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The sting of capital market segmentation
Greg Mankiw shows that real interest rates are rising on inflation-adjusted government bonds. Paul Krugman shows that short-term Treasury yields are down. The state of California cannot get short-term financing. There is simply no one willing to lend. Yet I would have no trouble buying a second home and getting another mortgage at a reasonable rate of interest and I am hardly a rich man.
Credit market segmentation is always there but it doesn't usually matter this much. The parts of the credit market that are paralyzed by fear are the major problem right now. And until that problem is cleared up, we will witness a step-by-step disembowelment of the American economy.
The clock is ticking. We need very rapidly to get to the point where natural lenders are willing to lend and "cross-market arbitrage" is no longer a dirty word.
Posted by Tyler Cowen on October 4, 2008 at 05:58 PM in Economics | Permalink
Comments
Yet I would have no trouble buying a second home and getting another mortgage at a reasonable rate of interest and I am hardly a rich man.
You say that, but have you tried lately? We've been threading the needle of a refinance that has been on the verge of falling apart for weeks. We have about the same income as when we got our current mortgage, with obviously longer employment and credit histories, we have no trouble with our existing mortgage, and we'd be paying substantially less; should be a slam-dunk, right? But our mortgage broker keeps running into hurdles, our lender spent last week not being able to decide who owns it or if it exists, and we had to drop me from the mortgage application to be able to get the refi at all (my credit is good -- better than it was when we got the mortgage! -- but not stellar, which makes it not good enough). It's totally insane.
Posted by: Andromeda at Oct 4, 2008 6:19:26 PM
This is something I have wondered about - If there is such a major credit problem, why am I still getting so many credit card offers? And Why am I not seeing CD interest rates at banks going sky high when LIBOR is up, and interbank lending is frozen?
Posted by: Iraxl at Oct 4, 2008 6:20:05 PM
"...and "cross-market arbitrage" is no longer a dirty word"
Woah there, chief! Isn't promising unreal returns and beating the market and all that fun stuff part of how we got into this mess in the first place?
Posted by: Robert Olson at Oct 4, 2008 6:29:38 PM
"...and I am hardly a rich man."
This comment is somewhat off topic, Professor, but by what metric are you hardly a rich man? Rich relative to whom? Probably relative to most of this country, and certainly relative to nearly all of the world, and obviously relative to all humans through time, you are a very rich man.
So if you mean to suggest that the distribution of credit is very odd, that you can get your hands on a large chunk of change compared to your current income, but the State of California is having difficulty getting credit, then I'm with you. That is weird, and it creates difficulty for individuals trying to understand the "freezing" of credit markets ("But they'll give my 11-year-old son a credit card!"). Your point, though, is weakened by the aside you use to demonstrate it, as it does not match with the stylized facts as indicated in the previous paragraph.
Posted by: Jared at Oct 4, 2008 6:29:58 PM
California has been on the verge of bankruptcy for years. I wouldn't want to lend them money, either.
Posted by: Sean at Oct 4, 2008 6:38:38 PM
California has severe problems that will extend far beyond meeting next week's payroll. My back of an envelope guess is that California accounts for about half the dollar value of all mortgages in foreclosure. Basically, what's going on now is California's fault -- that and the rest of the world for not realizing that, no matter what economic wonders California's former population accomplished in decades past, California's current population could never ever pay back their mortgages on all those absurdly expensive houses.
California's fundamental problem is that importing about ten million people from abroad who average below the mean in human capital hasn't worked out terribly well for the state's economic future.
Posted by: Steve Sailer at Oct 4, 2008 6:40:29 PM
I'm a little confused. I admit to not getting my head around this whole "credit crunch" so I'm asking for help. Is the problem that California can't find anyone willing to loan that much money, or is California's credit not good enough in the current market to get that much money? I would be surprised if a state that didn't have as much, or any, debt couldn't get a similar loan that California is now looking for. Part of me thinks that if you are relying on credit in order to maintain debt, failure is always an option. We would all like organizations to exercise fiscal responsibility, but is it unrealistic to think that the reason California is scrambling is because they don't deserve a new line of credit?
Isaac Crawford
Posted by: Isaac Crawford at Oct 4, 2008 6:46:36 PM
Just to follow up on my own comment... I guess what I'm asking is this, is California's current debt basically caused by easy credit of the past? If the current "crunch" has more to do with a realistic credit market, why would we want to allow the previous status quo? Tyler, if you can get the same loan now that you could before, It means that you had better credit than you needed then, and now you have sufficient credit for the same amount...
Isaac Crawford
Posted by: Isaac Crawford at Oct 4, 2008 6:51:14 PM
Has anyone any evidence that California cannot borrow the money it wants other than their say so?
I imagine that they just don't want to pay the high rates they'd have to pay.
Posted by: OneEyedMan at Oct 4, 2008 6:53:42 PM
I am not a rich man...compared to the state of California. In fact even today there are several parts of the state -- populous parts -- where I could not afford to live. The state of California has the power to tax those parts, I might add.
Posted by: Tyler Cowen at Oct 4, 2008 6:53:54 PM
The state of California is the poster child for "too big to fail". I have a HELOC with a large amount of available credit at 5%/year. Anyone have a suggestion for how I could loan that money to California at 10%/year?
Posted by: David Wright at Oct 4, 2008 7:01:16 PM
Professor,
Agreed. You are not as wealthy as California. And "cross-market arbitrage" is not a dirty word to me. Shall we pool assets, borrow for 'houses', and lend to the Great State of California?
I am only 95-percent joking.
Posted by: Jared at Oct 4, 2008 8:19:15 PM
Tyler,
Let me second or third the calls here to explain why credit is frozen in some sectors; and, even more importantly, why this will spread, leading to your rather vivid metaphor. I've heard that lots of banks with healthy balance sheets are still lending.
Posted by: Craig at Oct 4, 2008 8:24:43 PM
The prospect of a looming bailout that would enable me to sell of bad debt at a higher rate than had the bailout not ensued also blocks credit markets. I recommend Joseph Calhoun's good article here.
http://www.realclearmarkets.com/articles/2008/09/in_times_of_crisis_trust_capit.html
Posted by: Mark at Oct 4, 2008 8:51:17 PM
second the confusion re refi: always a hassle, but i was paying the higher monthly nut, right, and now i've got more history at job, at income, etc. makes little sense, but happens every time. though, i guess, this time it makes sense since most loans over the past X years were jokes (in terms of review done on ability of borrower to pay).
as for callie, why loan to a disfunctional deadbeat, whether an individual or a state?
Posted by: dj superflat at Oct 4, 2008 9:23:42 PM
...I am hardly a rich man.
Then I think you need to talk to Google Ads, because I check this site about 13 times a day, and I think other people do too.
Posted by: Bob Murphy at Oct 4, 2008 9:24:39 PM
Maybe rates on long term bills should rise. The crisis we are having is one of government. The balance sheet of the average american is garbage, and the FED balance sheet is now heading in that direction.
Treasury with new powers seems to be focused on turning back the clock, to a simpler time when everyone paid everything on their credit card and everyone got a 5% mortage.
Americans are sick of debt, but unfortunately our Government is a junkie and now has decided to force some more debt down our throats. It's a clear signal to the markets don't expect any attempt to address National debt in the next 10 years.
The future is layaway.
Posted by: Luis Martinez at Oct 4, 2008 11:39:41 PM
Tyler
That's because the full faith and credit of the US government is now warranting full payment of your loan, why not charge you a credit spread when there's effectively none?
Posted by: nelsonal at Oct 5, 2008 12:15:16 AM
Tyler, it's unlikely that rising yields for one type of government debt (Mankiw's data) and falling yields for another type of government debt (Krugman's data) are both evidence for the statement, "there is simply no one willing to lend."
Besides anecdotes, I haven't seen much evidence that "there is simply no one willing to lend." I have seen some reasonably convincing evidence that lending is continuing mostly unabated.
Posted by: Ian at Oct 5, 2008 1:28:52 AM
Cheer up, Citigroup. You didn't get Wachovia, but maybe the feds can help broker you a deal for California.
Posted by: mobile at Oct 5, 2008 1:40:12 AM
Add me to the ranks of those who are looking to be convinced there is a lending problem, but have yet to see the evidence.
On California's problems, we have this wonderful paragraph from my local paper...
Locally, the cratering economy is already projected to cost Peninsula schools invested in a failed Wall Street titan millions of dollars, is holding up San Jose redevelopment bonds and threatens to increase city and county borrowing costs while lowering interest earnings.
Uh, okay. Money you borrow will require higher interest, but money you loan will earn less interest? I can buy that new credit friction might cause a little change in spread there, but a big change?
In perhaps the worst immediate fallout locally, the bankruptcy two weeks ago of Lehman Brothers, the fourth-largest U.S. investment bank, wiped out $155 million of a $2.7 billion San Mateo County investment pool, which serves local school districts and other agencies.
Hey! Instead of handing that money to high finance big shots who'll kite it into risky mortgages, how about... I don't know... putting it toward California bonds? What? Bad investment?
Posted by: MikeP at Oct 5, 2008 5:00:34 AM
I'm not sure what you mean by cross-market arbitrage.
If an invester isn't interested in any risk, then their only option is the Treasury's offerings. There is inflation risk, but your risk is diluted by other dollar holders, and if your main business isn't dollars, then you don't really care, especially if you are inflating yourself.
Why doesn't Warren Buffett offer bonds at whatever rate he could get and then buy more Goldman Sachs or Wells Fargo if he thinks the $700bn is such a great deal? I think it's because he couldn't get a great rate on his bonds. But, he can't get a great rate because the Treasury option is available. Am I wrong?
I don't see that lending to the government helps us right now. Well, I don't see that it helps us ever, but it especially doesn't help right now. As always, it depends on what the gov't is going to do with the money. This is why I ask why there is no talk of crowding out by the mirage of risk-free Treasurys?
But, in line with my views on user fees, any bailout funds should come from current bond sales. So, in that respect, I believe if you are buying Treasurys from the government you are endorsing their economic plan.
Posted by: Andrew at Oct 5, 2008 7:13:55 AM
If the US is undergoing restructuring, and we have just started, then investors do not yet know where to put their money.
Posted by: Matt at Oct 5, 2008 8:54:31 AM
"California's fundamental problem is that importing about ten million people from abroad who average below the mean in human capital hasn't worked out terribly well for the state's economic future."
Last time I checked, gardeners and taco cooks provide more real value than the CEOs of leading investment banks :) Not too many illegals got zero down loans on McMansions either.
California's problem is socialism, not immigration.
Posted by: Mr. Econotarian at Oct 7, 2008 3:14:48 PM
Real rates are being posted in the REAL lending being done privately - by hedge funds and mezz funds today - at 15% or more. And of course, Credit card companies, that were able to get around usury laws because of "inflation" (how long have we NOT had that - but we still have these rates) can charge the poorest people 30% and not be called crooks. It used to be illegal.
Everyone wants to be in CASH - the safest investment is treasuries - so that demand keeps rates down - to almost zero.
But in the so called "risky market" - where we all do business today - there are real rates being charged for the deals that are actually done. Look at the fees. And the terms. All in the rates for senior loans are extreemly high. Just because of fear and NO LIQUIDITY. AAA credits cannot get money. Perhaps we need a new market to evolve with analysts we trust - just like when this country was founded. The trust of one person to another.
Perhaps we need a new MARKET>>>>>
Posted by: Anne V at Oct 22, 2008 11:41:50 PM
