Vicious Cycles Persist As Global Lending Standards Tighten

One of the major factors in the Central Banks of the world having stepped up the pace of flushing the world with increasing amounts of freshly digitized cash is writ large in the contraction in credit availability to the real economy (even to shipbuilders). Anecdotal examples of this constrained credit are everywhere but much more clearly and unequivocally in tightening lending standards in all of the major economies. As Bank of America's credit team points out, bank lending standards to corporates have tightened globally in Q4 2011 and the picture is ubiquitously consistent across the US, Europe, and Emerging Markets. Whether it is deleveraging, derisking, or simple defending of their balance sheets, banks' credit availability is becoming more constrained. While the Fed's QE and Twist monetization and then most recently the ECB's LTRO has led (aside from self-reinforcing short-dated reach-arounds in BTPs and circular guarantees supposedly reducing tail risk) to nothing but massive increases in bank reserves (as opposed to flowing through to the real economy), we suspect it was designed to halt the significantly tighter corporate lending environment (most significantly in European and Emerging Markets). The critical corollary is that, as BAML confirms, the single best non-market based indicator of future defaults is tightening lending standards and given the velocity of shifts in Europe and EM (and very recent swing in the US), investors reaching for high-yield may be ill-timed at best and disastrous credit cycle timing at worst (bearing in mind the upgrade/downgrade ratio is also shifting dramatically). Liquidity band-aids are not a solution for insolvency cardiac arrests as the dual vicious cycles of bank and sovereign stress remain front-and-center in Europe (with EM a close second) and the hope for real economic growth via credit creation kick-started by an LTRO is the pipe-dream the market is surviving on currently.


The US recently shifted from slight softening to tightening standards while at the same time, Europe and the Emerging Markets have tightened standards quite significantly. Furthermore, the dispersion in European markets is much less than one would expect with only Germany really holding steady as the rest (including other core nations such as France) are tightening aggressively.

The reason this is such a concern is the leading nature of this indicator for high yield defaults. But it is not simply the high yield bond investor directly who will suffer, it is the real economy that faces significant drops (largest since data began in 2003) in Euro-area loans to non-financial corporates  (noted in Barclay's chart below) as a dearth of credit-worthy borrowers combined with banks unwilling (and almost implicitly pushed away from direct lending to the real economy via carry trades, capital needs, and closed private debt markets) leave sbanks squandering the cash (and rightfully so in their risk-managing minds).

Clearly this impact has already been felt across European economies in terms of growth and jobs and while throwing more money at the problem (LTRO 2.0) may be the choice of the Kenynesian kleptocrats, it should seem obvious from Japan's bank reserves (and balance sheet recessionary debt minimization versus profit maximization), the US huge rise in bank reserves and drop in lending (and Keynesian multipliers) that the European efforts will merely get swallowed up in the bank balance sheets never to see the light of day in the real economy.

This leads us back to LTRO as a liquidity band-aid on an insolvency cardiac-arrest as the austerity focus drags any growth prospects into vicious spirals, as illustrated here by a recent Barclay's presentation.

The hope, as they note, is that the LTRO can do more than just fix banks balance sheets (and create a self-aggrandizing demand for local government debt as the all-in ultimate bet of all time) and actually has an impact on the real economy via lending and credit creation...we wait with baited breath for the disappointment to wash over a stunned economist and politician audience.