Lasting Situations of Wealth

Where You Stand Today May Determine Where You End Up Tomorrow

The ripple effect of the financial crisis that originated in the sub-prime mortgage sector in 2007 is still reverberating through the global economy. The shakeout is far from over, but recent responses of both individuals and institutions in the aftermath of the first waves of financial distress are likely indicators of some long-lasting changes in the financial culture of the United States.

Among the issues that most likely will see major change: the use of credit, and the business of lending and borrowing.

Assessing the Credit Landscape

Today, on a global basis, we are feeling the aftershocks of too much credit gone bad. After a boom period of easy credit when almost anyone could buy anything, the bust is upon us. People are looking for strategies and actions that will stop the bleeding and lead to a recovery. Some responses to the current financial adversity are logical and self-explanatory, others are unexpected or unusual.

1. No surprise: Financial institutions have tightened their lending standards. It doesn’t make sense to lend to people who can’t make payments. With both credit card and mortgage default rates at all-time highs, lenders have become more conservative in their lending practices.

Citing information by the Federal Reserve, Sara Murray and Jon Hilsenrath wrote in the August 18, 2009 Wall Street Journal that “most banks reported that they expected their lending standards across all loan categories would remain tighter than their average levels over the past decade until at least the second half of 2010.”

Remember how you used to get four or five offers a week for a new credit card – with no fees and no interest for 6 months? For most, such offers are things of the past. Now credit card companies are reducing limits, canceling cards and looking to clean out problem borrowers. Andrew Martin, writing in the May 18, 2009 New York Times says: “Banks are expected to look at reviving annual fees, curtailing cash-back and other rewards programs and charging interest immediately on a purchase instead of allowing a grace period of weeks, according to bank officials and trade groups.”

The message: If you want to borrow, prove to us you can pay it back. We’re no longer taking your word for it.

2. A bit of a surprise: Americans have decreased their borrowing and increased their saving. For years, financial commentators have lamented Americans’ pathetic savings rate, which as little as two years ago was actually negative. Well, it didn’t take long for that behavior to swing around.

Under the headline, “Amid Recession, U.S. Savings Rate Hits Highest Mark Since 1993,” a June 26, 2009 article posted on pbs.org stated:

 As the longest recession since World War II drags on, Americans are responding by shying away from spending, opting instead to save money at the fastest pace in 15 years, a new report shows. 

The Commerce Department reported Friday that consumer spending rose 0.3 percent last month, in line with expectations. Meanwhile, the savings rate that had hovered near zero in early 2008 surged to 6.9 percent, the highest level since December 1993.

It’s somewhat remarkable that saving would spike so dramatically in the midst of a severe recession that includes high levels of unemployment and diminished incomes. The reduction in spending can be attributed to not having money, but an increase in savings indicates some people do have money but are choosing not to spend it.

3. Quite a surprise: Some financial commentators and politicians have been critical of both cautious financial insti-tutions and thrifty individuals. Prudent lending practices and increased saving rates may seem like rational economic responses, but according to those who believe in the financial power of credit, these common-sense actions will not lead to a robust recovery.

When governments poured new money into lending institutions to stabilize the financial system, it was with the belief the institutions would then be able to continue making loans and allow the economy to keep spending. But lenders are understandably reluctant to use new money to make the type of loans that got them into trouble in the first place. They have the money, but are much more careful about lending it. This lack of new lending prompted Campbell Harvey, a finance professor at Duke University's business school, to observe “Basically we have dropped a huge amount of money ... and we have nothing to show for what we actually wanted to happen.” (Wall Street Journal, 01/26/2009).

President Obama’s comments in his State of the Union Address in February 2009 summarized the perspective of those who see renewed lending as necessary for recovery:

The concern is that if we do not re-start lending in this country, our recovery will be choked off before it even begins.

You see, the flow of credit is the lifeblood of our economy. The ability to get a loan is how you finance the purchase of everything from a home to a car to a college education; how stores stock their shelves, farms buy equipment, and businesses make payroll.

But credit has stopped flowing the way it should. Too many bad loans from the housing crisis have made their way onto the books of too many banks. With so much debt and so little confidence, these banks are now fearful of lending out any more money to households, to businesses, or to each other. When there is no lending, families can't afford to buy homes or cars. So businesses are forced to make layoffs. Our economy suffers even more, and credit dries up even further.

And it’s not only lending institutions that need to loosen up. Every American must do his/her part by continuing to be a healthy consumer. Here’s a February 12, 2009 headline from Chris Isidore, a senior writer at CNNMoney.com: Why Saving is Killing the Economy.

The opening paragraph

It wasn't that long ago that many economists worried that Americans were saving too little.

Today, the growing concern is that Americans are starting to save too much.

It's not that the savings rate today is high by historic measures, or by comparisons to some other countries. But it has moved sharply higher in recent months -- at a time when what the economy needs most is for consumers to be spending more freely.

Later in the article, Isidore quotes Mark Zandi, chief economist for Moody's Economy.com who says increased saving is “a lot of spending that's not happening." Consumer spending is “the difference between an economy that is growing and one that is struggling mightily.”

Isidore concludes:

Saving more and cutting debt might sound like a good plan to deal with the recession. But if everyone does that, it'll only make matters worse.

In brief, lenders are getting tighter, individuals are saving more and borrowing less, and experts want both groups to loosen their purse strings.

What’s going on?