In a further sign of loosening of rules in the US, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency issued a final rule that increases the threshold for commercial real estate transactions requiring an appraisal from $250,000 to $500,000.
They say the increased threshold will not pose a threat to the safety and soundness of financial institutions. “Commenters opposing an increase to the commercial real estate appraisal threshold asserted that an increase would elevate risks to financial institutions, the banking system, borrowers, small business owners, commercial property owners, and taxpayers. Several of these commenters asserted that the increased risk would not be justified by burden relief”.
The agencies originally proposed to raise the threshold, which has been in place since 1994, to $400,000, but determined that a $500,000 threshold will materially reduce regulatory burden and the number of transactions that require an appraisal. The agencies also determined that the increased threshold will not pose a threat to the safety and soundness of financial institutions.
The final rule allows a financial institution to use an evaluation rather than an appraisal for commercial real estate transactions exempted by the $500,000 threshold. Evaluations provide a market value estimate of the real estate pledged as collateral, but do not have to comply with the Uniform Standards of Professional Appraiser Practices and do not require completion by a state licensed or certified appraiser.
The final rule responds, in part, to concerns financial industry representatives raised that the current threshold level had not kept pace with price appreciation in the commercial real estate market in the 24 years since the threshold was established and about regulatory burden during the Economic Growth and Regulatory Paperwork Reduction Act review process completed in March 2017.
Has the FED’s increased recent debt monetisation enabled US banks to lend out more money than they otherwise would? This is an important question, given the current round of rate tightening, and the potential impact down stream. So a recent article from the St. Louis On The Economy Blog makes interesting reading.
One can think of the government as issuing three types of nominal liabilities:
Currency
Central bank reserves
Treasury debt
Historically, currency and central bank reserves are considered money, whereas Treasury debt is not. Hence, to finance the deficit—the difference between government revenue and expenditures—the government needs to borrow money. The burden of finance is reduced if the central bank transforms high-interest government debt into low-interest reserves. The act of converting debt into money is often labeled “debt monetization.”
Reserves and the Money Supply
The creation of reserves increases the supply of base money. The reserves of chartered banks are held at the central bank and play an important role in the banking system.
In particular, banks finance a variety of investments by creating their own form of money—demand deposit liabilities, such as checking accounts—which are convertible on demand for currency. Note that private banks do not lend reserves: They lend the liabilities they create, and these liabilities are then convertible into currency at the discretion of “depositors” (those who have demand deposit accounts with banks).
Banks are motivated to keep some minimum level of reserves on hand to meet everyday redemption requests for currency and to settle their obligations with other banks on the interbank market for federal funds.
Spurring Lending
But because the interest earned on reserves is typically low (historically, zero), banks are motivated to increase their lending to the point that their demand deposit liabilities can no longer be safely increased, lest they fail to meet their obligations for redemption and settlement. In this way, debt monetization can increase the total money supply, which includes currency, reserves and bank deposit liabilities.
The figure below plots the percent of debt held by the Federal Reserve—the monetization rate—against personal consumption expenditures (PCE) inflation.
From 1953 to 1974, the monetization rate increased hand-in-hand with inflation, with both peaking near the end of 1974. The positive correlation between the two indicators during this span seems consistent with the expectation that debt monetization puts upward pressure on inflation.
From 2009 to 2017, the monetization spiked up at an even faster rate. However, this time the inflation rate stayed more or less constant. Why might the former episode of monetization have been inflationary while the latter was not?
The Interest Rate Spread
When the Fed buys a large amount of federal debt, as it did during these two time periods, it injects a large amount of reserves into the banking system to pay for those purchases. Commercial banks have two options of what to do with these additional reserves:
Use them to make more loans to customers
Hold onto them
All else equal, banks will pick whichever option is more profitable, which depends on (among other things) the spread between the interest rate it can charge on consumer/business loans and the interest rate it earns by holding reserves. The larger the spread, the more profitable it is for a bank to lend, and the more likely that a bank increases its lending.
Monetization of the Debt: Then
The figure below plots the spread between the yield on a one-year Treasury bill (a measure of short-term interest rates) and the interest rate paid on reserves from 1953 to 1974.
As the Fed ramped up its debt monetization during this span, the average rate of interest on a one-year Treasury bill was about 5 percent, and the interest rate paid on reserves was literally zero.
With the spread between interest rates so large, banks had more incentive to use their newfound reserves to make loans than to hold onto them. These loans would then create money, which would boost the money supply and have inflationary effects. While several factors led to the Great Inflation of the 1970s, the gradual rise in the monetization rate was likely a significant one.
Tightening of the Spread
However, the interest rate spread has narrowed significantly in recent years for several reasons:
Since the financial crisis of 2007-08, the federal funds rate target has been near zero, keeping short-term interest rates low throughout the economy.
The demand for federal debt rose greatly after the start of the crisis, pushing bond prices up and bond yields down.
Beginning in 2008, the Fed began to pay interest on reserves held by its member banks.
Monetization of the Debt: Now
As shown in the next figure, during the spike in debt monetization from 2009 to 2017, the spread between short-term interest rates and the interest paid on reserves was essentially zero.
Unlike during the first scenario, banks now had no incentive to use their newfound reserves to increase their lending. After all, it would be just as profitable to hold onto those reserves. In fact, at times the spread was even negative, making it more profitable to hold reserves.
As such, there was little to no upward pressure on prices. The Fed’s increased debt monetization didn’t lead banks to lend out more money than they otherwise would. Contrary to the episode from 1953 to 1974, banks could make a profit holding onto reserves, which doesn’t create new money and ultimately doesn’t have the same inflationary effects as increased lending does
But the article also highlights a fundamental fallacy, namely that deposits leads loans. Actually, we now know this is incorrect, and that banks can create loans first, which flow TO deposits. So the fundamental assumption they make seems incorrect. Therefore, their conclusions may be suspect! In addition, we know US consumer debt is still very high now at 80% of US GDP! More importantly, it reduces the potential impact central bank have on the economy in terms of credit availability.
Today we examine the recent Financial Market Earthquakes and ask, are these indicators of more trouble ahead?
Welcome to the Property Imperative Weekly to 24th March 2018. Watch the video or read the transcript.
In this week’s review of property and finance news we start with the recent market movements and consider the impact locally.
The Dow 30 has come back, slumping more than 1,100 points between Thursday and Friday, and ending the week in correction territory – meaning down more than 10% from its recent high.
The volatility index – the VIX which shows the perceived risks in the financial markets also rose, up 6.5% just yesterday to 24.8, not yet at the giddy heights it hit in February, but way higher than we have seen for a long time – so perceived risks are higher.
And the Aussie Dollar slipped against the US$ to below 77 cents from above 80, and it is likely to drift lower ahead, which may help our export trade, but will likely lead to higher costs for imports, which in turn will put pressure on inflation and the RBA to lift the cash rate. The local stock market was also down, significantly. Here is a plot of the S&P ASX 100 for the past year or so. We are back to levels last seen in October 2017. Expect more uncertainty ahead.
So, let’s look at the factors driving these market gyrations. First of course U.S. President Donald Trump’s signed an executive memorandum, imposing tariffs on up to $50 billion in Chinese imports and in response the Dow slumped more than 700 points on Thursday. There was a swift response from Beijing, who released a dossier of potential retaliation targets on 128 U.S. products. Targets include wine, fresh fruit, dried fruit and nuts, steel pipes, modified ethanol, and ginseng, all of which could see a 15% duty, while a 25% tariff could be imposed on U.S. pork and recycled aluminium goods. We also heard Australia’s exemptions from tariffs may only be temporary.
Some other factors also weighed on the market. Crude oil prices rose more than 5.5% this week as following an unexpected draw in U.S. crude supplies and rising geopolitical tensions in the middle east. Crude settled 2.5% higher on Friday after the Saudi Energy Minister said OPEC and non-OPEC members could extend production cuts into 2019 to reduce global oil inventories. Here is the plot of Brent Oil futures which tells the story.
Bitcoins promising rally faded again. Earlier Bitcoin rallied from a low of $7,240 to a high of $9175.20 thanks to easing fears that the G20 meeting Monday would encourage a crackdown on cryptocurrencies. Finance ministers and central bankers from the world’s 20 largest economies only called on regulators to “continue their monitoring of crypto-assets” and stopped short of any specific action to regulate cryptocurrencies. So Bitcoin rose 2% over the past seven days, Ripple XRP fell 8.93%and Ethereum fell 14.20%. Crypto currencies remain highly speculative. I am still working on my more detailed post, as the ground keeps shifting.
Gold prices enjoyed one of their best weeks in more than a month buoyed by a flight-to-safety as investors opted for a safe-haven thanks to the events we have discussed. However, the futures data shows many traders continued to slash their bullish bets on gold. So it may not go much higher. So there may be no relief here.
Then there was the Federal Reserve statement, which despite hiking rates by 0.25%, failed to add a fourth rate hike to its monetary policy projections and also scaled back its labour market expectations. Some argued that the Fed’s decision to raise its growth rate but keep its outlook on inflation relatively unchanged was dovish. Growth is expected to run at 3%, but core inflation is forecast for 2019 and 2020 at 2.10%. They did, however, signal a faster pace of monetary policy tightening, upping its outlook on rates for both 2019 and 2020. You can watch our separate video blog on this. The “dots” chart also shows more to come, up to 8 lifts over two years, which would take the Fed rate to above 3%. The supporting data shows the economy is running “hot” and inflation is expected to rise further. This will have global impact. The era of low interest rates in ending. The QE experiment is also over, but the debt legacy will last a generation.
All this will have a significant impact on rates in the financial markets, putting more pressure on borrowing companies in the US, and the costs of Government debt. US mortgage interest rates rose again, a precursor to higher rates down the track.
Moodys’ said this week, that the U.S.’ still relatively low personal savings rate questions how easily consumers will absorb recent and any forthcoming price hikes. Moreover, the recent slide by Moody’s industrial metals price index amid dollar exchange rate weakness hints of a levelling off of global business activity.
The flow on effect of rate rises is already hitting the local banks in Australia. To underscore that here is a plot of the A$ Bill/OIS Swap rate, a critical benchmark for bank funding. In fact, looking over the past month, the difference, or spread has grown by around 20 basis points, and is independent from any expectation of an RBA rate change. The BBSW is the reference point used to set interest rates on most business loans, and also flows through to personal lending rates and mortgages.
As a result, there is increasing margin pressure on the banks. In the round, you can assume a 10 basis point rise in the spread will translate to a one basis point loss of margin, unless banks reduce yields on deposit accounts, or lift mortgage rates. Individual banks ae placed differently, with ANZ most insulated, thanks to their recent capital initiatives, and Suncorp the most exposed.
In fact, Suncorp already announced that Variable Owner Occupier Principal and Interest rates will rise by 5 basis points. Variable Investor Principal and Interest rates will increase by 8 basis points, and Variable Interest Only rates increase go up by 12 basis points. In addition, their variable Small Business rates will increase by 15 basis points and their business Line of Credit rates will increase by 25 basis points. Expect more ahead from other lenders. The key takeaway is that funding costs in Australia are going up at a time when the RBA is stuck in neutral. It highlights how what happens with rates and in money markets overseas, and particularly in the US, can have repercussions here – repercussions that many are possibly unprepared for.
Locally, the latest Australian Bureau of Statistics showed that home prices to December 2017 fell in Sydney over the past quarter, along with Darwin. Other centres saw a rise, but the rotation is in hand. Overall, the price index for residential properties for the weighted average of the eight capital cities rose 1.0% in the December quarter 2017. The index rose 5.0% through the year to the December quarter 2017.
The capital city residential property price indexes rose in Melbourne (+2.6%), Perth (+1.1%), Brisbane (+0.9%), Hobart (+3.9%), Canberra (+1.7%) and Adelaide (+0.6%) and fell in Sydney (-0.1%) and Darwin (-1.5%). You can watch our separate video on this, where we also covered in more detail the January 2018 mortgage default data from Standard & Poor’s. It increased to 1.30% from 1.07% in December. No area was exempt from the increase with loans in arrears by more than 30 days increasing in January in every state and territory. Western Australia remains the home of the nation’s highest arrears, where loans in arrears more than 30 days rose to 2.44% in January from 2.08% in December, reaching a new record high. Conversely, New South Wales continues to have the lowest arrears among the more populous states at 0.98% in January. Moody’s is now expecting a 10% correction in some home prices this year.
According to latest figures released by the Australian Bureau of Statistics (ABS), the seasonally adjusted unemployment rate increased to 5.6 per cent and the labour force participation rate increased by less than 0.1 percentage points to 65.7 per cent. The number of persons employed increased by 18,000 in February 2018. So no hints of any wage rises soon, as it is generally held that 5% unemployment would lead to higher wages – though even then, I am less convinced.
The latest final auction clearance results from CoreLogic, published last Thursday showed the final auction clearance rate across the combined capital cities rose to 66 per cent across a total of 3,136 auctions last week; making it the second busiest week for auctions this year, compared with 63.3 per cent the previous week, and still well down from 74.1 per cent a year ago. Although Melbourne recorded its busiest week for auctions so far this year with a total of 1,653 homes taken to auction, the final auction clearance rate across the city fell to 68.7 per cent, down from the 70.8 per cent over the week prior. In Sydney, the final auction clearance rate increased to 64.8 per cent last week, from 62.2 per cent the week prior. Across the smaller auction markets, clearance rates improved in Brisbane, Perth and Tasmania, while Adelaide and Canberra both returned a lower success rate over the week. They say Geelong was the best performing non-capital city region last week, with 86.1 per cent of the 56 auctions successful. However, the Gold Coast region was host to the highest number of auctions (60). This week they are expecting a high 3,689 planned auctions today, so we will see where the numbers end up. I am still digging into the clearance rate question, and should be able to post on this soon. But remember that number, 3,689, because the baseline seems to shift when the results arrive.
As interest rates rise, in a flat income environment, we expect the problems in the property and mortgage sector to show, which is why our forward default projections are higher ahead. We will update that data again at the end of the month. Household Financial Confidence also drifted lower again as we reported. It fell to 94.6 in February, down from 95.1 the previous month. This is in stark contrast to improved levels of business confidence as some have reported. Our latest video blog covered the results.
Finally, The Royal Commission of course took a lot of air time this week, and I did a separate piece on the outcomes yesterday, so I won’t repeat myself. But suffice it to say, we think the volume of unsuitable mortgage loans out there is clearly higher than the lenders want to admit. Mortgage Broking will also get a shake out as we discussed on the ABC this week. And that’s before they touch on the wealth management sector!
We think there are a broader range of challenges for bankers, and their customers, as I discussed at the Customer Owned Banking Association conference this week. There is a separate video available, in which you can hear about what the future of banking will look like and the importance of customer centricity. In short, more disruption ahead, but also significant opportunity, if you know where to look. I also make the point that ever more regulation is a poor substitute for the right cultural values. At the end of the day, a CEO’s overriding responsibility is to define the right cultural values for the organisation, and the major banks have been found wanting. A quest for profit at any cost will ultimately destroy a business if in the process it harms customers, and encourages fraud and deceit. You simply cannot assume banks will do the right thing, unless the underlying corporate values are set right. Remember Greenspans testimony after the GFC, when he said “I made a mistake in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms.”
The Fed lifted, as expected. The “dots” chart also shows more to come. The supporting data shows the economic is running “hot” and inflation is expected to rise further. This will have global impact. The era of low interest rates in ending. The QE experiment is also over, but the debt legacy will last a generation.
This chart is based on policymakers’ assessments of appropriate monetary policy, which, by definition, is the future path of policy that each participant deems most likely to foster outcomes for economic activity and inflation that best satisfy his or her interpretation of the Federal Reserve’s dual objectives of maximum employment and stable prices.
Each shaded circle indicates the value (rounded to the nearest ⅛ percentage point) of an individual participant’s judgment of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate at the end of the specified calendar year or over the longer run.
Information received since the Federal Open Market Committee met in January indicates that the labor market has continued to strengthen and that economic activity has been rising at a moderate rate. Job gains have been strong in recent months, and the unemployment rate has stayed low. Recent data suggest that growth rates of household spending and business fixed investment have moderated from their strong fourth-quarter readings. On a 12-month basis, both overall inflation and inflation for items other than food and energy have continued to run below 2 percent. Market-based measures of inflation compensation have increased in recent months but remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The economic outlook has strengthened in recent months. The Committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in the medium term and labor market conditions will remain strong. Inflation on a 12-month basis is expected to move up in coming months and to stabilize around the Committee’s 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.
In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-1/2 to 1-3/4 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.
Voting for the FOMC monetary policy action were Jerome H. Powell, Chairman; William C. Dudley, Vice Chairman; Thomas I. Barkin; Raphael W. Bostic; Lael Brainard; Loretta J. Mester; Randal K. Quarles; and John C. Williams.
Strategically, the economic risks relating to the changing climate are one of the most significant challenges we face. But what are the potential long term impacts likely to be? In this Federal Reserve of St. Louis, on the economy blog, this important subject is explored.
We think there is a need for similar modelling to be done in Australia, as many of the most populated areas are most likely to be impacted.
How might climate change impact the economy over the long term? Some potential impacts include increased mortality, higher demand for electricity and reduced yields for certain crops.
At a recent Dialogue with the Fed presentation, William Emmons, lead economist with the St. Louis Fed’s Center for Household Financial Stability, highlighted research1 that identified geographic “winners and losers” on a county-by-county level across the United States.
Looking out to the year 2090, the findings showed that the St. Louis region could expect a significant impact on its economic activity, Emmons said.
“And if you zoom in and look at our region, [the researchers’] estimates are that we could lose the economic equivalent of 5 to 10 percent of GDP as a result of these effects,” he said, noting that impacts would be gradual.
The London interbank offered rate, known by the acronym Libor, is back on investors’ radar.
Libor reflects what banks charge to borrow dollars from each other and is used as a benchmark for trillions of dollars worth of loans. The rise is nothing like the panic mode of 2008, when soaring Libor reflected a reluctance by banks to lend to each other, reflecting stress in the system and fueled fears of an existential threat to the global banking system.
But the increase is seen tightening financial conditions. Also on the radar is the sharp widening of the spread between Libor and the overnight index swap rate as three-month Libor moved above 2% for the first time since 2008.
“What this means is that rates on more than $350 trillion of debt and derivatives contracts hitched to the U.S. benchmark are on the rise,” said David Rosenberg, chief economist and strategist at Gluskin Sheff, in a Monday note.
“Overleveraged entities will be in for a spot of trouble. We have a situation where half of the investment-grade bond market in the USA is BBB,” he wrote. BBB is the second-lowest investment grade rating by S&P Global Ratings and Fitch Ratings.
In 2016, Libor rose in response to money-market reforms.
The catalyst for the more recent rise, and widening of the Libor-OIS spread, is placed by economists and analysts partly on the U.S. tax legislation signed into law in December. The repatriation of cash held overseas has led to U.S. firms pulling money out of foreign dollar funds, analysts said.
In addition to the suspected return of overseas cash, the financial system is also adjusting to a world of less Federal Reserve-provided liquidity as the central bank unwinds its balance sheet, wrote George Goncalves, head of fixed-income strategy at Nomura, in a late February note.
Meanwhile, analysts will be watching the Libor-OIS spread with the idea that a stubborn widening—and the resulting tightening of financial conditions—could affect the pace of Federal Reserve tightening in the year ahead. Rising Libor in 2016 served to tighten financial conditions, analysts said.
These rising rates spell trouble ahead in an over-leveraged world, and once again underscores that the risks are rising, and that the RBA may have to lift sooner than some expect.You can watch my recent video blog where I discuss these three charts.
The U.S. economy is currently experiencing a prolonged productivity slowdown, comparable to another slowdown during in the 1970s.
Economists have debated the causes for these slowdowns: The reasons range from the 1970s oil price shock to the 2007-08 financial crisis.
But did the baby boom generation partly cause both periods of slowing productivity growth?
A Demographic Shift
Guillaume Vandenbroucke, an economist at the St. Louis Fed, explored the role of the baby boom generation—specifically, those born in the period of 1946 to 1957 when the birth rate increased by 20 percent—in these slowdowns.
In a recent article in the Regional Economist, he pointed out a demographic shift: Many baby boomers began entering the labor market as young, inexperienced workers during the 1970s, and now they’ve begun retiring after becoming skilled, experienced workers.
“This hypothesis is not to say that the baby boom was entirely responsible for these two episodes of low productivity growth,” the author wrote. “Rather, it is to point out the mechanism through which the baby boom contributed to both.”
Productivity 101
One measure of productivity is labor productivity, which can be measured as gross domestic product (GDP) per worker. By this measure, the growth of labor productivity was low in the 1970s. Between 1980 and 2000, this growth accelerated, but then has slowed since 2000.
“It is interesting to note that the current state of low labor productivity growth is comparable to that of the 1970s and that it results from a decline that started before the 2007 recession,” Vandenbroucke wrote.
How does a worker’s age affect an individual’s productivity? According to economic theory, young workers have relatively low human capital; as they grow older, they accumulate human capital, Vandenbroucke wrote.
“Human capital is what makes a worker productive: The more human capital, the more output a worker produces in a day’s work,” the author wrote.
The Demographic Link
Vandenbroucke gave an example of how this simple idea could affect overall productivity. His example looked at a world in which there are only young and old workers. Each young worker produces one unit of a good, while the older worker—who has more human capital—can produce two goods. If there were 50 young workers and 50 old workers in this simple economy, the total number of goods produced would be by 150, which gives labor productivity of 1.5 goods per worker.
Now, suppose the demographics changed, with this economy having 75 young workers and 25 old workers. Overall output would be only 125 goods. Therefore, labor productivity would be 1.25.
“Thus, the increased proportion of young workers reduces labor productivity as we measure it via output per worker,” he wrote. “The mechanism just described is exactly how the baby boom may have affected the growth rate of U.S. labor productivity.”
The Link between Boomers and Productivity Growth
Vandenbroucke then compared the growth rate of GDP per worker (labor productivity) with the share of the population 23 to 33 years old, which he used as a proxy for young workers.
This measure of young workers began steadily increasing in the late 1960s before peaking circa 1980, which represented the time when baby boomers entered the labor force.
Looking at these variables from 1955 to 2014, he found the two lines move mostly in opposite directions (the share of young people growing as labor productivity growth declined) except in the 2000s.
“The correlation between the two lines is, indeed, –37 percent,” Vandenbroucke wrote.1
The share of the population who were 23 to 33 years old began to increase in the late 2000s, which can be viewed as the result of baby boomers retiring and making the working-age population younger.
“This trend is noticeably less pronounced, however, during the 2000s than it was during the 1970s,” the author wrote. “Thus, the mechanism discussed here is likely to be a stronger contributor to the 1970s slowdown than to the current one.”
Conclusion
If this theory is correct, it may be that the productivity of individual workers did not change at all during the 1970s, but that the change in the composition of the workforce caused the productivity slowdown, he wrote.
“In a way, therefore, there is nothing to be fixed via government programs,” Vandenbroucke wrote. “Productivity slows down because of the changing composition of the labor force, and that results from births that took place at least 20 years before.”
Notes and References
1 A correlation of 100 percent means a perfect positive relationship, zero percent means no relationship and -100 percent means a perfect negative relationship.
On Feb. 6, the Wall Street Journal published a startling statistic: Between June 2016 and June 2017, more than 1,700 U.S. bank branches were closed, the largest 12-month decline on record.1
Structural Shift
That large drop, while surprising, is part of a trend in net branch closures that began in 2009. It follows a profound structural shift in the number and size of independent U.S. banking headquarters, or charters, over the past three decades.
In 1980, nearly 20,000 commercial banks and thrifts with more than 42,000 branches were operating in the nation. Since then, the number of bank and thrift headquarters has steadily declined.
The reasons for the decline in charters and branches are varied. Regarding charters, the passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act in 1994 played a significant role in their decline. Banks operating in more than one state took advantage of the opportunity to consolidate individual state charters into one entity and convert the remaining banks into branches. Almost all states opted in to a provision in the law permitting interstate branching, which led to a steady increase in branches.
Trend Reversal
Even before the number of charters declined, however, the number of branches grew steadily throughout the 1980s, 1990s and early 2000s. It peaked in 2009, when the trend reversed, as seen in the figure below.
Since 2009, the number of commercial bank and thrift branches has shrunk nearly 10 percent, or just over 1 percent per year.
The initial wave of closings can be attributed to a wave of mergers and failed bank acquisitions following the financial crisis. There was an immediate opportunity to reduce cost through the shuttering of inefficient office locations. Branch closings were also influenced by earnings pressure from low interest rates and rising regulatory costs.
More recently, changing consumer preferences and improvements in financial technology have further spurred the reduction in branches. Customers increasingly use ATMs, online banking and mobile apps to conduct routine banking business, meaning banks can close less profitable branches without sacrificing market share.
Uneven Changes
The reduction in offices has not been uniform. According to the Federal Deposit Insurance Corp., less than one-fifth of banks reported a net decline in offices between 2012 and 2017, and slightly more than one-fifth reported an increase in offices.
Just 15 percent of community banks reported branch office closures between 2012 and 2017. And though closures outnumber them, new branches continue to be opened. It’s also important to note that deposits continue to grow—especially at community banks—even as the number of institutions and branches decline.
The Industry of the Future
It seems inevitable that this long-term trend in branch closings will continue as consumer preferences evolve and financial technology becomes further ingrained in credit and payment services.
Although it is unlikely that the U.S. will end up resembling other countries with relatively few bank charters, it seems certain that consumers and businesses will increasingly access services with technology, no matter the size or location of bank offices. This change creates opportunities as well as operational risks that will need to be managed by banks and regulators alike.
Moody’s says a possible $975 billion increase in U.S. government debt for fiscal 2018 would leave Q3-2018’s outstanding federal debt up by 5.9% annually. As of Q3-2017, federal debt outstanding grew by $597
billion, or 3.8%, from a year earlier.
Into the indefinite future, federal debt is likely to materially outrun each of the other broad components of U.S. nonfinancial-sector debt. Because of non-federal debt’s relatively slow growth, the private and public debt of the U.S.’ nonfinancial sectors may grow no faster than 4.3% annually during the year ended Q3-2018 to a record $50.77 trillion. For the year-ended Q3-2017, this most comprehensive estimate of U.S. nonfinancial-sector debt rose by 3.8% to $48.64 trillion.
Though expectations of faster growth for total nonfinancial-sector debt complements forecasts of higher short- and long-term interest rates for 2018, the quickening of total nonfinancial-sector debt growth may not be enough to sustain the 10-year Treasury yield above the 2.85% average that the Blue Chip consensus recently predicted for 2018.
The projected growth of nonfinancial-sector debt looks manageable from a historical perspective. For one thing, 2018’s projected percent increase by debt lags far behind the 9.1% average annual advance by U.S. nonfinancial sector debt from the five-years-ended 2007. Back then, unsustainably rapid growth for total nonfinancial-sector debt and 2003-2007’s 2.1% annualized rate of core PCE price index inflation supplied a 4.4% average for the 10-year Treasury yield of the five-years-ended 2007. By contrast, the 10-year Treasury yield’s moving five-year average sagged to 2.2% during the span-ended September 2017 as the accompanying five-year average annualized growth rates descended to 4.4% for nonfinancial-sector debt and 1.5% for core PCE price index inflation.
Many participants noted that financial conditions had eased significantly over the intermeeting period; these participants generally viewed the economic effects of the decline in the dollar and the rise in equity prices as more than offsetting the effects of the increase in nominal Treasury yields.
So we know the question you’re asking — what are “financial conditions” and why is this interesting?
According to the St Louis Fed, financial conditions indices “summarise different financial indicators and, because they measure financial stress, can serve as a barometer of the health of financial markets”.
Using short and long-term bond yields, credit spreads, the value of the US dollar and stock market valuations, it attempts to measure the degree of stress in financial markets.
What the minutes conveyed in January was despite a lift in longer-dated bond yields, strength in stocks and decline in the US dollar suggest that financial conditions still improved.
So why is that important?
According to Elliot Clarke, economist at Westpac, it suggests the Fed may need to hike rates more aggressively than markets currently anticipate.
“That financial conditions have eased at a time when the FOMC is tightening policy will grant confidence that downside risks associated with further gradual rate increases and quantitative tightening are negligible,” he says.
“More to the point, this implies that risks to the FOMC rate view, and Westpac’s, are arguably to the upside.”
Adding to those risks, and even with the correction in US stocks seen after the January FOMC meeting was held, Elliot says in February “we have seen a further significant increase in government spending and signs of stronger wages”.
He also says the stronger-than-expected consumer price inflation in January — also released after the FOMC meeting was held — “will have also given the FOMC greater cause for confidence that inflation disappointment is behind them and that the risks are instead skewed to inflation at or moderately above target”.
As such, Elliot says the tone of the January minutes points to gradual rate rises from the Fed, mirroring what was seen last year.
However, the risk to this view, he says, is for more and faster hikes in the years ahead.
“In these circumstances, a continued ‘gradual’ increase in the fed funds rate through 2018 and 2019 — implying five hikes in total — is still the best base case,” he says.
“However, a careful eye will need to remain on financial conditions.
“Should they continue to move in the opposite direction to policy, a more concerted effort by the FOMC may prove necessary to keep the economy on an even footing.”
