From Crunch to Catatonia

Bloomberg had a great headline this morning:

Banks' 'Catatonic Fear' Means Consumers Don't Get TARP Relief

While it does have a little bit of on-the-other-hand, the thrust of the story is strong and clear: We're trying to kick-start bank lending by throwing money at the financial system, and it's not working. And the names lined up to push this thesis are big ones, including Alan Blinder, who provided the "catatonic fear" quote which got promoted into the headline.

I love these Bloomberg stories: While remaining objective and true to Bloomberg's wire-service mission, they aren't afraid to be provocative and contentious as well. Would that the WSJ followed suit more often. In any case, do read the piece: It's a nice antidote to whatever piece you've just seen saying that there really isn't a credit crunch at all. Of course there is:

The Fed said consumer credit fell by $6.4 billion in August, the largest drop in 65 years, and then by $3.5 billion in October, the first time since 1992 that there were two months of declines in a year.

In its most recent quarterly Senior Loan Officer Opinion Survey in October, the Fed reported that about 85 percent of U.S. banks said they had tightened standards on commercial and industrial loans to companies with more than $50 million in annual sales, up from 60 percent in July. Ninety-five percent said they increased the cost of those loans. About 70 percent said they made it more difficult to obtain prime mortgages, and almost 65 percent said they did the same for consumer loans.

Yes, despite the falling interest rate environment, 95% of banks have increased the cost of their loans. Sounds like a credit crunch to me -- and sounds, too, like the stated aim of the government buying equity stakes in banks simply isn't working. As Neel Kashkari described it:

The goal of the Capital Purchase Program is to stabilize the financial system and restore confidence in financial institutions, which will increase the flow of credit.

Even if the first has happened (and that's debatable), the second two are clearly still a long way off.

Comments

[Larry House:]

It's hard to ask a person who is bleeding profusely if he/she wants to donate blood. That is how the banks look at lending. Consumer spending is likely to contract further as credit card issuers continue to reduce credit limits and increase lending rates. Also, consumers are learning to say no to spending to increase cash and pay down debt. We are entering a new era.

Jan 05 04:14 PM

[LariAnn:]

Too bad the bank bailouts didn't come with the kind of scrutiny and preconditions that the auto bailouts did. If they had, maybe some lending would be going on. However, living more within your means is always a good idea and perhaps it's time for people to cut back on credit purchases. Just because the government thinks deficit spending is a good idea doesn't mean we as individuals should do the same!

Jan 05 04:25 PM

[nosajio:]

So the availability of credit might be limited to people that can actually pay it back? What is the world coming to?!

Jan 05 04:26 PM

[hanumanhojo:]

Interest rates should reflect risk and proper return for that risk, not some mystical number that the Fed decides to set the short rate to. That's how banking is done in the real world.

Thus, interest rates have risen. Many companies and individuals are overleveraged, thus they are less likely to get a loan, as things should be.

If the government really wanted credit to be extended more, they should have taken the bailout money and given it to the healthy banks. Instead, the money went to filling potholes caused by shoddy lending at the weak banks.

Until we start rewarding the prudent instead of the weak and foolish, the "credit crunch" will continue.

Jan 05 05:02 PM

[driftwood2:]

The government has been far too soft with banks and given away money for too little in exchange. They should have demanded much bigger stakes in the failed banks that needed a handout to stay afloat. And the stakes should have had full voting rights. With enough shareholder clout, the government can simply mandate the banks to lend.

Jan 05 05:09 PM

[Chris B:]

Step 1 was to prevent bank failures by acting as the lender/buyer of last resort. Failure to do so would have cost the FDIC and the IRS a lot more than the price tag of TARP. Mission accomplished regarding step 1.

Step 2 is to stimulate the economy through the consumer. The reason you are not seeing more lending is because consumers fear for their jobs, are facing foreclosure, and are basically broke. Public works spending, education grants, and an adequate safety net in the form of extended unemployment benefits or temporary Medicaid access for those who were laid off would be helpful here.

Step 3 is to shift to a contractionary policy once the recovery takes hold so that high inflation does not result. Cutting government spending (e.g. get out of Iraq / Afghanistan) is critical here.

Jan 05 05:39 PM

[Jason Rines...:]

Those I know are seeking credit, they just can't get any. And the cost of credit has increased causing second thoughts for those whom can borrow. Take my business partner. $400k of assets as collateral and a 710 credit score. He expected 4.9% fixed on a re-fi but was offered 5.5% just at the level he was currently at on a fixed mortgage. After a week of he meeting multiple banks, I thought he was going to pop. His credit score had improved in the last two years as has his collateral. Your comments were also relevant Chris B, sorry if I seemed I was splitting hairs. I think the safety net is already showing strains. Best bet in my opinion is long-term job creation projects and tax breaks with the fiscal stimulus. In the short term, government should be setting up more homless shelters and ploughing a lot of needed food to the food pantries.

> Step 2 is to stimulate the economy through the consumer. The reason
> you are not seeing more lending is because consumers fear for their
> jobs, are facing foreclosure, and are basically broke. Public works
> spending, education grants, and an adequate safety net in the form
> of extended unemployment benefits or temporary Medicaid access for
> those who were laid off would be helpful here.

Jan 05 06:14 PM

[Socialism c...:]

Stimuli are the wrong answer because the question is wrong. The question should not have been "how do we restimulate this economy", but "is this the right kind of economy to have, and will it ever be what it was again?"

Banks aren't lending because a) they've been burned; b) we are not wanting to borrow and go into debt. And that's as it SHOULD BE. We had a faux economy, based on too much debt. It *shouldn't* go back to where it was. What the government should have done instead of bailouts, was to cut nonessential government (heh...2/3 of it?), and give the people their money back...permanently. I.e. lay a WHOLE NEW FOUNDATION, based on a new economic reality of much, much, lower taxation. To make the economy more nimble and non-debt focused, we need small government, and a move to the Fair Tax, so that taxation is decided and controlled at a micro level -- that of the individual consumer. When each of us regains full control of our OWN money, and the power to decide how to use it as WE KNOW BEST...then you introduce new efficiency in the U.S. economy that we haven't seen in decades, since the dawn of the IRS. And let's face it...who enjoys doing their taxes??? Kill the beast.

fairtax.org

Jan 05 06:27 PM

[mathgeek:]

On Jan 05 06:27 PM Socialism cannot compete! wrote:

> Stimuli are the wrong answer because the question is wrong. The question
> should not have been "how do we restimulate this economy", but "is
> this the right kind of economy to have, and will it ever be what
> it was again?"
>
> Banks aren't lending because a) they've been burned; b) we are not
> wanting to borrow and go into debt. And that's as it SHOULD BE. We
> had a faux economy, based on too much debt. It *shouldn't* go back
> to where it was. What the government should have done instead of
> bailouts, was to cut nonessential government (heh...2/3 of it?),
> and give the people their money back...permanently. I.e. lay a WHOLE
> NEW FOUNDATION, based on a new economic reality of much, much, lower
> taxation. To make the economy more nimble and non-debt focused, we
> need small government, and a move to the Fair Tax, so that taxation
> is decided and controlled at a micro level -- that of the individual
> consumer. When each of us regains full control of our OWN money,
> and the power to decide how to use it as WE KNOW BEST...then you
> introduce new efficiency in the U.S. economy that we haven't seen
> in decades, since the dawn of the IRS. And let's face it...who enjoys
> doing their taxes??? Kill the beast.
>

The old economic reality was huge economic swings (that made the so called "great depression" look like a minor recession) and there was no more "efficiency in the U.S. economy."

Credit is the same as money supply. Contracting credit leads to contracting money, which leads to Deflation. Deflation kills economic activity because no one wants to buy anything that they know will cost less if they just wait. It's the "catching a falling knife" issue, only for everything in the economy (including employees).

All the commentary (and it is very widespread) that paying off debt, and "living within our means" is good for us is understandable, but it makes one of the most common errors in economics... assuming that something that is true individually is true collectively.

Saving more and spending less may be virtuous... but when everyone tries to do it at the same time, the result can be dire. It is similar to saying that you should sell a stock that is going down in price. Perhaps it is true, but everyone trying to sell it at the same time means there are no buyers, and by definition when there are no buyers there can be no sellers.

It is vital that credit availability be restored... and as the main article points out, the current TARP has failed to accomplish this goal. We had all better hope that the government takes action to whatever steps are taken next are more sucessful.

Jan 05 07:01 PM

[Longinvestor:]

The government gave the money to the wrong kind of lender. Credit unions have a much closer relationship to borrowers. It is not to late to funnel the funds to them.

Jan 05 07:38 PM

[User 265729:]

Felix,

Always a pleasure to read your commentary.

I really feel that people simply don't understand the scale of this problem... According to the United States Federal Reserve, during Q4 2007 through Q3 2008, there was a wealth destruction of almost $8 trillion (see p. 113)

www.federalreserve.gov...

Remember, this does not even include the worst quarter, Q4 and does not include all sources of loss...

To give readers the scale of the problem... If you use the high-end calculations of the damage caused by Hurricane Katrina it is the equivalent of over 26 Katrinas hitting the United States. A major wipe of 26 American cities...

Remember, this EXCLUDES Q4 2008, excludes all of the DEBT that is out there, excludes several classes of assets, and, since it is from the government, perhaps a more positive picture than reality.

Add to that, the wealth that has been lost in the world's markets --only the world’s markets at 31.1 Trillion -- almost 104 Hurricane Katrinas in world stock value alone...

www.bloomberg.com/apps...

Get the picture?

They are using peashooters against Godzilla and hoping to hype the economy back to 2007.

My projection: This sucker's going down. There is NOTHING they can do about it...

Jan 05 07:41 PM

[discov:]

All the stimulus and bailouts are a drop in the bucket compared to the deflation that is currently going on
www.marketoracle.co.uk...
concisetrading.blogspo...
Ryan

Jan 05 08:07 PM

[Lin:]

Curbs-in

You are correct ! This sucker is going down , zip they can do about it . I just read comments from Noriel Roubini today . He states " that the worst is still in front of us ". When you have the " shadow banking system " collapsing , nothing , nothing, can bring back 30-60 trillion of lost capital back . It was illusionary from the get-go . Add in the next to default commercial loans + corporate bankrupsies , municipalities etc. The Fed + US treasury are bankrupt 1 Tax cuts ? What 's going to pay the interest on the uS debt alone ? Foreigners are no longer going to " finance our spending ".

Jan 05 08:20 PM

[prudentinve...:]

You state that "..Yes, despite the falling interest rate environment, 95% of banks have increased the cost of their loans.".

I suggest this indicates that the fed, try as they may, cannot force rates down too far below where the market's risk/reward balance is. The fed should accept reality and allow the market to run its course, as private investors possess adequate liquidity, but need to lend it to acceptable risks at acceptable interest rates.

Jan 05 08:20 PM

[bobomite:]

Let's see, the Treasury goes further into debt to give money to the banks (who own the Federal Reserve System, with it's FOMC) so the banks then can get consumers further into debt...

Meanwhile Madoff is an evil guy because he pretended to have more money than he really did.

Hmmm, how does fractional reserve banking work? At least the banks are lowering that ratio from 30-1 (or more) by having the Fed buy their crappy assets. Wait - the banks own the "Fed." Now I'm confused. Isn't that a Ponzi scheme? Two sets of books and all that?

Yea sounds like a great system. If only that was "working better" we'd all be in a good place.

Jan 05 08:49 PM

[Crocodilian:]

Lending in a deflationary environment is a bad bet for both lenders and borrowers-- its hardly surprising that lenders don't want to lend, and borrowers don't want to borrow: why should they? If that house I buy will be worth %10 less in six months, then buying a house with %10 down is a quick way to lose my nest egg.

In a deflationary environment, the best use of excess capital is often paying down debt, not incurring more of it. Why borrow to purchase an asset that you believe will be worth less tomorrow?

Jan 05 09:26 PM

[Bruce Vande...:]

Deflation is here. Can the government do anything about it? I doubt Obama's plan can stop it.

I guess they can print money, but who gives the authorization. Congress probably will not authorize it unless things get much worse. Government is slow but this crisis is swift. So, expect deflation to strike hard for now. Afterward, who knows?

Jan 05 10:07 PM

[sickofthehype:]

Deflation is temporary, and the mindset of the Fed is to print until it reverses. So it will happen and the question is, will they be able to stop the INflation once it begins?

The cash being created for the banks has done nothing more than enhance their balance sheets for now, but in due time they'll be lending again. Banks don't make money hoarding cash for balance sheets.

Oh, and those people claiming to be saving again and turning a new leaf. Just wait until they're convinced the market has turned, their 401K's are increasing, and their home's value is moving up again. They'll forget soon enough about 'hard times' and having to 'save' money. Just watch.

Jan 05 10:52 PM

[Ricard:]

Larry,

Your first sentence is probably the most well-stated argument about bank lending today I've heard to date.

So here's the $8.5 trillion question...what would it take to get the consumer to start spending again?




On Jan 05 04:14 PM Larry House wrote:

> It's hard to ask a person who is bleeding profusely if he/she wants
> to donate blood. That is how the banks look at lending. Consumer
> spending is likely to contract further as credit card issuers continue
> to reduce credit limits and increase lending rates. Also, consumers
> are learning to say no to spending to increase cash and pay down
> debt. We are entering a new era.

Jan 05 11:28 PM

[Mark Anthony:]

Quote: "The Fed said consumer credit fell by $6.4 billion in August, the largest drop in 65 years, and then by $3.5 billion in October, the first time since 1992 that there were two months of declines in a year."

Is $6.4B a whole lot of money? It sounds like just pocket change as nowadays we are accustomed to hear trillions of dollars. $6.4B averaged over the US population is a mere 20 bucks per person. That doesn't seems to be a whole lot of consumer credit shinkage, percentage-wise. The outstanding consumer credit must be in multiple trillions so the functuation of a few billion is really nothing.

People will continue to spend on basic needs, whether it is on credit cards or on cash:
seekingalpha.com/artic...

Jan 05 11:45 PM

[jrs87sch:]

We need to stagnate in order to recover, then we can worry about spending and growth again. You can't wipe out trillions of dollars of wealth and knock 100,000's of people out of jobs and tell them to start spending.

We need time, I don't think the Fed and Treasury realize that.

Jan 06 12:04 AM

[Griz:]

I ask the questions again: Can more debt be the solution?

Jan 06 12:53 AM

[Anthony Alfidi:]

Wouldn't banks want to lend in a deflationary environment? They'd be repaid with future dollars that have increased in value. Banks may be more afraid of this becoming an inflationary environment - a debtor's best friend.


On Jan 05 09:26 PM Crocodilian wrote:

> Lending in a deflationary environment is a bad bet for both lenders
> and borrowers-- its hardly surprising that lenders don't want to
> lend, and borrowers don't want to borrow: why should they? If that
> house I buy will be worth %10 less in six months, then buying a house
> with %10 down is a quick way to lose my nest egg.
>
> In a deflationary environment, the best use of excess capital is
> often paying down debt, not incurring more of it. Why borrow to purchase
> an asset that you believe will be worth less tomorrow?

Jan 06 01:31 AM

[Mick Weinstein:]

Re. Bloomberg vs. WSJ coverage of the meltdown, be sure to see CJR's Dean Starkman: is.gd/dNox

Jan 06 02:20 AM

[nym:]

Thanks for the CJR link is.gd/dNox: it is a gem.

Jan 06 11:02 AM

[Ricard:]

Regarding the CJR article:

I've had a subscription to the WSJ for years, and ended up coming here in recent months to get more information. Bloomberg updates on my IPhone were also most enlightening. I've been wondering why that was...

Jan 06 03:41 PM

[levin70:]

Felix:

I would be one to disagree that there is a credit crunch. What is occurring is that there is now a return to more prudent lending standards. It now requires more than a pulse to get consumer loans. This isn't a credit crunch, but a return to normal.

As someone with a healthy income, assets and no debt outside of a mortgage, I don't find it really that difficult to obtain credit if i want it. A credit crunch would be if banks wouldn't lend to me no matter what.

Kind Regards

Jan 07 11:43 AM