A tremendous credit boom took place in 2022 and it may not even be over. The combination of healthy banks, financially strong households, and attractive rates appears to have to led to a surge in bank lending. Banks and credit unions together created $1.5t in cash last year that likely has not yet fully filtered into economic activity. Recall, bank lending creates money out of thin air. Interestingly, higher interest rates have so far only shown very tentative signs of moderating the boom. This post reviews the credit boom of 2022, suggests it was due to the strong financial position of banks and households, and notes that it will be supportive of demand throughout the year.
Partying Like It’s 2006
The total size of the banking sector was little changed over 2022, but the static surface obscures a boom in lending of epic proportions. Banks changed the composition of their assets by replacing their cash and security holdings with loans to the real economy. Around $1.2t in loans were made in 2022, a level around three times higher than that of recent years. The same explosive growth is also seen in credit unions, which are functionally similar to small banks. Credit union loans outstanding grew $0.23t from 2021Q3 to 2022Q3 (Q4 data not available), a level also three times higher than recent years. Loan growth was strong across categories and appeared to persist despite rising rates.
Note that explosive loan growth is likely the key reason banks recently increased market borrowings, as deposit growth usually lags loan growth. Banks may be temporarily borrowing from Federal Home Loan Banks and even the discount window to keep up with loan growth.
Initial Conditions
Credit growth is influenced by interest rates, but also the willingness and capacity of banks to lend and borrowers to borrow. As noted before, the Fed’s post-GFC change to transmitting monetary policy by adjusting marginal asset returns rather than marginal funding costs encourages loan growth when rates are high. Higher rates mechanically raise net interest margins as funding costs are little changed. As shown by their resilience throughout March 2020, banks today are financially sound and capable of lending. This is a very different context than the post-GFC years when they were nursing significant losses.
The strong financial position of households suggests they have a high capacity to take on additional debt. Household net worth remains historically high and many have a favorable debt profile comprised largely of long term mortgages at very low rates. At the same time, the historically strong labor market continues to push wages higher. This is a combination that makes lenders comfortable to lend and borrowers confident to borrow. It may also make credit growth more resistant to higher interest rates.
Money, but not Free
Increasing the supply of money boosts economic activity by directly increasing the purchasing power of the public. The enormous fiscal stimulus in 2020 created a few trillion out of thin air and just gave it away to the public – predictably supercharging growth and inflation. Note that fiscal stimulus is very different from QE, which merely exchanges Treasuries for cash. QE changes the composition of liquid assets held by non-banks (fewer Treasuries, more cash), but not their purchasing power. In contrast, stimmy checks and forgivable loans are essentially free “helicopter money” that increase potential demand.
The huge credit growth in 2022 can be likened to the prior fiscal stimulus, with the exception that the money must one day be repaid. Borrowers have $1.5t more in purchasing power that they did not have before. The need to repay the money may affect their spending decisions and willingness to take on additional debt, but credit cycles can last for years. The housing led boom of the early 2000s continued for years even as rates rose. Financial conditions today have been loosening with rising equity pricing and declining yields, potentially extending the cycle. At the very least, the credit boom thus far should sustain demand for the coming months.
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