Reference no: EM131528738

Assignment

Neither Borrowers nor Lenders be By James C. Cooper, Business Outlook August 27, 2009.

In his detailed analysis of the events of the past year, presented in a speech on Aug. 21, Federal Reserve Chairman Ben Bernanke noted the substantial progress markets have made in healing the wounds from the financial crisis. But, as he was quick to add, the patient is far from healthy. "Strains persist" in many markets, he said. Institutions face "significant additional losses," and consumers and business still have "considerable difficulty" getting credit. The bottom line: Credit is not yet flowing sufficiently to assure a strong and sustainable recovery.

The latest data from the banking sector highlight that point. Through mid-August, overall bank lending to consumers and businesses continued to contract. Over the past six months all loans and leases have declined at a record annual rate of 8%, with no hint of an upturn despite the Fed's massive efforts to get credit flowing again.

What's becoming clear is the two-sided nature of the problem that won't be resolved anytime soon. One side is the reduced willingness of banks to lend in a risky economic climate amid record loan delinquencies and charge-offs. The other is the subdued desire to borrow. Households are already saddled with enormous debt, and companies are hesitant to invest in expanding their operations. The Fed has done its best to lead the horse to water, as they say, but that's about it.

This dichotomy was evident in the Fed's latest survey of bank loan officers. The July survey continued to show that more banks had tightened their lending standards than had eased them, although the stringency was not as widespread as in the Fed's April survey and significantly less so than in January. A few banks actually eased terms and conditions in July, whereas none had done so in April. At the same time, the Fed said, loan demand, outside of prime mortgages, continued to weaken across all major categories.

The double whammy against credit growth is why the Fed will most likely keep its target interest rate near zero for a long time and why its flood of funds into the banking system will not spark inflation in the near future. The Fed's monetary fuel is meaningless until banks are willing to lend and people want to borrow. Right now, households are more interested in shedding debt amid lost wealth and sagging incomes, and banks want to invest in only the safest assets. Since February, bank holdings of Treasury and government agency securities have soared by $200 billion, while loans have shrunk by $295 billion.

Banks are sure to remain skittish. Many say their lending standards will not return to normal for some time. For commercial and industrial loans to investment-grade companies, more than a third of banks said terms would stay tighter than average until the second half of 2010, according to a Fed survey. For prime residential and commercial mortgages, some 40% of banks said standards would be tougher than normal "for the foreseeable future."

Lenders are more cautious partly because they must increasingly hold on to the loans they make instead of packaging and selling them as asset-backed securities (ABSs). Thanks to the Fed's Term Asset-Backed Securities Loan Facility, securitization, which affects many types of consumer loans, is stirring again after a shutdown late last year. But ABS issuance in the second quarter remained 23% below the year before and 72% below two years ago.

The good news is that bank loans account for only about 30% of debt held by households and nonfinancial businesses. In the broader financial markets, credit flows have improved notably in recent months, especially corporate borrowing. Corporate bond issuance, for both investment-grade and high-yield bonds, is running well ahead of last year.

As Bernanke, now nominated for a second term, has pointed out, the drag from the credit crunch is diminishing. But credit growth is a dance for two, and right now lenders and borrowers are still far apart.

Neither Borrowers nor Lenders be

1. Discuss the importance of credit markets to a well-functioning economy.What was the current condition of the US credit market mentioned in the article? What caused this situation?

2. What cause banks to hesitate to lend out loans?

3. What was the current target interest rate from the Fed in the article? Did this solve the credit crunch problem?

4. Debate whether the Federal Reserve should be adding billions of dollars to the banking system.

5. How much did bank loans account for debt held by households and nonfinancial business? Was there any good sign for the financial market mentioned in the article?