Forget jobs or inflation, credit is what matters. And credit is…

A credible theory
I have a vaguely defined theory that the single most important part of the economic puzzle is credit. I think that as long as you can see that credit creation is expanding, that people and businesses are taking out loans, the economy will continue growing. 

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But it seems to me the foundation of our economy is credit. People get paid in cash, but live on credit. Businesses take in cash, but expand on credit. Inflation, the unemployment rate, wage growth, or purchasing manager indexes might be too high or too low, but as long as people and businesses are taking on debt, you will see economic activity and growth as a result. 

Without credit, though, most if not all growth would come to a halt. The most dramatic example of this of course was the Crash of 2008 and the resulting credit freeze, but I think in general it’s almost so self-evident as to be a truism. It’s more a belief than a theory, I suppose. I haven’t done the research to test the hypothesis.

Banks will start reporting third-quarter earnings next week, and we will get concrete updates on credit growth. Right now, though, it seems like we can expect at least decent numbers. U.S. bank-loan growth in the quarter “remained firm,” S&P Capital IQ reported. Loan growth for commercial banks was up 6.6% from a year ago, and flat with the second quarter. Whether or not that’s good is probably in the eye of the beholder.

Most of that credit is being extended to institutions. S&P reported that 37% went to nonfinancial depository institutions, or NFDIs. Commercial and industrial loans comprised another 20%. Commercial real estate was 14%. 

S&P said that broadly speaking most banks have projected both strong lending activity, and a slowdown in the second half of the year. I’m not sure if both of those things can actually be true, but I also suspect there’s a lot of cover-all-bases thinking there, for good reasons. 

While rising rates can be a good thing for banks in terms of net interest margins, rates can and often do hurt the broader demand for loans. That’s the primary reason the KBW Nasdaq Bank Index is down 12% from the year highs it hit in August. 

Credit growth is the key. It looks healthy compared to a year ago, but flat compared to a few months ago. Which is more important?

Too many cooks?
The Federal Reserve’s major takeaway from the review of the 2023 bank meltdowns seems to be that there were too many supervisors.

Is that an unfair reading of it? I don’t know. What I do know is that Michelle Bowman, the central bank’s vice chair for supervision, laid out plans for a big overhaul of how the Fed monitors banks and its central proposition, as our Kate Berry reported, is to realign oversight from 12 separate regions, one for each regional Fed bank, into five. The benefit of this, Bowman argued, is that it will improve coordination with state regulators. 

Maybe. But a counter argument could be that the problem wasn’t too many cooks, so to speak, but not enough ingredients. The failure of Silicon Valley Bank can be directly traced to rules the Fed itself implemented that weakened oversight, Christopher Appel, the director of banking policy at Better Markets, argued in a BankThink essay on this website. And the obvious fixes, he said, are straightforward and involve making large banks be more transparent about their unrealized losses.