Crunch This
I'd like to put down a marker that not all reductions in the supply of credit should qualify as a credit crunch. A credit crunch occurs when a large number of borrowers cannot get a loan at any interest rate. What we are seeing is that interest rates on borrowing are increasing and some financial institutions are looking to lend in smaller quantitites than previously.
Maybe those using the reduction in the supply of credit to push large bailout plans haven't been keeping up on current events, but higher interest rates and less borrowing are exactly what we need. It would have been better to get them sooner rather than later, but most of what we are seeing is just the more prudent lending policies that should have been in place all along.
Consider some excerpts from a good article in Time from Tuesday. What part of this is supposed to be a credit crunch?
Just ask anyone who wants to buy a house with a subprime mortgage — they're not all evil, but these days they are exceedingly rare — or with a jumbo loan, which now carries an average rate 1.2 percentage points above a regular mortgage. (In normal times, the spread is closer to a quarter of a percentage point.)
So what? There's a higher premium for risk. Mortgage rates are still quite low by historical standards, and we didn't refer to those periods as a crunch. Another excerpt:
Now, about those credit card offers. You may not feel it, but there are fewer of them going out — 1.1 million during the second quarter, down 17% from the same time last year, according to Synovate, a research firm that tracks direct mail. Who's being ignored? Well, subprime borrowers (no surprise there), but also anyone who doesn't make a lot of money: 52% of households with an annual income of less than $50,000 received at least one offer in the second quarter, compared with 66% of such households during the same period last year.
Is there anyone who thinks that we should have more of those ridiculous credit card offers going out? Or that low-income households or subprime borrowers should be getting more of them? This looks like sensible policy to me. Risk needs to be priced. That it might be temporarily priced too high seems like a small problem compared to the damage done over a period of years when it was priced too low.
An actuarially fair increase in the FDIC limits makes sense -- $100k is a bit low for a reasonably sized business managing its accounts at a single bank. But the capital to shore up the banking system ought to come from investors, not bailouts. The price of risk will fall over time as the true magnitudes of risk become better known.
Credit Crunch
If this is truly a credit crunch affecting Main Street business then:
For every financial institution regulated by the Federal Reserve that meets the current capital adequacy standards for its investment risk - lower its reserve requirements by half.
This does not save bad banks, it does not reward risky behavior. Banks that have adequate capital will be able to double the lending that their existing reserves will support. If the reserve requirement reduction is set for 5 years or until the bank fails to meet the capital adequacy standards based on risk the bank will avail themselves of the opportunity to make more money but will continue to do so prudently.
Voila! no more credit crunch.
Yes, the Credit Crunch is here
"A credit crunch occurs when a large number of borrowers cannot get a loan at any interest rate."
That's already happening. I've heard from business owners who say their credit lines have been cut or cut completely. That's the same as being told you can't have a loan. Period.
Could they get a loan at a higher interest rate? Maybe. But maybe not. Bernanke has an interesting piece (in today's paper) about relationship banking. In small communities it's all about whether or not the loan officers know the customer. If they don't (like it's the guy from 3 towns over who had his credit line cut at his bank) then forget it.
How it played out in 1930's:
"Once a bank in a given town closed, all the knowledge accumulated by the bank officers there effectively disappeared. Other banks weren't nearly as willing to lend money to local businesses and residents because the loan officers at those banks didn't know which borrowers were less reliable than they looked. Credit dried up.
"If a guy has a good investment opportunity and he can't get the funding, he won't do it," said Mishkin, an economics professor at Columbia. "And that's when the economy collapses."
By 1932, consumption and investment had both collapsed.
As an academic economist in the 1980s, Bernanke developed the theory that the loan officers' lost knowledge was a crucial cause of the Depression. He referred to this lost knowledge as "informational capital." It means that trust vanished from the banking sector."
The trust is quickly vanishing. That's why there are, and will increasingly be, people who can't get loans at any price. And some of them will be very good people, with very good business investment opportunities. Those opportunities are then lost to the economy.
http://www.startribune.com/nation/29981729.html?elr=KArksUUUU
Ooops, not article by Bernanke, just mentions his research
Got that wrong . . . the guy is too busy to work for the Strib
credit
since this stuff started in the news, at least one entity has raised my credit limit without me asking.
fair value accounting and credit crunch
this is worth reading if you are concerned about fair value accounting.
Banks want to shoot the messenger over fair value rules
By Lynn Turner
Published: October 2 2008 03:00 | Last updated: October 2 2008 03:00
Excerpt
Even if fair value reporting is suspended, the crisis will remain. Whether a bank reports an asset on its books at $100 or $60 does not change its available cash or the amounts it owes. That is why even if fair value reporting is suspended, the crisis will remain.