ABA Banking Journal - December 2008 - (Page 48)

briefing The Economy MICHAEL J. SWANSON Wells Fargo Corp. Necessary contraction THE ECONOMY HAS ENTERED into a contractionary phase. How long and how deep will the contraction be before expansion returns? Historically, recessions have a range of durations and intensities. Post World War II, the average duration is ten months (range, 6 to 16 months) and the average peak-to-trough contraction is 1.6% (worst, 1957, 3.7%). Is it different this time? I doubt it. The U.S. economy isn’t some passive system. It responds to its inputs and shocks to return to its growth pattern. One thing jumps out in reviewing GDP trends. Since the mid-1980s, the growth path has been smoother with only very minor contractions. This predictability of growth and mildness of recessions led to a very natural business and consumer response. They increased leverage to take advantage of this growth. Financially, it makes sense for businesses to increase their return to equity using debt (but only to a certain degree). Likewise, consumers can have more today because they know they’ll have more to pay with tomorrow (but only to a certain degree). However, the opposite is true as well. At the same time, the nominal and real cost of money has been falling since the early 1980s. This also encouraged an increase in leverage and asset values, but with a profound disconnect between the durations of borrowing and lending. Very few people want to lock up investments in CDs and other instruments beyond five years, but many people like to borrow money for 15 and 30 years. This presented a duration mismatch that the market thought it had solved by swapping floating rates for fixed with entities willing to take on that risk. The only problem was that real risk didn’t go away, and it became concentrated in the hands of a limited number of holders. So who really leveraged up in the last couple of decades? If you can believe the numbers, it was households tainable rate. The good news comes from the consumer debt side, which, while higher than the historical average, is nowhere near as out of line as mortgage debt (see chart). An increase in economic volatility and the real cost of interest is leading to a reversal of this leverage trend. Businesses and consumers are responding in an economically predictable way, and the deleveraging isn’t 12 Percent of disposable income Never spread equally Mortgage 10 8 6 Consumer 4 1980 Q1 1984 Q1 1988 Q1 1992 Q1 1996 Q1 2000 Q1 2004 Q1 2008 Q1 Source: Federal Reserve Board, Wells Fargo and non-corporate, non-financial businesses. The numbers show that corporate non-financials have been reducing leverage since the last recession. But how much debt was off balance sheet? Just like businesses, the consumer responded to the economic and financial stimulus and leveraged up to enjoy today at tomorrow’s expense. Houses, our current economic bête noir, led consumers to take on debt at an unsus- fun. Asset values will continue to fall, and consumer spending will be constrained until the ratios make sense. Even as economic growth returns, business investment and consumer spending growth will be slower than during the last couple of decades. This will allow both of them to rebuild their balance sheets to deal with an greater economic volatility and a higher real cost of interest. BJ 48 DECEMBER 2008/ABA BANKING JOURNAL www.ababj.com/subscribe.html http://www.ababj.com/subscribe.html

Table of Contents for the Digital Edition of ABA Banking Journal - December 2008

ABA Banking Journal - December 2008
Contents
Editor’s Column
Cover Story
ABA Resources
ABA Chairman’s Position
Community Banking
Pass the Aspirin
The Bank that Hates "Customers"
"Ivan the Terrible"Wreaks Havoc, but Adds New Business Line
New Twist on Philanthropy:the "Second-Chance" Account
Risk Management
Tech Topics
Webnotes
Compliance Clinic
MailBox
Banker’s Mart
To Advertise/Index of Advertisers
The Economy

ABA Banking Journal - December 2008

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