Will a Thaw in Credit End the Crisis?

The world economy in general, and the U.S. economy in particular relies on credit. Credit is the life source of much, if not all growth. However, we have all witnessed the negative impact of too much credit. According to Allbusiness.com, over-extension is defined as:

A loan balance or total credit obligation beyond the borrower's ability to pay . In situations where the borrower has taken on more credit than he can handle, a debt consolidation loan (combining several obligations in a single loan repayable over a longer term) may be the only alternative to bankruptcy. As a rule of thumb, borrowers who pay more than one-third of their net income to repayment of consumer debt, excluding mortgage debt, may be over-extended in their ability to repay recurring household debt.[1]

As we noted, credit drives growth. The question is can the American consumer handle more credit at this point in the economic cycle? According to one Reuters report,

"In spite of rising energy prices, a turbulent stock market and an
ongoing state of war, US consumers have continued to spend. While this spending has prevented the economy from slipping, it has come at the cost of decreased individual savings and increased personal debt." [2]

According to Reuters, one of the most influential groups driving consumer credit is aging baby boomers. This demographic has increased spending in a period when many have decreased it. This would suggest that many retailers would be best served by marketing services to this influential class.

Credit cards, which have been the key to consumer spending are adjusting their offers. According to creditmall.org, "The last year and one-half has been interesting in that banks are seeking the affluent, the credit worthy, and stable." [3] People who were able to qualify for cards several years ago cannot get it." Revolving credit at the corporate and individual level could well have run its course. A new "growth" engine must be found. A source which does not put the taxpayer at risk for additional loss.

TARP for the Good Banks

Like most Americans, I am growing increasingly frustrated with the TARP Program. In general, there has been a lack of progress. Banks who received these funds have not begun to loan... There are a variety of reasons. 1. If you were a cash-poor bank, you would think twice about lending as well. 2. You are concerned about loaning money because you are uncertain about the counter-party's ability to repay the loan. 3. You would rather keep the dividend charade going for as long as possible to prop up the stock price. Finally, Representative Steve LaTourette who is on the House Finance Committee insisted that institutions receiving TARP funds must report how the monies are being used.

There could well be a more modest proposal which would serve the good banks, punish the bad banks, and more importantly destroy the weak business models. If another TARP program were developed, and I am certain there will be a second TARP, then it should be done with the most solvent and well-run banks. The good banks should be given government loans to purchase the good assets of the bad banks, and allow the bad banks to fail. [4]

While I am certain this will create a great deal of turbulence in the world of finance, it could well be the only viable solution that truly saves the financial system. One thing is for certain, the Government will not be able to bail out every group that needs it. Heck, instead of cooking the books to make them look good, there could well be a case of cooking the books for TARP funds. [5]

Sources:
1. http://www.allbusiness.com/glossaries/over-extension/4944338-1.html
2. http://www.reuters.com/article/pressRelease/idUS157743+09-Jan-2008+BW20080109
3. http://www.creditmall.org/
4. http://www.marketwatch.com/news/story/bloody-start-earnings-season-batters/story.aspx?guid={3746153F-B946-4C22-8870-66BC92C0B31B}&siteid=trackedcomment#comment1416992
5. http://beltwayblips.dailyradar.com/story/the_cook_the_books_financial_collapse/

Disclosure: Stock Holdings-SCC, EFU, SRS, D

Options Holdings [SHORT]-RYL, MDC, WYNN, MCRI, FXI, CNK, BBW, MLHR

Comments

[CautiousInvestor]

While the financial crisis is horribly complex, it might help to break down the problem into two subsets for purposes of disccussion.

Bank balance sheets are deteriorating and Nouriel Roubini, along with others, have said the industry will prove to be insolvent. The losses at State Street and revised estimates of what BAC will require to stay afloat are in sympathy with this view.

Even with TARP and the steps taken by the Federal Reserve, banks are "hoarding" cash to protect their balance sheets in the face of rising risk and knowing more witedowns are to come. Their continued existence is at stake.

The second issue of banks making more loans is directly tied into the first issue of desiring to maintain an adequate capital structure; making anything less bullet proof loans is seen as too risky. Generally, only consumers with the highest credit scores and businesses with the highest ratings have access to credit.

There can be no general thaw until the writedown process has been completed, solvency is established and fear subsides.

2009 Jan 21 07:02 AM

[rdr4]

Perhaps I am failing to see what you see, but it's not that complex.
You can't spend what you don't have, for long.
A bail out for those who largely caused the problem causes
an extension of the problem, not a solution, and makes me doubtful regarding their suggested fixes. Economic theory is not an exact science, too many variables exist.

Giving the same amount of money to taxpayers with the stipulation that no monies of a taxpayer buy out could be spent until that taxpayer satisfies all debt would not only help banks but also help the taxpayers.

One reason boomers are less impacted by the credit issues is that they are nearing the fruition of their labors. They typically have more equity in their dwelling, retirement savings, and property holding that make them a more attractive loan prospect.

If we go into another big depression and things get really ugly, people who lose property because of ongoing official stupidity will become a volatile element in our society. Violent crime and theft will become the norm and class warfare is a real potential. I saw my first "shoot a lobbyist" bumpersticker, yesterday,...

2009 Jan 21 08:54 AM

[kelm]

It surprises me that boomers are still spending. Yes, they have greater retirement savings ...or had. My experience with them as a group is that they stayed fully invested through both the dot com bust and the current crisis and so have lost considerable resources.

2009 Jan 21 09:42 AM

[Ray Winter]

The comments from cautiousinvestor are the underlying truth as to the reason Banks are not lending. The Banks have received considerable injections of taxpayers cash and yet are not really lending to anyone. The reason is the spiral within which they are caught. As the economy slows, even the previously identified good borrowers are now sliding into the group that is unlikely to meet their obligations which forces the banks to increase their reserves and need for more injections of cash.

The UK is experiencing this scenario and having just received a second tranche of money it still looks to be insufficient.

Things will only stabilise when the economies steady and a line can be drawn as to the level of bad debts the Banks need to account for. I fear we have yet some way to go because the politicians have very little idea as to what they can do halt this downward spiral.

2009 Jan 21 11:26 AM

[AndrewBaker]

We need people to spend to get us out of the terrible economic situation too much cheap and easy credit has got us into: yet more of the same for all is likely just to make a dreadful situation even worse, so why not encourage aging baby boomers to spend now rather than store it up for the future and the next generations? Their spending won't cause such problems as that of younger people, yet the consumption will help to get the engines running properly again. Give this group credit, maybe even using their home as collateral, and let them spend. Tell the TARP enabled banks they must lend, and encourage them to seek out the groups where this will have the most beneficial effect: lending to people who already own their homes without a mortgage will not cause problems of unaffordable debt and the foreclosures that go with that, and the repayments could even have an option of rolling up, capital and interest, until after they die, if they choose that for all or part of any loan. If the loan amount and interest rate is properly set, our older citizens can enjoy their final years on a roll, help the economy, and not get anyone into trouble in doing it. It wouldn't cost much either for a guarantee that no matter what, they will never owe more than the value of the house they own. It's been done in the UK successfully for years: let's do it here. Maybe they could buy bank and financial stocks with the capital, supporting the markets at the same time as investing for extra income.

2009 Jan 21 03:06 PM

[Steven Hansen]

"In spite of rising energy prices, a turbulent stock market and an
ongoing state of war, US consumers have continued to spend. While this spending has prevented the economy from slipping, it has come at the cost of decreased individual savings and increased personal debt."

you do realize this was issued in 4Q2007.

most of your references are not for current data.

2009 Jan 21 11:19 PM