The American economy
A spent force
Ominous signs that the crisis will have a big impact on spending
IT WAS, admitted Hank Paulson as he threw a $250 billion lifeline to American banks, objectionable to most Americans, himself included, to see the government owning stakes in private companies.
He had no real alternative. But it would have been less objectionable had he been able to promise that the economy would escape a recession as a result. He could not. It may well be in recession already.
The economy appears to have barely grown in the third quarter and the surge in financial stress that followed Lehman Brothers’ failure in mid-September will make things worse. The subsequent plunge in stocks on top of still-falling home prices could result in a 14% drop in household wealth this quarter, the largest on record, according to ISI Group, a broker. News that retail sales sank 1.2% in September triggered the biggest drop in the Dow industrials in 21 years on October 15th.
If it were only wealth, construction and other tangible factors that were in decline, the recession could still be on the mild side—especially as oil prices are falling. But the credit crunch is a wild card. The experience of the Carter era suggests the effect of credit restraint can be large. In 1980 President Jimmy Carter imposed credit controls in a ham-fisted effort to reduce inflation: banks that exceeded targets for some types of loans such as for consumer purchases and mergers had to set aside extra reserves. Americans overreacted in a burst of patriotic fervour; credit usage plunged and GDP fell by an annualised 8%, the steepest quarterly drop in the past 50 years.
Since then the influence of debt has probably grown as the economy has become more credit-intensive. Consumer and home-equity loans equalled 26% of annual personal consumption in the 1990s; they recently reached 36%. In the 1980s about half of homeowners had a mortgage; now about two-thirds do, says Ivy Zelman, a housing consultant.
Meanwhile, the demand for bank credit by companies shut out of the commercial-paper market is straining balance-sheet capacity. In theory the government’s $250 billion rescue package for banks, levered ten-to-one, could support $2.5 trillion of lending (total credit in the economy was $27 trillion as of June 30th). But no one expects so large an effect because banks are trying to delever and will probably build their reserves in anticipation of more loan losses as the economy worsens.
Non-banks are a particular problem. The finance affiliates of the big carmakers, most prominently GMAC, 49% owned by General Motors, now face funding constraints, forcing them to raise underwriting standards and loan charges. Approvals for car-loan applications have fallen sharply (see chart).
Non-banks can tap the Federal Reserve’s new commercial-paper guarantee programme, but are not eligible for government capital. Credit-card debt continues to grow but in that business, too, lenders are cracking down in subtle ways, says David Robertson of the Nilson Report, an industry newsletter. One is to reduce unused credit limits on middle-to-higher-income borrowers who might use more credit if they lose their jobs.
Surprisingly, mortgage-lending conditions may be improving. Under pressure from the federal government, Fannie Mae and Freddie Mac, the now-nationalised mortgage agencies, and the Federal Housing Administration, the programme for low-income buyers, are stepping up their activity. A buyer can now obtain an FHA loan with as little as 3.5% down on a house costing up to $625,000—which would include most of the homes in the country. Ms Zelman reckons the FHA accounted for 22% of mortgage originations in the third quarter, up from 5% in all of 2007.
The real problem, Ms Zelman says, is that almost a quarter of homeowners with mortgages have zero or negative equity in their homes. Householders, she says, have too much debt and must save more. It is, she says, not about credit. “It’s about a hangover from hell.”
Oct 16th 2008 | WASHINGTON, DC
From The Economist print edition