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The Big Picture
Wall Street Problems are Real, but This is Not a Credit Crunch
Last Update: 13-Aug-07 08:18 ET
The credit markets are experiencing liquidity problems. These are real and of serious concern to the financial markets. There is no evidence yet, however, of a credit crunch that would impact the overall economy. So long as this remains the case, a crash in stock prices is unlikely.
The Current Problems
There are many financial debt instruments that have been backed by subprime mortgages. These securities are in trouble. As subprime and other mortgage loans go bad, the payments to these debt instruments evaporate. The value of these securities plummets, and the value can be hard to determine because the degree of non-payment on the original mortgages is hard to assess. Sometimes these securities are in hedge funds or other investment portfolios that then drop in value as the mortgage-backed securities drop in value.
That is what happened last week when BNP Paribas Investment Partners halted payments from some of its hedge funds. BNP did not say that the funds were illiquid. They simply could not value the mortgage assets accurately enough to properly pay redemption requests.
There are also many other funds on Wall Street that are in trouble as a result of a decline in the value of mortgage backed securities held. The loss of value in these funds is a definite risk to many financial companies.
The primary problem however, apart from the loss of value on the mortgage-backed assets, is that liquidity problems have developed. There are few buyers for the mortgage-backed assets because the price is hard to determine. The instruments are not liquid.
The Fed stepped in to the market last week to help with this problem. It did repurchase (repo) agreements with banks in which it in effect lent money to the banks. The Fed accepted mortgage-backed assets as collateral, creating temporary liquidity for the instruments. (Technically, the operation is a 3-day repurchase, in which the Fed buys the instruments and sells them back three days later, but it serves in effect as a loan using the instruments as collateral).
This temporary easing of the liquidity problem was an attempt to help the markets settle down, overcome fears, and allow market mechanisms time to again provide liquidity. The Fed's primary function as a central bank is to provide a smoothly operating financial system, and they will continue to do this as long as necessary.
The Problems Spread - Somewhat
The liquidity problems on Wall Street can be considered problems in the "financial economy." These problems have had some modest impact on the broader economy, but the impact so far is extremely limited.
For example, there are reports that banks are having trouble selling debt to finance buyout deals. That is, private equity firms are having trouble raising large amounts of money in the form of debt to buy companies. There are reports, for example, that the private equity deals to buy Texas utility TXU and Sallie Mae are running into some problems.
A reduction in the ability of private equity firms to raise debt is a definite negative for the stock market. It would reduce the positive impact of buyouts that were so supportive to the stock market earlier this year (when talk of tremendous liquidity was all the rage).
But these problems are still within in the financial arena.
No Signs of a Real Credit Crunch
The problems in the financial markets have not yet hit the "real economy." The extension of credit to companies and individuals in aggregate has not shown any signs of a significant slowdown, and nothing greater than would be expected given the sluggish economy.
The chart below shows total bank credit outstanding over the past two years. This data is released weekly in the Fed's H.8 report. Total bank credit includes commercial and industrial loans and real estate loans, among other categories.
As can be seen, there has been at most a slight dip in the growth rate of bank credit in recent months.
The chart below shows the important commercial and industrial loan component of bank credit since early 2000.
Again, it is clear the business loans have not been greatly impacted by the problems on Wall Street. The recession of 2000 and 2001 led to a reduction in demand for loans that is clearly apparent on the chart. But so far:
THE AGGREGATE DATA DO NOT SHOW ANY MAJOR IMPACT ON OVERALL CREDIT EXTENSION TO THE REAL ECONOMY IN THIS CYCLE.
Companies are still able to get credit, and are doing so.
That banks are willing to lend to businesses is evidenced by the following chart. It shows the percentage of banks that are tightening business credit standards, as reported by regular Federal Reserve surveys.
Banks have not tightened commercial lending standards much at all in this business cycle. (Note: the above chart does not apply to mortgage lending).
What it All Means
The confusion in the media that the liquidity problems on Wall Street imply a credit crunch are simply not supported by the facts. And the implications are important.
As long as there is no credit crunch, and loans to companies and qualified mortgage borrowers are readily available, the impact from the Wall Street problems on the overall economy will be limited. That means that earnings growth will continue and that the worst fears for the stock market are overdone.
This is not to say that housing is not in a deep slump. It is, and will continue to be for a quite a while. It is not to say that all will be fine for the stock market. The problems on Wall Street mean direct problems for the financial sector earnings and will curtail demand for leveraged buyouts and other financial deals.
But the overall impact on the economy will probably be limited. The liquidity problems on Wall Street will ease, and the fears will fade over time.
The outlook for the economy is for at best sluggish growth even apart from the current liquidity problems, so we aren't saying that real GDP growth will return to the long-term trend of 3% in the near term. The housing slump will make sure of that.
We are also cautious about the earnings outlook and have been for some time, as regular readers know. So our Market View remains neutral.
But unless the current liquidity problems cause banks to develop more cautious lending habits for good old fashioned business loans, there is no reason to believe that a credit crunch will cause a recession.
Of course, anything is possible, but so far there is not a credit crunch, and our opinion is that one is not likely to develop soon.
- - Dick Green, Briefing.com
Wall Street Problems are Real, but This is Not a Credit Crunch
Last Update: 13-Aug-07 08:18 ET
The credit markets are experiencing liquidity problems. These are real and of serious concern to the financial markets. There is no evidence yet, however, of a credit crunch that would impact the overall economy. So long as this remains the case, a crash in stock prices is unlikely.
The Current Problems
There are many financial debt instruments that have been backed by subprime mortgages. These securities are in trouble. As subprime and other mortgage loans go bad, the payments to these debt instruments evaporate. The value of these securities plummets, and the value can be hard to determine because the degree of non-payment on the original mortgages is hard to assess. Sometimes these securities are in hedge funds or other investment portfolios that then drop in value as the mortgage-backed securities drop in value.
That is what happened last week when BNP Paribas Investment Partners halted payments from some of its hedge funds. BNP did not say that the funds were illiquid. They simply could not value the mortgage assets accurately enough to properly pay redemption requests.
There are also many other funds on Wall Street that are in trouble as a result of a decline in the value of mortgage backed securities held. The loss of value in these funds is a definite risk to many financial companies.
The primary problem however, apart from the loss of value on the mortgage-backed assets, is that liquidity problems have developed. There are few buyers for the mortgage-backed assets because the price is hard to determine. The instruments are not liquid.
The Fed stepped in to the market last week to help with this problem. It did repurchase (repo) agreements with banks in which it in effect lent money to the banks. The Fed accepted mortgage-backed assets as collateral, creating temporary liquidity for the instruments. (Technically, the operation is a 3-day repurchase, in which the Fed buys the instruments and sells them back three days later, but it serves in effect as a loan using the instruments as collateral).
This temporary easing of the liquidity problem was an attempt to help the markets settle down, overcome fears, and allow market mechanisms time to again provide liquidity. The Fed's primary function as a central bank is to provide a smoothly operating financial system, and they will continue to do this as long as necessary.
The Problems Spread - Somewhat
The liquidity problems on Wall Street can be considered problems in the "financial economy." These problems have had some modest impact on the broader economy, but the impact so far is extremely limited.
For example, there are reports that banks are having trouble selling debt to finance buyout deals. That is, private equity firms are having trouble raising large amounts of money in the form of debt to buy companies. There are reports, for example, that the private equity deals to buy Texas utility TXU and Sallie Mae are running into some problems.
A reduction in the ability of private equity firms to raise debt is a definite negative for the stock market. It would reduce the positive impact of buyouts that were so supportive to the stock market earlier this year (when talk of tremendous liquidity was all the rage).
But these problems are still within in the financial arena.
No Signs of a Real Credit Crunch
The problems in the financial markets have not yet hit the "real economy." The extension of credit to companies and individuals in aggregate has not shown any signs of a significant slowdown, and nothing greater than would be expected given the sluggish economy.
The chart below shows total bank credit outstanding over the past two years. This data is released weekly in the Fed's H.8 report. Total bank credit includes commercial and industrial loans and real estate loans, among other categories.
As can be seen, there has been at most a slight dip in the growth rate of bank credit in recent months.
The chart below shows the important commercial and industrial loan component of bank credit since early 2000.
Again, it is clear the business loans have not been greatly impacted by the problems on Wall Street. The recession of 2000 and 2001 led to a reduction in demand for loans that is clearly apparent on the chart. But so far:
THE AGGREGATE DATA DO NOT SHOW ANY MAJOR IMPACT ON OVERALL CREDIT EXTENSION TO THE REAL ECONOMY IN THIS CYCLE.
Companies are still able to get credit, and are doing so.
That banks are willing to lend to businesses is evidenced by the following chart. It shows the percentage of banks that are tightening business credit standards, as reported by regular Federal Reserve surveys.
Banks have not tightened commercial lending standards much at all in this business cycle. (Note: the above chart does not apply to mortgage lending).
What it All Means
The confusion in the media that the liquidity problems on Wall Street imply a credit crunch are simply not supported by the facts. And the implications are important.
As long as there is no credit crunch, and loans to companies and qualified mortgage borrowers are readily available, the impact from the Wall Street problems on the overall economy will be limited. That means that earnings growth will continue and that the worst fears for the stock market are overdone.
This is not to say that housing is not in a deep slump. It is, and will continue to be for a quite a while. It is not to say that all will be fine for the stock market. The problems on Wall Street mean direct problems for the financial sector earnings and will curtail demand for leveraged buyouts and other financial deals.
But the overall impact on the economy will probably be limited. The liquidity problems on Wall Street will ease, and the fears will fade over time.
The outlook for the economy is for at best sluggish growth even apart from the current liquidity problems, so we aren't saying that real GDP growth will return to the long-term trend of 3% in the near term. The housing slump will make sure of that.
We are also cautious about the earnings outlook and have been for some time, as regular readers know. So our Market View remains neutral.
But unless the current liquidity problems cause banks to develop more cautious lending habits for good old fashioned business loans, there is no reason to believe that a credit crunch will cause a recession.
Of course, anything is possible, but so far there is not a credit crunch, and our opinion is that one is not likely to develop soon.
- - Dick Green, Briefing.com
Memories, haaaa seems like yesterday.
Another low and I'll rethink.
