Peter Pays Paul

During my morning reading two articles in the Wall Street Journal stood out to me and indicated that credit is not flowing the way that it had in the recent past.

I believe that this is a sign that the economy is deleveraging itself. We are likely in for a period of economic deflation followed by a period of inflation due to the governments massive printing of money.

First, this article regarding asset backed bond woes. These asset backed bonds are car loans, credit card loans, student loans, etc. wrapped up into bundles and sold to investors as a rated bond.

In October, only one deal of $500 million was sold, compared with $50.7 billion done the year before. That is a huge decline and means that far fewer consumer loans are being made. We should see a drop in consumer discretionary spending in the coming months.

Second, this article highlighting the rise in requests for trade financing to boutique firms. These boutique firms are thriving with the slow down in lending from banks.

One of the difficulties is that “They have no guarantee that the buyer’s bank will accept the seller bank’s credit because of solvency issues…”

Currently, banks don’t trust one another and do not want to lend to one another.

Government Intervention’s Role

I believe that the government’s intervention has added to the problems.

The Fed began the term auction facility in December of 2007. This allowed banks to borrow from the Fed without other banks knowing who was borrowing. Borrowing from the Fed in the past had been seen as a last resort and a cause for concern to other banks. With transparency removed, banks become distrustful of one another and slowed interbank lending.

I mentioned here that banks are lining up to get TARP funds because they don’t want to have a negative public opinion, and not necessarily because they need or want the funds.

Until the government takes a “hands off” role to the current financial system, there will be fear, mistrust, and hesitancy that will prolong the economic downturn rather aid it.

When governments intervene into private contracts it has long-term unintended consequences, and usually they are negative.

Read a blurb regarding the research from the St. Louis Fed on the downside of a moratorium on foreclosures.

Governments cause both immediate and long-term effects when they rewrite the terms of contracts between private parties, Wheelock argueded. “Although the economic and societal benefits of lower foreclosure rates are difficult to measure,” he said, “research shows that the foreclosure moratoria of the Great Depression imposed costs on future borrowers.”

Future borrowers were faced, according to the analysis and cited studies, with a restricted supply of loans and sky-high interest rates, because lenders needed to compensate for the possibility that their right to foreclose on delinquent loans would be constrained. Under the nation’s current turmoil, policymakers are scrambling to enact similar regulations as were made during the great depression, in order to limit the highest foreclosure rates since (what else?) the Great Depression.

Here is the link to the HousingWire.com article.
History Warns Against Foreclosure Moratoria: Study : HousingWire.

Here is a link to the St. Louis Fed report.

Update (HT: Tom Vanderwell)

The WSJ.com is reporting that the banking bailout is luring thousands of banks to apply for some of the $700 billion the government is handing out.

Why are the banks lining up for the funds?

Now institutions across the U.S. worry that if they don’t try for the money, the market will judge them as too unhealthy to qualify, or lacking the savvy to deploy cheap government capital on acquisitions and investments.

Is this what the government had in mind when they intervened in the banking system?

Rescue Cash Lures Thousands of Banks – WSJ.com.

Through the use of a clever experiment with a skating rink, John Stossel argues the faults of central planning.