When Will the "Chicken and Egg" Cycle Hampering Corporate Lending Break?

A “chicken and egg” conundrum is plaguing credit markets. While banks that get federal bailout money are faulted for not using the funds to make loans to kickstart the economy, hamstrung corporations are not seeking loans. A Federal Reserve study shows that 60 percent of loan officers at banks surveyed said that as of January, middle and large firms aren’t seeking more credit.

The news is a counterbalance to another Fed survey that shows that 79 percent of loan officers surveyed for the same, three month period ending last month reported that they had tightened credit for companies.

So what to make of this? Critics of the federal bailout and populists campaigning against big banks like to toss out the factoid that banks aren’t lending to show how greedy the banks are. But reality is a little more complicated. Here’s why:

• Plenty of firms are laying off employees in droves and hardly are in a position to go for credit. Caterpillar is laying off 20,000; liquidating Circuit City is laying off 30,000; Home Depot, 7,000; Sprint 8,000 and Philips, 6,000. That’s just in the past month or so. Unemployment is expected to go national from about 7 percent to 9 percent — not the worst ever but bad enough.
• When hard times hit, the proper response for companies is to horde cash. That’s the advice of management guru Ram Charan in his recent and timely book “Leadership in the Era of Economic Uncertainty: The New Rules for Getting the Right Things Done in Difficult Times.” In one telling example, Charan explains how chemical giant Dupont realized early on how bad things would get and started a company-wide campaign to save cash and winnow clients to those who had good cash positions.
• Firms are shoring up cash like Dupont. Consider Textron which makes Cessna jets and Bell helicopters. The firm is drawing down its $3 billion lines of credit and will use $1.2 billion of it to pump up its cash liquidity. It doesn’t have to revisit the lines of credit until April 2012 when, hopefully, the recession will be over.
• Firms aren’t borrowing if they don’t have to because the terms are so one-sided. Banks, facing still gummed- up credit flows and perhaps still overreacting to last fall’s credit panic, are demanding onerous terms. One example of how bad it is is Southwest Airlines, the only domestic air carrier with investment-grade credit. In December, the airline went to the bond market to raise $400 billion to cover its losses when it bet that fuel prices would remain high. Despite its good credit record, Southwest had to pay interest of 10.5 percent and use 17 of its Boeing jets as collateral. That’s double the finance fee it paid five years ago to raise $350 million.

There’s no remedy on the horizon even though the engineers manning the switches of the still-evolving bailout program badly want to get credit flowing on all sides. If banks get more capital on easier terms, they might switch on the lending lamp. If they start offering finance on more reasonable terms, firms might actually start borrowing again. But that’s not likely to happen until they see good reason to do so, and so on.

When will the circle be broken?