Monday, September 29, 2008

'Credit crunch, what credit crunch?'

Listening to the car dealer on TV reporting massive reduction in sales due to lack of credit and Arnold seeking 2 billion loan from Fed does not support this sentiment. But is it all that bad? Is the sky really going to fall lacking a 700 billion bonus from tax payer to the bankers? Probably not. What is the basis for me to say this? I am no expert in the complex matters of finance and do not have any credibility to question the financial acumen of the best and brightest like Paulson and Bernanke. But hey, this is a free country and every one can have their opinion. In my opinion, the present credit freeze is the result of bankers trying to over correct their excesses of last 5 years. It is like the cat refusing to drink cold milk after burned once while sipping it hot. For years, they lend to any warm body and now they don't want to lend to any one who is "sub prime". They are hoarding cash fearing that there are few safe hands these days they can trust. Aren't they lending to their "prime" customers? How are they able to do that if there is truly a cash shortage?

I wanted to test out my opinion with a real world credit exercise. I tried to get banks to lend to me in this "credit-freeze" environment. Like many of you, I still keep getting balance transfer or cash advance check in the mails from my credit card companies. I almost always shred them but decided to cash out some money before the cash completely "dried up". I decided to cash out a large sum from JP Morgan Chase. I got immediate approval and pulled money into my checking account with 0% APR for nine months. During the height of 700 billion bail out plan negotiation in the capitol hills, I pulled out another sum from BofA credit card with 0% APR for a year!!! Now that we established that banks still lend to credit worthy customers (I have a FICO score north of 700 but I am an average middle class person who is among 95% of Americans who will get tax cut under president Obama), let us explore what is happening at the home mortgage business which is the root cause of the current mess. My friend in LA just got funding for home purchase with less than 20% down payment and a 30-year fixed loan at 6.5%. Not bad in the days of credit freeze. He too probably has a good FICO score. What about small business owners? I know a gas station owner who got a large loan albeit large amount of paper work. But the point is that banks do have cash and they are still lending to credit worthy customers. They are not lending to each other probably because they are protecting their cash from one another just like the kids protecting their favorite toys from their friends afraid that they might break it! But when the price is right, they will lend again. How long they can hunker down with the cash without doing their primary business of lending?

Now that bailout plan got a second life in Congress, you would think Banks will start lending more freely? Absolutely not, at least for next few years. Once bitten, twice shy! They will hoard all that cash until next batch of whiz kids from HBS (Harward Business School) come up with innovative things they can trade. It will neither be dot com nor CDOs. But it will be some thing quite mind bending stuff. More complex and logic defying than CDOs and CDSs. According to some reports, the wealth of world's High Net Worth Individuals is in excess of 40 trillion dollars! They not only need a place to park their cash but investments that they can buy and sell for a profit. An American, even with a FICO score below 600, is a better borrower than any one else in the world. Because only in America, you will see a bailout package of this scope and ramification gets introduced to the law makers, gets debated, gets defeated after angry calls to Congressman's office and then finally getting passed after local business owners call and plead and president signs into law within hours of House adopting the motion. All in a matter of a fortnight! Americans have the audacity to do mind bending, logic defying stuff. Be it dot com or it Subprime or borrowing almost a trillion dollar more to pay off some bad loans. That too when the treasury is running half a trillion deficit already. And the world wonder in amazement in her triumphs and tribulations and buy her treasury bills like a clock work. I love this country :)

The Credit Cruch:Where Is It Happening? TIME article

My previous post on 'Defending Subprime lending - case for democratic economy'


Asish said...

I think your experience with two different banks are very telling. The banks now regard lending to other banks more risky than lending to Main Street. That is what I guess is happening. This $700 billion bail out plan is nothing but helicopter money that Fed just injected to the market from air and hoped banks would come and collect. This is, for sure, not happening any time soon.

Here is an interesting data on US bank loans.

The bottom line is the bleeding US economy was heading for a great depression and now after spending $700 billion (soon) tax payers money we are in a global recession. That is imminent.

Sree said...


I was very reluctant to write this article fearing that it might sound like totally moronic. But the Forbes article really assured me that every one in the government and press are crying wolf! I was amazed how much money the banks were willing to give me in the middle of the "credit-freeze", a whopping $40,000 on two separate credit cards! And as you know I am an ordinary white collar worker.

Bank Loans Have Not 'Dried Up' - Forbes Article


Tom said...

since I'm officially part of the bail out package and since you are using me to support your story; i expect to be paid for this.

- Tom