Friday, March 14, 2008

$10 trillion of new credit

at some point, financial assets will grow sufficiently to give the banking sector the capacity it needs to lend at a pace that supports economic expansion. capital is, of course, needed in order for banks to absorb losses, add assets onto balance sheets that were once off the books and hold loans that were once sold to the marketplace. money-supply growth will eventually make this possible, and it has begun to grow at a fast pace.

over the past 7 weeks, m2, the fed's broad money gauge, has increased $200 billion, a 22% annual pace, which is much quicker than the usual 5% pace. the increase has been led by an $80 billion increase in savings deposits, a vital source of capital to the banking system, totaling $3.963 trillion as of the week ended 3/3/08.

savings deposits represent a relatively inexpensive form of financing for banks, which is one reason banks seek to grow such deposits. in fact, from 1996 to 2005, savings deposits grew to about 30% of bank deposits, up from about 20%.

as savings deposits rise, lending capacity grows. the rule is that for each dollar received, banks can lend 90 cents on the dollar because each dollar is subject to a 10% reserve requirement (small banks could pay rates as low as 3%).

this is why it is rational to believe by the end of this year, the recapiapitalization of the banking system will be well on. already, bank credit is expanding rapidly, growing at a 13% pace since the end of July, or $660 billion, to $9.369 trillion.

a year from now, it would not be surprising to see financial assets grow by about $1 trillion, which, in theory, would give the financial system the capacity to handle roughly $10 trillion of new credit, more than plenty to handle current problems.

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