
None of this is looking good.