Debt Ceiling Resolution Affects Commercial Loans

Today the world is breathing a sigh of relief that the debt ceiling crisis was resolved yesterday, and the U.S. Treasury was able to meet all of its debt obligations. However, that feeling of debt relief is surely going to be short lasting. Although there was no doubt a default by the U.S. Government in paying its bills was going to have resounding negative effect on not only the national but global economy, including hurting the income and capital available to Banks and other financial institutions in the United States; but the changes taking hold following the resolution could be just as devastating as a default would have been in the long-run.

Commercial Banks have been hording cash and capital for the past two months in preparation of a potential default by the United States, limiting new commercial loans. If the debt ceiling was not raised, the Treasury would not have had the capital to lend to banks and other financial institutions in need, nor would it have had the capital to pay them on the money banks typically lend to the Treasury in overnight funds (which is whatever deposits the Banks have that are not leant out). This would have negatively impacted not only the income of just about every bank in the United States, but it would have also impacted their ability to make new loans as Banks would have had to reserve cash instead of relying on lines of credit from the Federal government to maintain liquidity, which would have in turn allowed them to lend their cash on consumer and commercial loans. Furthermore, had the Federal Government defaulted on its debt obligations and the rating agencies had downgraded U.S. sovereign debt, the government’s borrowing costs would have gone up, which in turn would have raised Bank borrowing costs; negatively impacting bank profitability and making borrowing costs for commercial loan borrowers even higher.

Although it appears the very bad storm that could have been created for the commercial loan markets was avoided when the debt plan was passed, the truth is it only changed the path of the storm and a new one is about to hit us. The plan passed by Congress and signed by the President to raise the debt ceiling included some huge federal spending reductions. In addition, the plan failed to take into account the extension of stimulus programs such as extended unemployment benefits. Although many of those spending cuts are in the future and will not go into place today, many will start to take effect within the next year, and will lead to less funding for Federal projects as well as money flowing to other agencies and the States. As Federal and State agencies and non-governmental agencies that rely heavily on Federal and State money to operate (such as many non-profits), see the money available to them decline, you are going to see budgets slashed and payrolls for all organizations reduced. In addition, less money will pour into the private sector from spending on government projects. All of this comes at a time when unemployment is already terribly high, and will likely only drive unemployment higher.

The commercial loan markets started to open back up in 2011 as many Bank’s finished working through many of their problem consumer and commercial loans and as the economy began to recover. Commercial lenders began to gain confidence that the worst was behind them and had started to get more aggressive in commercial lending. Over the past quarter concerns were beginning to mount that the economy was starting to slow again, and with a large number of additional layoffs coming down the line related to government spending cuts, consumer and commercial loan defaults are likely to start to climb again as government employees and commercial businesses that do a lot of work for government agencies lose business. That is going to cause a second round of consumer and commercial loan defaults that would likely lead to additional tightening of commercial loan credit in the marketplace. It would likely also lead to the closure of some additional commercial lenders / banks that are barely holding on and cannot afford any more loan defaults.

Overall the road to recovery is going to be a long one in the United States. Although commercial lending is much improved from its lows in 2009 and 2010, there is still continued weakness and a general lack of capital to support all of the commercial loan requests out there. A continued weakening of the economy, which is likely to be the result of additional government spending cuts, will only further reduce the capital available for commercial loans as Banks become more cautious and must reserve capital to cover a new round of bad loans. Although there is no question government spending is too high, unfortunately additional tax revenues are likely necessary to balance out the reduction of government spending and limit its effect on the overall economy. Right now a continuation of the economic recovery is the best case for Banks to improve and for additional capital to pour into the commercial lending market, which in turn will help small business owners and investors create much needed jobs to grow the economy even further.