'Crunch' time for the Grand Old Party in US
Lending hasn't collapsed in part because the subprime losses, though large in billions, are still small compared with the financial system's total capital.
By Robert J Samuelson, |
WASHINGTON: Don’t believe all the hype about the ‘credit crunch’. Not yet, anyway. It’s supposedly suffocating the economy. True, big banks and investment houses have suffered multibillion-dollar losses on ‘subprime’ mortgages and related securities.
But except for housing — where lending has collapsed — the effects on consumers and businesses have so far been modest. Should they get worse, however, the ‘crunch’ wouldn’t be just about economics. It could decide the next president. People vote their pocketbooks. Up to a point, this is unfortunate, because politicians of both parties usually get too much praise or blame for the economy, when their influence on its behaviour is often negligible.
But politics isn’t always rational or fair, and a slowing economy is already a burden that — along with Iraq — Republicans will carry into the election. Consider the latest economic outlook from the forecasting firm Global Insight. Though not yet predicting a recession, it sketches an economy that won’t feel good for much of the 2008 election cycle:
But except for housing — where lending has collapsed — the effects on consumers and businesses have so far been modest. Should they get worse, however, the ‘crunch’ wouldn’t be just about economics. It could decide the next president. People vote their pocketbooks. Up to a point, this is unfortunate, because politicians of both parties usually get too much praise or blame for the economy, when their influence on its behaviour is often negligible.
But politics isn’t always rational or fair, and a slowing economy is already a burden that — along with Iraq — Republicans will carry into the election. Consider the latest economic outlook from the forecasting firm Global Insight. Though not yet predicting a recession, it sketches an economy that won’t feel good for much of the 2008 election cycle:
• Housing’s slide continues. New home starts fall to 1 million, down from 2.1 million in 2005. By early 2009, home prices decline a cumulative 11% from their peak. On a median-priced home of $220,000, the loss is $24,000.
• Car and light-truck sales dip to 15.7 million, the lowest since 1998; they were 16.9 million as recently as 2005.
• Unemployment averages 5%, up from 4.6% this year.
• Pretax corporate profits decline 2.1%, the first decrease since 2001.
Moreover, Global Insight thinks there’s a 35% chance that the slowdown might become a recession. Two threats loom. One is oil. The forecast assumes that prices will fall from about $90 a barrel now to $76 in 2008. Every $10 above that is reckoned to raise gasoline prices 19 cents a gallon and cut employment by 1,00,000. The second threat is an aggravated credit crunch.
What we call ‘crunch’ is merely a new label for the old credit cycle. In a strong economy, people think they can handle more debt. Lenders relax credit standards. Sooner or later, the process reverses. Heavy debt payments oppress borrowers. Lenders react to rising delinquencies by tightening lending. Housing’s recent boom-and-bust cycle conforms perfectly to this script. But elsewhere, lending proceeds. Other consumer debt (credit cards, auto loans, personal loans) is growing at about a 5% annual rate, says Susan Sterne of Economic Analysis Associates. Although corporate bond issuance has declined, the main consequence seems to have been a drop in mergers, acquisitions and private-equity buyouts. These have relied heavily on bonds for financing. As yet, business investment in new machinery, software and buildings seems barely affected.
Lending hasn’t collapsed in part because the subprime losses, though large in billions, are still small compared with the financial system’s total capital. Brian Bethune of Global Insight figures that American investors have so far lost $50 billion. By contrast, stockholders’ equity in the US banks alone exceeds $1 trillion. Still, the crunch is the first major crisis for a new financial system that has taken shape slowly since 1980. Loans that were once made and held by banks are now increasingly ‘securitised’. That is, they’re bundled into bondlike financial instruments and resold to other investors (pension funds, hedge funds, other banks).
Two major problems have emerged. First, because banks and other loan ‘originators’ didn’t keep all the loans they made — and earned fees for making the loans — they got careless and greedy. They relaxed credit standards; weak borrowers got mortgages or were persuaded unwisely to refinance existing mortgages for higher amounts. Second, some of the securities into which the mortgages were packaged were so complex that the people selling and buying them didn’t understand, with hindsight anyway, what they were doing. As a result, it’s hard to determine the securities’ value.
The spectre of the subprime debacle is that it’s just a start. Huge amounts of auto loans, credit-card debt, commercial mortgages and equipment leases have also been securitised. If similar problems emerged, it would shake confidence in the securitisation model and, by magnifying investors’ losses, threaten to turn the credit crunch from a slogan into a reality. A broader crisis, though a long shot, can’t be excluded.
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All of which brings us back to politics. Global Insight has one of many computer models that calibrate voting behaviour with the economy’s performance. The model has picked the winner of the popular vote in 13 of the last 15 presidential elections (it missed 1968 and 1976). Right now, the Republican and Democratic candidates are, putting Iraq aside, dead even. A deeper credit crunch would swing the advantage to the Democrat. Ironically, while all the candidates are fighting frantically for their parties’ nomination, the financial markets may be quietly determining the ultimate victor.(c) 2007, The Washington Post Writers Group
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