Crunch This

Wed, 01 Oct 2008 14:14:26 +0000

I'd like to put down a marker that not all reductions in the supply of credit should qualify as a credit crunch. A credit crunch occurs when a large number of borrowers cannot get a loan at any interest rate. What we are seeing is that interest rates on borrowing are increasing and some financial institutions are looking to lend in smaller quantitites than previously.

Maybe those using the reduction in the supply of credit to push large bailout plans haven't been keeping up on current events, but higher interest rates and less borrowing are exactly what we need. It would have been better to get them sooner rather than later, but most of what we are seeing is just the more prudent lending policies that should have been in place all along.

Consider some excerpts from a good article in Time from Tuesday. What part of this is supposed to be a credit crunch?

Just ask anyone who wants to buy a house with a subprime mortgage — they're not all evil, but these days they are exceedingly rare — or with a jumbo loan, which now carries an average rate 1.2 percentage points above a regular mortgage. (In normal times, the spread is closer to a quarter of a percentage point.)

So what? There's a higher premium for risk. Mortgage rates are still quite low by historical standards, and we didn't refer to those periods as a crunch. Another excerpt:

Now, about those credit card offers. You may not feel it, but there are fewer of them going out — 1.1 million during the second quarter, down 17% from the same time last year, according to Synovate, a research firm that tracks direct mail. Who's being ignored? Well, subprime borrowers (no surprise there), but also anyone who doesn't make a lot of money: 52% of households with an annual income of less than $50,000 received at least one offer in the second quarter, compared with 66% of such households during the same period last year.

Is there anyone who thinks that we should have more of those ridiculous credit card offers going out? Or that low-income households or subprime borrowers should be getting more of them? This looks like sensible policy to me. Risk needs to be priced. That it might be temporarily priced too high seems like a small problem compared to the damage done over a period of years when it was priced too low.

An actuarially fair increase in the FDIC limits makes sense -- $100k is a bit low for a reasonably sized business managing its accounts at a single bank. But the capital to shore up the banking system ought to come from investors, not bailouts. The price of risk will fall over time as the true magnitudes of risk become better known.