Wednesday, March 19, 2008

Can't get a loan? You're not alone

Can't get a loan? Don't worry, you're in good company. Neither can anyone else, and that's including some top-shelf investment funds and financial institutions. Today we'll continue to examine why this is so.


In our last post, "Money is cheap and unavailable", we highlighted comments from investor Wilbur Ross on the current availability of money and credit. In a recent interview with the Wall Street Journal, Ross noted the following:

"Usually when money is cheap, it's also very, it's cheap, except you can't get it".

It's an odd situation, and it led me to wonder how such a disparity came about. Was money being priced too cheaply as a result of artificial forces? If there is demand for money and credit, yet little availabilty, wouldn't that suggest high prices for access to credit?

Higher Rates, Nervous Lenders

Well, it turns out that banks are now charging higher rates to individuals seeking loans for new homes or for refinancing their mortgages, in spite of the latest Fed rate cuts.

Meanwhile, the recent credit crunch has also proved disastrous for mortgage lenders, hedge funds, and private equity firms, all of whom depend on short-term loans to drive their business models.

Washington Post columnist, Steven Pearlstein explains:

"The underlying problem is that, over the past 20 years, we've allowed the process of credit creation to be shifted from banks, which are regulated and required to keep a minimum capital cushion, to largely unregulated securities markets with no limits on the amount of leverage they take on.

Like banks, these markets borrow short and lend long, which creates profit margins but makes them vulnerable to an old-fashioned bank run if that short-term capital suddenly dries up. The first victims in such a scenario run the gamut from mortgage lenders like New Century and Countrywide, hedge funds such as Peloton Partners and Carlyle Capital and even venerable investment banks like Bear Stearns."

Following the rapid decline of blue-chip investment firms like Carlyle Capital and Bear Stearns, banks are now especially wary of any exposure they might to highly leveraged firms holding large amounts of illiquid and opaquely priced assets. Carlyle Capital was forced into insolvency after the value of their securities were called into question, and the firm was hit by a round of margin calls from nervous lenders.

A Lender's Strike

Dow Theory Letters editor, Richard Russell recently labeled the situation a, "lender's strike". While the Fed is trying to create a renewed environment of easy money and low interest rates, banks and the private sector, fearing for their very survival, refuse to make new loans.

At least that's the message I seem to be getting from some of the more seasoned observers, like investor Marc Faber, who recently offered a similar view in an interview with CNBC. Here's how Faber explained the recent money conditions:

"The Fed is pumping money into the system, and other central banks will do the same. But the private sector is tightening credit conditions, and as a result of that we have a relative illiquidity in the world that, in my opinion, will affect all asset markets..."

So in Faber's view, the Federal Reserve is trying to bring about continued liquidity and easy money conditions in an effort to keep things going, while the private sector is resisting these attempts. Clearly, the priority for private firms is a focus on survival and retrenchment, rather than expanding their business at this time.

What Started This Mess?

You might also be interested to hear Marc's views on the origins of this current financial crisis.

In short, Faber feels that the Fed's pursuit of easy monetary policies in the past fostered the growth of a gigantic credit bubble, and brought about the increased leverage in the financial system which led to many of the recent problems.

He also notes that the current financial crisis is "yesterday's story", and that we are now in a painful process of deleveraging, during which investors should focus on "other potential areas of danger" that could hit asset prices.

So, having covered all of that, we'll end here for now.

Join us tomorrow when we serve up a little break from the markets, and remember to stop in on Friday for our latest, "Features of the week". We hope to see you then.