Thursday, August 9, 2007

Credit crunches - no credit for nobody


We Don't Want Nobody Nobody Sent, Milton J. Rakove Chicago, June 1979. Title of a book about Chicago ward politics, but may be the new standard of credit officers for lending.


The current arguments that we may see a slowdown in the economy caused by an old fashion credit crunch may be right on the mark. But first we have to define terms. A credit crunch is caused by growing conservative lending policies during periods of financial stress and reduced profitability. If there are higher risks from lending, reduce the amount (quantity) that is being done. There is the crunch.

It has been found that monetary policy is largely ineffective in alleviating a true credit crunch, while changes in loan standards and regulation can erase it. This is one of the problems in the current environment of rising short-rates in Europe. While the ECB has provided an unprecedented amount of funds which has brought rates down from their highs, changing credit standard will close the borrowing window for some institutions. If credit lines are pulled, then funds are not available at any price. The less credit-worthy institutions will have to search for those banks which may be willing to lend on a short-term basis and those institutions will want to be compensated for the risk.

In the current environment, liquidity is still available as measured by the money in the financial system. The problem is that those who have liquidity and funds are not willing to part with the money at almost any price. In an uncertain market, this is very rational. One of the ways that the credit markets can be stabilized is through information on the problems. Who has sub-prime exposure? What are the sizes of those exposures? What are the credit protections in place for those risks? Unfortunately those who have the risks would like the markets to remain opaque. Disclosure of information may actually cause the markets to adjust faster. This may be good for the economy as a whole but it will not be good for those with bad loans.

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