US Financial System Liquidity

In this post, I take a little different approach to the issue of financial system liquidity.
Over the 2000 - mid 2008 period, US bank financial assets grew at a rate of 9.4%
annually. This dramatic growth was sufficient to fund a major boom in real estate
plus moderate levels of economic expansion and inflation. Then came the grand bust in
both the economy and finance. Since the middle of 2008, total bank credit has grown
by 1.1% per year, with this lowly rate of growth supported and backstopped by a $2 tril.
expansion of credit by the Federal Reserve Bank. When you toss in the Fed's $2 tril.,
total bank system credit has compounded by only 3.7%. That is still a low number, and
if you use total cash and credit to determine the velocity of "money", compared to GDP,
there has been a modest increase in a relatively well balanced MV = PT equation. There
has been no "liquidity trap", but the modest growth of total financial system liquidity
and the economy reflects the damage done to supply and demand for credit within the
private sector since the deep recession.

The new round of large QE the Fed is set to start is in large measure intended to assist
a still very conservative commercial banking system that has been intent on maintaining high
balance sheet liquidity and on re-building capital. The banks have been very slow to
return to normal cash flow analysis as a basis for credit decisions and away from collateral
value based lending. Solid borrowers with strong income and cash flow profiles are
still finding it difficult to to obtain credit, especially in the real estate sectors. Obviously,
one cannot lay off the slow growth of private sector credit entirely on the banks. Housing
affordability measures are very strong assuming borrowers can put 20% down on a home
purchase. The 20% down hurdle is going to remain a barrier for a goodly of number of
applicants whose incomes have grown very slowly since 2008.

The plan for QE 4, which could be quite large if the Fed steps up buying MBS as well as
Treasuries, is to speed the thawing of private sector credit growth. Prior QE programs
have helped with the tahwing out process and so we'll see if the new round of support will
push bank lender confidence higher in the year ahead.