Why Is Wells Fargo Shuttering ALL Personal Lines of Credit?

Sometimes you hear a news story that totally rocks your world, and you spend an inordinate amount of time trying to make sense of it. Last week I read the third largest bank in the United States, Wells Fargo, with $1.7 trillion in assets was shuttering all personal lines of credit with its customers.

This story is quite puzzling for many reasons. At its core, the entire purpose of the banking industry is to boost loan growth. When one of the largest banking institutions, with over 70 million customers, purposely curtails loan growth, by closing all existing lines of credit, I think it is worth pondering and trying to understand why.

The Wells Fargo revolving credit lines, typically let users borrow $3,000 to $100,000, were a viable way for customers to consolidate higher‑interest credit card debt, pay for home renovations or avoid overdraft fees on linked Wells Fargo checking accounts.

Wells Fargo Customers credit scores may be adversely affected by this move, which is how most in the media interpret this inconvenience. I tend to look at it much more organically.

Imagine a lumber distributor stopping its selling of certain wood products?

Or a steel manufacturer no longer selling steel beams used for construction?

Or ponder why your grocer might suddenly stop selling meat. The first question you could ask is, did he have a vegan conversion? Or is there a problem with the meat?

When the Federal Reserve manipulates Interest Rates and bypasses the free market process of price discovery, the unintended consequence is our previous definitions of risk are no longer functional. This results in massive price distortions as markets try to understand what is occurring.

The most important definition in finance is how you define risk.

When this definition is unclear, chaos can easily prevail in the markets.

Today RISK has never been more prevalent. The challenge, dear reader, is how can you eliminate risk at all when the Fed has pushed interest rates to zero in the hopes of increasing economic growth?

Since the Fed has pushed interest rates down to close to ZERO and last month’s Consumer Price Index number was 5.4%, anybody who has their money parked in these short-term treasury assets will experience a greater than negative 4% real rate of return every year.

In other words, the best that you could do for a widow and orphan today is guarantee them that they would lose 4% per year on their savings.

This problem compounds for banks, as depositors do not want to lose money on their deposits, so they only keep a minimal amount in the banking account. Since depositors are keeping less money in the bank, the bank has less money to invest in productive loans.

What makes this action on the part of Wells Fargo so confusing is that Wells Fargo is literally returning the funds to the Fed that it borrowed from the Federal Reserve.

Last year, Wells Fargo halted all new home equity lines of credit. Months later, the bank also withdrew from a large segment of the auto lending business.

Stop and think about that. Particularly since housing prices are up over 15% year over year and many used car prices are up over 30% in the same time frame.

Why would a top lender in those markets stop lending?

That is a real head scratcher until I saw this headline:

While not privy to the goings on at the board meetings of the large banking institutions, my take on this is that Wells Fargo and J.P. Morgan are thinking that it is much riskier to loan funds now.

They are analyzing their loan portfolios and have concluded that risk outweighs return in the personal credit sector. You may disagree with their decision. However, keep in mind these institutions were central to the 2008 Great Financial Crisis, what is it that is stopping them from lending now?

What is possible that they too are being squeezed by the low interest rate environment? Might they require a higher yield and return on investment to compensate for what they perceive to be a greater chance of default on the part of the borrower?

What is clear is that both J.P. Morgan and Wells Fargo perceive that there is greater counterparty risk in the financial system now.

What is worthy of every investor and trader’s attention is to ponder the potential consequences of what occurs when a bank curtails lending.

If people couldn’t borrow, do you think the housing prices would continue moving higher? The totality of economics is the puzzle of supply and demand reaching an equilibrium. When the Fed manipulates the cost of money it distorts the definition of risk, and even the largest financial institutions are forced to wrestle with how they can safely navigate the landscape.

Here is a chart published by the St. Louis Federal Reserve of all Commercial and Industrial Loans at all Commercial Banks going back to 1950. You can see how loan activity has exploded exponentially initially since we came off the Gold Standard in 1971. Since the 2008 Financial Crisis Commercial Loans have gone up 150%. The shaded areas are recessions in the economy.

Observe how since the pandemic began the rise of loan activity has been almost straight up.

Before the Great Financial Crisis in 2008, Commercial loan activity contracted by 23%!

What is concerning to Fed Watchers is that since last Summer Commercial Loan activity has contracted 19%!  That is the steepest decline since the Great Financial Crisis.

Could this be what is spooking the banks?

Here is a closeup of Commercial Loan activity of the past year.

Money and credit are what drives the economy.

Why is this of concern?

We live in a credit-based world. If lending does not occur, then neither does commerce and the potential consequences could be severe.

Why is this important?

If banks are struggling to define risk, you can rest assured that spells huge volatility in the financial markets for their customers.

When the largest banks in the country curtail personal loans accompanied by massive commercial loan contraction, my question is where is the money going to come from to drive price higher?

I would challenge you to pay very close attention to next month’s Consumer Price Index and Producer Price Index Reports If those numbers are elevated my expectation is that Commercial bank lending will contract further.

That could be disastrous.