2007 November 30 Friday
Some Measures Of Credit Down In US

Some forms of credit are shrinking.

The combined value of two leading sources of credit outstanding commercial and industrial bank loans, and short-term loans known as commercial paper peaked at about $3.3 trillion in August, according to data from the Federal Reserve. By mid-November, such credit was down to $3 trillion, a drop of nearly 9 percent.

Not once in the years since the Fed began tracking such numbers in 1973 has this artery of finance constricted so rapidly. Smaller declines preceded three recessions going back to 1975; at other times such declines tended to occur in conjunction with an economic downturn.

Credit contraction increases the odds of a recession.

Mortgage payments are falling behind.

Moody's U.S. Home Equity Index Composite showed that the rate of loans at least 60 days past due or that entered the foreclosure process was 16.53 percent in September.

That's more than double the 7.93 percent rate a year earlier, and more than triple the 4.99 percent level in June 2005. The rate was 15.23 percent in August.

Henry Paulson is trying to keep Humpty Dumpty from falling apart. I hope he succeeds.

Treasury Secretary Henry Paulson is scheduled to make remarks on housing Monday, though it is unclear whether a deal could be in place by then.

Regulators have been grappling all year with how to stem the record wave of foreclosures, caused in large part by rising monthly requirements on subprime adjustable rate mortgages, or ARMs. Regulators and industry officials are focusing in on a plan that would possibly make it much easier to extend starter rates on certain existing ARMs for five to seven years, the people familiar with the matter said.

This would be aimed at borrowers who are living in their homes, not on speculators and investors. And policy makers are trying to figure out a way to do it broadly to expedite the slowed case-by-case loan modification process.

The credit instruments built up to sell packages of mortgages make renegotiation of credit terms really difficult. That pushes more people into default than ought to be necessary. Paulson and some banks are trying to come up with ways to make renegotiation of terms easier to do so that fewer people give up trying to pay their mortgages.

Fed Vice Chairman Donald Kohn says that we need to prevent some people from paying the full costs of bad lending decisions.

"To be sure, lowering interest rates to keep the economy on an even keel when adverse financial market developments occur will reduce the penalty incurred by some people who exercised poor judgment," he said in a speech at the Council on Foreign Relations. "But these people are still bearing the costs of their decisions and we should not hold the economy hostage to teach a small segment of the population a lesson."

There is a moral hazard problem here. If people don't pay the full cost of their mistakes then they will make more mistakes and live more recklessly. On the other hand, we don't want the markets to build up so much fear that a stampede away from risks becomes a vicious cycle where each pull-back reduces economic activity so much that successively more businesses fail and lenders become so risk averse that all lending stops. A depression is one character building experience that I'd just as soon do without.

Share |      By Randall Parker at 2007 November 30 12:22 AM  Economics Business Cycle

Wolf-Dog said at November 30, 2007 2:40 PM:

MOST of the ones "who made mistakes" and got ruined were (and will be) from the middle class.

The housing boom that materialized after the 2000-2002 bear market, was helped not only by lower interest rates, but also by the enormous government deficit spending (at least half the government deficit spending is given to the lower and middle class people in the form of various allowances). The middle class was thus lured into accepting these innocent-looking mortgages.

But the MAIN point is that in this case, the money that was "lost" has not vanished, it merely got transferred to the bank accounts of those who built the new houses and those who sold the houses at much higher prices. Thus even after millions of people are ruined, a happy majority will end up with a huge amount of cash as net profits in their bank accounts. This was a transfer of wealth.

Wolf-Dog said at November 30, 2007 2:42 PM:

Sorry for the typographical error: Instead of "happy majority", I should have written "happy minority."

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