Wednesday, September 4, 2013

Balance Sheet Recession About Over

Because of the weak nature of this recovery, there is ample statistical ammunition for both the bullish and bearish economists to make their case.  The bears can point to overall consistently weak GDP growth, still high unemployment and weak wage growth.  In contrast, the bulls can point to strong auto purchases, rising home sales, an accommodating Fed and strong stock market.  Neither side has sufficient data on their side to rhetorically put the other side away, as it were.

Last week, I made the argument that we may be closer to a recession than previously thought.  I noted that industrial production and capacity utilization have stalled over the last nine months, along with recent weak readings from durable goods and new home sales.  At the same time, a bullish argument can still be made, as highlighted be several recent well-written articles that also appeared last week.  Bill McBride over at Calculated Risk made the following points:

It still appears economic growth will pickup over the next few years. With a combination of growth in the key housing sector, a significant amount of household deleveraging behind us, the end of the drag from state and local government layoffs (four years of austerity mostly over), some loosening of household credit, and the Fed staying accommodative (even if the Fed starts to taper, the Fed will remain accommodative).    

He also makes this very salient point for the long term (frankly, the rest of my natural born life):

And in the longer term, I remain very optimistic too. I mentioned a few long term risks in my January post, but I also mentioned that I wasn't as concerned as many others about the aging of the population. By 2020, eight of the top ten largest cohorts (five year age groups) will be under 40, and by 2030 the top 11 cohorts are the youngest 11 cohorts. The renewing of America was one of the key points I made when I posted the following animation of the U.S population by age, from 1900 through 2060. The population data and estimates are from the Census Bureau (actual through 2010 and projections through 2060). 

Working age population growth is the lifeblood of any economy.  The influx of new, working age people means they will have to find a job (or start a business) to support themselves.  So long as the economy remains open and accommodating (which it will despite the overheated political rhetoric there is a very strong chance the economy will continue growing.

Bloomberg also published as article last week with a bullish outlook.  It mentioned the following:

The signs of resilience are everywhere: Households continue to spend. Businesses are investing and hiring. Home sales are rebounding, and the automobile industry is surging. Banks have healthier balance sheets, and credit is easing. All this coincides with the economy shedding the excesses of the past, such as unmanageable levels of consumer and corporate debt. 

Both Calculated Risk and Bloomberg point to to very key development: the cleaning up of our respective balance sheets.  What started this recession was a massive build-up of debt in the system, largely related to the housing bubble.  When the bubble burst, people had to sell the asset(s) underlying their debt, usually at a loss.  As this process continued for a few years, people had to either declare bankruptcy and/or pay off their debt from existing earnings.  This meant they had less money to spend on other items, meaning there was overall less economic demand, culminating in weak overall growth.

Here are some charts of the underlying data:

Total household and non-profit debt, according to the Federal Reserve's Flow of Funds report, has been dropping since a little bit before the recession began.

The IMF provided the data for this chart, which shows that total household debt has been declining as a percentage of GDP since mid-way through the last recession.

And finally, household obligations as a percent of disposable personal income are at very low historical levels.

And there is the continued good news from the banking sector, as reported in the latest quarterly banking profile from the FDIC:

Rising noninterest income and falling loan loss expenses continued to lift bank earnings in the second quarter. FDIC-insured institutions reported net income of $42.2 billion, an increase of $7.8 billion (22.6 percent) compared with second quarter 2012 when industry earnings were reduced by losses on credit derivatives. This is the 16th consecutive quarter that earnings have registered a year-over-year increase. For a second consecutive quarter, industry earnings reached a new nominal high. However, the quarterly return on assets (ROA) of 1.17 percent, while up from 0.99 percent a year ago, remained below the 1.27 percent average for the industry from 2000 through 2006. More than half of all banks—53.8 percent—reported higher quarterly net income than a year ago, and only 8.2 percent reported negative net income. This is the lowest proportion of unprofitable institutions since third quarter 2006.  


Loan Losses Fall to Lowest Level Since 2007

Net loan and lease charge-offs totaled $14.2 billion, a $6.3 billion (30.7 percent) year-over-year decline. This is the smallest quarterly total since third quarter 2007. While charge-offs were down across all major loan categories, the overall decline was led by residential real estate loans. Charge-offs of home equity lines of credit were $1.1 billion (41.7 percent) below the level of a year ago, while charge-offs of other loans secured by 1-to-4 family residential properties were $1.4 billion (32.1 percent) lower. Smaller reductions occurred in charge-offs of real estate construction and land loans (down $772 million, or 67 percent), real estate loans secured by nonfarm nonresidential properties (down $775 million, or 52.5 percent), commercial and industrial loans (down $760 million, or 37.3 percent), and credit cards (down $748 million, or 11 percent).

Noncurrent Loans Post Thirteenth Consecutive Quarterly Decline
Noncurrent loan levels also showed improvement across all major loan categories. The amount of loans and leases that were 90 days or more past due or in nonaccrual status fell by $21.7 billion (8.3 percent) during the second quarter, marking the 13th consecutive quarter that noncurrent balances have declined. Noncurrent first lien mortgage loans declined by $13.3 billion (8.2 percent), while noncurrent real estate construction and land loans dropped by $2.8 billion (19.1 percent), and noncurrent real estate loans secured by nonfarm nonresidential properties fell by $2.5 billion (8.8 percent). During the quarter, the percentage of total loans and leases that were noncurrent declined from 3.41 percent to 3.09 percent, the lowest level since fourth quarter 2008.

Here are some charts of the data:

Put in economic terms, the above charts show the "balance sheet" recession is close to ending.