On Frozen Credit Markets

by Don Boudreaux on October 1, 2008

in Current Affairs, Financial Markets, Myths and Fallacies

I can’t count the number of times I’ve heard in the past few days that credit markets are now frozen in America.  Such a ‘freeze’ allegedly is a main reason justifying Uncle Sam’s longed-for bailout of Wall Street.

Well, some tropical sun must be hitting at least a small part of the credit market, for yesterday’s mail brought to my son, Thomas, an offer of a credit card from American Express.

Thomas is eleven.  And while his credit is pretty good with his mother and me, I’m very impressed that he’s managed to establish his credit creds so firmly with a company that, if there’s truth in today’s told tale, has scant amounts money to lend.

In looking over this offer of credit to my pre-pubescent son, I see that Thomas Macaulay Boudreaux’s qualifications for this generous offer seem to be the fact that he has a mailing address and a frequent-flyer number with a major airline.

Geez, I can only imagine what sorts of offers of credit will flood in to Thomas if and when Uncle Sam thoroughly thaws the credit markets with a bailout.

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{ 38 comments }

Martin Brock October 1, 2008 at 7:08 am

Pre-pubescent?! Daaaad!

vidyohs October 1, 2008 at 7:13 am

I don't know how response to the failed vote on the bailout was played in other cities, but here in Houston the Chronicle bannered the news as "HOUSE REJECTS BAILOUT; DOW PLUNGES 777.68 With stunning vote comes historic point loss, promise to reconvene Thursday"…….with no mention of the almost immediate rebound in the market of 349(?) points.

But, of course there is no unified effort to scare the crap out of the American people by reporting disaster. Uh-uh, not happening.

tarran October 1, 2008 at 7:41 am

If Congressional leaders are serious about unfreezing credit markets, they should announce, this morning, as early as possible, that there isn't going to be a bail out.

Financial institutions don't know which way the wind is going to blow. Steps that would be prudent under one scenario are unprofitable or highly sub-optimal under others. So they wait until they see which way the chips are going to fall.

An immediate announcement would end the uncertainty and allow all economic actors to start working on ending their losses and returning themselves to profitability. Defunct firms would more quickly go into bankruptcy, allowing sales of their assets to firms with profitable plans.

If the Senate passes its bailout bill today, and another bill is introduced in the House, and it eventually is passed, you will still have negotiations in the Conference committee. This can go one for weeks. The end result prolonged uncertainty, and people sitting on their money, which is the phenomenon described by a frozen market. Quod erat demonstrandum.

dave smith October 1, 2008 at 8:07 am

Good point. I, too, have been continuously flooded with credit card applications.

This certainly contradicts the notion that credit will be frozen, ie, non existent.

A fellow professor thinks by the end of the week no one will be able to use their cards, let alone get a new one, she thinks that no one will be able to get a car or any other type of loan. (That is unless the gov't acts.) I doubt it.

Randy October 1, 2008 at 8:38 am

I think its reasonable to believe that credit will tighten. Good. It should. But a "freeze"? That's just scare talk.

muirgeo October 1, 2008 at 8:39 am

"Credit is a system whereby a person who can't pay gets another person who can't pay to guarantee that he can pay."

Charles Dickens

Martin Brock October 1, 2008 at 8:42 am

I've seen the following spin on recent events repeatedly.

"Stocks were poised to fall Wednesday as the Senate prepared to vote on a tweaked version of the $700 billion bailout bill.

Nasdaq and S&P futures were down at 7:30 a.m. ET, a sign that stocks would fall at the market open.

This follows a tremendous Tuesday on Wall Street, which saw the Dow Jones industrial average jump 485 points, or 4.7%, on hopes for a new bailout package."

So a rise following defeat signals "hopes for a new bailout". A fall preceding a second bailout vote signals pessimism that the bailout will pass.

Yet when I look at particular stocks, I see banks with more subprime exposure falling and banks with less exposure rising.

Methinks October 1, 2008 at 9:01 am

Credit cards aren't the credit they're talking about. Credit spreads on such revolving credit wasn't under as much pressure as credit spreads on illiquid assets.

Notice how interbank lending completely froze when the bailout was announced. Why take the risk, when government is about force taxpayers to take it for you? A letter in the WSJ this morning put it best: This is like the government breaking your leg, giving you a crutch and claiming that you wouldn't be able to walk at all were it not for government.

muirgeo October 1, 2008 at 9:10 am

Look at the interest rate on those cards. The predators are desperate and are hoping to turn some low interest loans from the treasury into cash pulled from the pockets of desperate and stupid consumers.

Back in the good old days we had usury laws that prevented this form of financial predation. Not now.. in the era of Friedmanism.

Now they are stealing from desperate students needing loans and even offering advances on pay checks with interest rates as high as 100% or more. Of course they lobbied for protection for themselves and received it in the form of the bankruptcy bill.

My goal is to stop using credit cards as well. Even if you pay them off they charge interchange fees of 1-6% to merchants forced to accept them. Everyone pays those fees just like an additional sales tax the merchant passes on to you.

If everyone stopped using credit cards and used local Credit unions people could take away a lot of power from he Wall Street pirates.

mbainter October 1, 2008 at 9:30 am

I can do you one better. Yesterday I got a call from wellsfargo and the guy was literally begging me to take credit. It went something like this:

Him: "do you need any financial help"
Me: I don't think so…why, whatve you heard?"
Him: "can we consolidate some debt for you?"
Me: "no thanks, I don't have enough to make it worth it."
"Need any credit cards?"
"No, we don't use credit cards."
"How about cash?"
"No – no we're good"
"Anything at all we can help you with?"
"No…I'm good thanks."

Yeah the credit is REALLY tight right now.

Don Boudreaux October 1, 2008 at 9:49 am

Muirgeo,

Someone offering me a deal is not a predator. If I don't like the offered terms, I simply refuse the deal.

A real predator is someone who threatens violence against me if I do not do as he or she commands. Uncle Sam, for example, is a predator. If I do not pay the taxes he demands me to pay, he will use force to imprison me and/or confiscate my assets.

By the way, I have long had the habit of paying off all of my credit-card bills in full each month. I pay NO interest for the one-, two-, three-, and four-week-long extensions of credit that my card issuers extend to me each month. (Hey, perhaps — on Muirgeo's understanding of the term — the "predator" here is ME!)

Speedmaster October 1, 2008 at 10:31 am

I'm starting to believe that much of the alleged credit freeze is Wall Street firms sitting on their hands waiting to see how much they can get from a bailout.

Randy October 1, 2008 at 10:42 am

Don saved me a post… well, maybe not…

Muirgeo,

Why should your "desperate" student be asking for a loan? And why should anyone give it to them? The ability to borrow money is something that has to be earned, and the average student hasn't earned crap. Now if your student can show me a 3.5+ GPA after a couple of years of study in something useful like Engineering or Business, I can see how a lender might find that deserving (sorry, no doctors or nurses, Obama is about to nationalize them). But just being a student? No way. And certainly not a "desperate" student.

Keith October 1, 2008 at 10:59 am

Quote from muirgeo: "If everyone stopped using credit cards and used local Credit unions people could take away a lot of power from he Wall Street pirates."

You should call your socialist buddies and get that passed into law. It's only for our own good.

Maybe you could get them to pass laws on exercise and healthy eating, too. Then maybe you could set standards on how we should wipe our butts.

Current October 1, 2008 at 11:07 am

Muirgeo: "Look at the interest rate on those cards. The predators are desperate and are hoping to turn some low interest loans from the treasury into cash pulled from the pockets of desperate and stupid consumers."
As Don says customers are not stupid. They can take a deal or leave it. If you consider that customers are stupid and that you can reliably think for them then you disagree with freedom entirely, except your own.

"Back in the good old days we had usury laws that prevented this form of financial predation. Not now.. in the era of Friedmanism."
Consider a "desperate" person in those good old days. Would they get charged a lower interest rate? Of course not, they would simply not be able to find credit. Usury laws simply prevent legal trade in debt above a certain interest rate. They are a ban on lending to people who are in the worst of situations, a ban on lending to those who need it most.

"Now they are stealing from desperate students needing loans and even offering advances on pay checks with interest rates as high as 100% or more."
Students and others though will only take such deals if they are in their interest. To seek to eliminate them is to seek to remove choice from those who need it most.

A man who gets paid 100$ next week and has nothing currently is badly off. A similar man who cannot borrow to cover that period because of government prohibitions is worse off.

"Of course they lobbied for protection for themselves and received it in the form of the bankruptcy bill."
Fair point

"My goal is to stop using credit cards as well. Even if you pay them off they charge interchange fees of 1-6% to merchants forced to accept them. Everyone pays those fees just like an additional sales tax the merchant passes on to you."
Why in that case to merchants charge people who pay in cash the same as those who pay with credit cards? The reason is because there are costs in using both. The credit card companies charge a fee for their services, that is entirely reasonable. Do you think they could give the service away for free?

"If everyone stopped using credit cards and used local Credit unions people could take away a lot of power from he Wall Street pirates."
Sure, but they would lose the benefits of convience that credit cards come with.

colson October 1, 2008 at 11:09 am

muirgeo:

The interbank rates have been pretty low for quite a few years. The problem with usury laws is they tend to forget that interest is in loans is usually a function of risk.

Of course, this doesn't stop some lenders from pursuing clients with better credit by offering junk cards. The cool thing is that no one is showing up with a gun to your head to make you accept them. It's hard to call it predation when the predator needs your permission to eat you.

Credit unions are not the solution. They tend to be banks under the guise of being "non-profit". But, like most banks, they rely on the same services of banking institutions. They rely on interest rates as well. Don't get me wrong on this: I like credit unions and believe they add a unique competitive force in the marketplace. I just don't believe the differentiation is as great as you make it out to be.

While you are right in how the credit card brands charge fees to merchants, much of this fee is already calculated into the cost. The benefits are two fold: it makes it easy to conduct a transaction from almost anywhere in the world and it gives consumers added leverage in how they utilize their cash flow. Of course this comes at a cost. What you don't realize is that as technology has evolved, so have the options available to merchants.

In some cases, a processor has the ability to detect a card type as a debit Visa/MC/Amex card and will charge it as a pin-less debit transaction lowering the fees even further. Most banks have stopped charging foreign ATM charges on debit purchases anyway. There's no reason you can't ask your processor for the same type of service.

You also have to thank your consumer rights regulations for the fees charged. Because of the nature of the transactions, credit cards carry a significant burden of regulation with a heavy dose of preference on the consumer's side.

There will always be costs involved; as anyone here will tell you: "there ain't no such thing as a free lunch"

If you really want to make a difference, you could start at:

http://www.fedpartnership.gov/

Open your own bank and conduct your business how you see fit. It's surprisingly detailed – more so than most "start-up" guides I've read at book stores.

Damian October 1, 2008 at 11:30 am

I would like to know one thing about credit markets now. If some banks here fail, is it not that much more of an opportunity for international and other local banks? Why wouldn't they jump at the chance to succeed where their competitors failed and offer credit if indeed "credit is frozen"?

If this is the case, why is the bailout necessary? If not, why not? What is it that these failing banks do that is so important that no one else can do?

Flambeaux October 1, 2008 at 11:49 am

Damian,

Pay off politicians, and give their kids jobs.

DKH October 1, 2008 at 12:05 pm

Current,

I agree that there are costs to using money rather than credit cards, and with other points you raise.

However, the Coyote Blog has some commentary on credit card fees vs. debit fees and so on:

http://www.coyoteblog.com/coyote_blog/2005/09/atm_cards_more_.html

I agree with your points; just thought that his commentary would help add more perspective.

John Turner October 1, 2008 at 12:05 pm

I defer to Frederic Bastiat:

However, the credit organizations would have to do just this in order for the end of the social reformers to be attained, since these gentlemen aspire to nothing less than to give plows, houses, tools, provisions, and raw materials to everyone who wants them.

And how do they imagine they will do this?

By giving to loans the guarantee of the state.

Let us go more deeply into the matter, for there is something here that is seen and something that is not seen. Let us try to see both.

Suppose that there is only one plow in the world and that two farmers want it.
Peter is the owner of the only plow available in France. John and James wish to borrow it. John, with his honesty, his property, and his good name, offers guarantees. One believes in him; he has credit. James does not inspire confidence or at any rate seems less reliable. Naturally, Peter lends his plow to John.

But now, under socialist inspiration, the state intervenes and says to Peter: "Lend your plow to James. We will guarantee you reimbursement, and this guarantee is worth more than John's, for he is the only one responsible for himself, and we, though it is true we have nothing, dispose of the wealth of all the taxpayers; if necessary, we will pay back the principal and the interest with their money."

So Peter lends his plow to James; this is what is seen.

And the socialists congratulate themselves, saying, "See how our plan has succeeded. Thanks to the intervention of the state, poor James has a plow. He no longer has to spade by hand; he is on the way to making his fortune. It is a benefit for him and a profit for the nation as a whole."

Oh no, gentlemen, it is not a profit for the nation, for here is what is not seen.

It is not seen that the plow goes to James because it did not go to John.

It is not seen that if James pushes a plow instead of spading, John will be reduced to spading instead of plowing.

Consequently, what one would like to think of as an additional loan is only the reallocation of a loan.

Furthermore, it is not seen that this reallocation involves two profound injustices: injustice to John, who, after having merited and won credit by his honesty and his energy, sees himself deprived; injustice to the taxpayers, obligated to pay a debt that does not concern them.

Current October 1, 2008 at 12:31 pm

"http://www.coyoteblog.com/coyote_blog/2005/09/atm_cards_more_.html

I agree with your points; just thought that his commentary would help add more perspective."

It's a fair point. This system of charges isn't the same in every country. I expect it will change in the US.

John Smith October 1, 2008 at 2:41 pm

Thanks for sharing “Coyote Blog” link. Very interesting reading.

Oil Shock October 1, 2008 at 2:57 pm

Just closing the italics

Sam Grove October 1, 2008 at 3:17 pm

2 demerits to Current for failure to close italics.

Use preview.

Crusader October 1, 2008 at 3:35 pm

Closing italics first.

Second, there is a difference between using credit as 30-day loans that are always paid back in full and living on credit to the point that you only make the minimum payments with interest. The former will get uninterrupted flow, while the latter will be shut off shortly.

Dan October 1, 2008 at 3:51 pm

Don,

The credit card market is not the problem here. Take a look at the commercial paper market. CP, which normally has a life of 270 days, was reduced to one day for AT&T.
http://biz.yahoo.com/paidcontent/081001/3_328145_id.html?.v=1

Look at the LIBOR spread. Look at the 3 month t-bill rates. The market that everyone is crowing for doesn't exist for these securities.

I don't doubt that the free market can fix the problem. The question is: Are we willing to let the market cause a run of the bank that we haven't seen since the 1930s? How much wealth should be destroyed to cure a problem that the government created*?

* I blame a majority of the mortgage mess on the GSEs with help from Barney Frank and Chris Dodd.

Oil Shock October 1, 2008 at 3:59 pm

Money and Credit are claims on real wealth and real consumption. Money by itself is not wealth. Destruction of Pyramid credit doesn't cause real wealth to disappear. It sure can cause disruptions that could lead to wealth destruction. So the wealth destruction argument is ruse. If supply of credit falls and all prices are allowed to adjust with it, there will be no destruction in real wealth.

Crusader October 1, 2008 at 7:19 pm

Oil Shock:

Real wealth:

* natural resources
* intelligence
* Knowledge
* health
* ability to organize people
* physical assets(buildings, materials)

In the absence of electronic currency, those that can harness the "real wealth" characteristics best will be the new overlords.

Sam Grove October 1, 2008 at 7:29 pm

I have come to think that real wealth is the ability to produce.

vidyohs October 1, 2008 at 8:29 pm

Sam, That is precisely correct and that is exactly what backs your FRNs.

Methinks October 1, 2008 at 9:34 pm

Sam, I have to agree with you.

The extension of credit is simply a bet on the borrower's ability to produce in the future. Given the sad descent into socialism, I doubt very much that lenders will be more willing to lend more freely than they are now as forecasts for future production are coming down.

Dennis Cardinale October 1, 2008 at 11:28 pm

Sad to say the credit freeze is real.
New car dealers -after years of lendig institutions overly-loose policies- are now swinging the pendulum too far in the opposite direction and are refusing credit to worthy borrower's!
See todays related stories on the downturn in the ato markets, even mighty Toyota down 37%.
If mortgage lenders had put in place sensible downpayment parameters, this whole thing could have been avoided. The percentage of forclosures on properties with 20% down ( a historic standard) are almost nill.

Randy October 2, 2008 at 9:44 am

Dennis,

But much of the reason that new cars cost so much is the availability of easy credit. Tighten up the credit market and we end up with cars that people can afford – and houses that people can afford. Tighter credit does mean that things are going to change, but that's not necessarily a bad thing.

Randy October 2, 2008 at 9:48 am

Sam Grove,

"I have come to think that real wealth is the ability to produce."

Minor correction… The ability to produce something of value.

Hammer October 2, 2008 at 9:59 am

Excellent news… I have been wanting to buy a 2005 Tacoma, but haven't been willing to pay the silly prices for them. Perhaps a big slump in credit will make my 14K$ in cash seem more appealing! :)

Sam Grove October 2, 2008 at 11:47 am

Minor correction… The ability to produce something of value.

I think that's implied. If one produces something of no value, then they have wasted resources.

Randy October 2, 2008 at 12:18 pm

Sam Grove,

I suspected as much and was pretty certain I was wasting a post. But its an import implication that the left often forgets with its labor theory of value.

Methinks October 3, 2008 at 9:30 am

But its an import implication that the left often forgets with its labor theory of value.

You're right, it's a wasted post. For those who understand this, it goes without saying. The Muidiots of the world will never get it.

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