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25 May 2024

Joblessness threatens banking system

By Reuters

Rising unemployment is now the largest single threat to attempts to stabilise the banking system through recapitalisation and assets swaps designed to remove toxic assets from bank balance sheets.

It is also the main impediment to restarting bank lending, renewing output growth and preventing debt-deflation from becoming entrenched.

So far, the rising wave of defaults has been concentrated in the riskier portions of banks' loan books: sub-prime mortgages, buy-to-let loans, and lending to private equity ventures and management to finance asset acquisitions and highly leveraged buyouts.

Defaults on prime mortgages, credit cards, auto loans and other forms of bank lending have all risen, but generally not very much, and from a very low cyclical starting point.

Senior bankers are correct when they insist conventional parts of the lending business have performed well until now. Problems have arisen mostly on the funding side of banks' balance sheets and certain specialised parts of the lending side. Elsewhere risk-management systems on the lending side have performed reasonably well. Losses have risen where credit control and risk management systems were deliberately overridden by senior executives anxious to grab market share or generate mortgages for packaging as part of the originate-and-distribute model. Leadership failure rather than technical errors in credit control lies at the heart of the debt crisis.

But the accelerating wave of job losses, especially in the United States and the United Kingdom, threatens to create a new and even more deadly threat to the banking system.


Between November 2007 and January 2009, the number of people in full-time employment in the US fell by 6.1 million (five per cent) from 121.9 million to 115.8 million, according to the Bureau of Labour Statistics' Current Population Survey (https://customers.reuters.com/d/graphics/EMP1.pdf).

The pace of job losses is accelerating. Almost as many full-time positions were lost in just the three months from November 2008 to January 2009 (2.6 million) as had been lost in the whole of the previous year (3.5 million).

It would be nice to assume most of those who have lost full-time jobs were well-paid professionals living off past bonuses and "resting" until banking picks up. But the statistics suggest otherwise.

The number of people unemployed but actively looking for work has jumped 4.4 million since November 2007 (and by 1.1 million in the past three months alone).

Others appear to have settled for part-time work instead. The number of part-time workers has risen by 1.5 million (and more than 600,000 in the last quarter).

Some have simply given up. The number of working age people not seeking work and no longer considered part of the labour force has risen almost two million in the past 15 months.


Falling full-time employment rates are now translating into declines in household income. Total personal income (adjusted for population growth but not prices) stood just 0.5 per cent higher in December 2008 than it had been 12 months earlier. Personal income is rising at the slowest rate since the start of 2002 and before that the 1960s.

As layoff programmes are implemented, income growth looks set to turn negative for the first time in more than 40 years during the first half of 2009 (https://cust-omers.reuters.com/d/graphics/INC1.pdf).

The situation is even worse than the headline figures suggest. Personal income from wages and salaries in private-sector employment posted declines in both November and December compared to the same period a year earlier, the first sustained fall since 2002-03 (https://cust-omers.reuters.com/d/graphics/INC2.pdf).

Only continued growth in public sector wages, social security payments and other transfers, some of them triggered by the rise in unemployment, is keeping the overall growth in household incomes positive (https://customers.reuters.com/d/graphics/INC3.pdf).


Even with the safety net, the rising tide of unemployment is pushing more and more households into default.

The proportion of single-family residential mortgages in which some or all payments are 30 days past due or more has climbed from 1.73 per cent in Q3 2006 to 2.72 per cent in Q3 2007 and a staggering 5.08 per cent in Q3 2008

By the middle of last year, the number of non-business bankruptcies was already running at an annualised rate of more than one million per year, up from 600,000 two years earlier.

Bankruptcies are increasingly wiping out households. The number of bankruptcies under Chapter 7 (which involves liquidation of assets) had doubled to 720,000 per year, while debt reorganisations under Chapter 13 were up 45 percent to 345,000 (https://customers.reuters.com/d/graphics/BUST1.pdf).

Default rates and insolvencies are both expected to have risen substantially when data for Q4 is published in the next few weeks, and will keep on rising in Q1 and possibly Q2 as job losses work their way through. The problem is that income losses associated with rising unemployment are highly concentrated. The risk of default on mortgage and other loans jumps sharply when a household's primary income earner becomes unemployed, or it loses a major secondary source of earnings.

Loan losses on otherwise sound conventional loans risk draining banks' capital, along with bonus payments and dividends paid to shareholders, even as governments on both sides of the Atlantic try to pump money into them through recapitalisation programmes and swap out more obviously impaired assets from their balance sheets.

Moreover, the fear of unemployment restrains spending even among households that remain in work, and the risk it will rise further increases the danger to banks making new loans.


Output in the US, the UK and most of the other major economies contracted sharply in the final three months of last year. But this is only the first round. Rising unemployment will force a second round of spending cutbacks in the coming months, deepening the recession. Unless government policy can stem the rising tide of redundancies, attempts to stabilise the banks and restart growth will come to nothing.

I have written elsewhere about the need to sustain nominal income growth (including generating a positive rate of inflation) to preserve capacity to repay debts fixed in nominal terms. But the distribution of nominal income is as important as the total in terms of default rates.

Government policy needs to sustain high levels of employment as well as ward off a collapse in asset values or a downward spiral in wages and prices. The central aim of the stimulus packages being considered around the world needs to be maximising employment, rather than output.

This suggests the focus needs to be on spending money on labour-intensive low-skilled services, construction and low-technology manufacturing areas rather than transformative new technologies intended for a long-term legacy.

Expanding employment within the public sector itself, or commissioning simple construction work and an expansion of existing services and procurement projects will probably be more effective.

In many of these areas, output can only be delivered locally rather than traded across borders, minimising the risk fiscal stimulus will leak abroad to foreign companies, without resorting to the more obvious trade barriers, such as the incendiary "Buy American" provisions in the US stimulus bill.

The risk with the current debate on stimulus spending is that it is confusing the important short-term goal of job creation with longer-term investment and social transformation needs such as new energy technology. Park keepers, social care workers, new school buildings and social housing are what the economy needs now.

Much of this spending is on the type of low-technology, semi-skilled, labour-intensive and low-productivity work that in other times would be decried as a waste of money. But right now creating jobs – not building a shining legacy for the future – is more important. There will be plenty of time to worry about technological transformations later.