Tags: recession

Loose Lending Leads to Recession

Wednesday, 23 Jan 2008 08:32 AM

By E. Ralph Hostetter

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Whenever loose lending policies become the order of the day, the forces of recession begin to move in. That is exactly what has been happening over the past months.

Secondary lending organizations, subsidiaries of very large financial institutions, are offering mortgages at sub-par rates to potential customers in amounts greater than the actual values of their properties, in some cases as high as 125 percent of property value. Credit ratings appear as secondary to the loan.

Many of the nation's largest banks are soliciting credit card customers, offering cards with initial credit limits of $2,500. In some instances, the $2,500 credit limit may be drawn down as cash.

As of January 2007, the total credit card debt in the nation stood at 872 billion dollars, or $2,898 for every man, woman and child. An additional 1.5 trillion dollars in debt represents non-revolving loans such as autos, furniture, and so forth, or $4,984 per person. The secured mortgage debt in the nation as of January 2007 stood at 6.5 trillion dollars or $21,000 per person.

Constant pressure by both sellers and buyers in this volatile market have kept interest rates low, encouraging expensive home purchases by those who cannot afford them.

The first signs of a recession are appearing on the horizon. Unemployment is up slightly. Inventories of unsold homes are increasing. Housing starts are slowing. Mortgage holders' payments are in arrears; property forfeitures are up as well as bankruptcies.

The stock market reacted first to the secondary lenders. Many of their stocks have lost up to 50 percent or more of their value.

And finally, this week, the secondary lenders' problems were delivered up the line to their lenders, causing substantial liquidity problems for many of the nation's major banks.

Quick action by the Federal Reserve in creating an immediate drop of 75 basis points in the bank discount rate averted a major liquidity problem for the banks involved, principally in the housing market. This marked the first time in nearly a quarter of a century, since 1984, that the Federal Reserve had taken such action. An additional 25 basis points are expected at the quarterly meeting of the Federal Reserve Board in March.

The discount rate is a major monetary policy tool and its management is entrusted to the Federal Reserve Board. The discount rate is the interest rate that banks pay the Fed to borrow directly from it.

The Fed's quick action on Jan. 22, 2008, also averted a major sell-off in the New York Stock Market that could have cost U.S. tax payers billions of dollars.

Fortunately, and to the credit of the management of the Federal Reserve Bank, the flexibility to release these basis points was available.

Had the Federal Reserve not resisted the pressure from the many self-serving sources to reduce interest rates previously, it may not have had the resilience to take the action it did.

Japan faced a somewhat similar, but far more serious problem 18 years ago.

Japan's problem in 1989-90 was brought about by the collapse of high land prices and high stock market prices.

Japan has since suffered a series of recessions over the last 18 years.

The causes and the resulting recessions are less important as examples than the methods Japan used in its recovery attempts.

Japan involved itself in excessive government borrowing to stimulate its economy by spending money on public works. The result has been some very well-equipped, if often unnecessary, regional infrastructure projects. Much of these expenditures went into the coffers of Japan’s huge construction companies, which had very close ties to ruling party politicians.

Japan also made the fatal mistake of lowering interest rates to zero, thereby creating what is known as a liquidity trap.

Lowering interest rates to zero created an unexpected situation whereby the monetary authority was unable to stimulate the economy with traditional monetary policy tools.

While the United States faces a far less serious problem than Japan, the solution that America seeks should be one that does not create more problems than it solves. The handling of interest rates becomes critical in the manner in which America goes about solving its recession problems.

There are other methods of stimulating the economy and creating job opportunities.

America has the opportunity to resolve its recession problems and solve the No. 1 threat to America’s economy today. An all-out effort to create energy independence for the nation would resolve all aspects of solving a recession problem.

The solution to the end of our recession problems lies in the hands of the U.S. Congress. A massive effort to bring America to energy independence would create hundreds of thousands of jobs by encouraging American oil companies to develop oil production facilities in the offshore areas of the coastal regions of the United States and in the ANWR region of Alaska.

U.S. guaranteed loans would enable the oil companies to explore and produce in areas where it is known there are billions of barrels of petroleum waiting to be taken. At the same time, America’s power generating companies could be subsidized to build dozens of atomic energy reactors on present atomic energy sites across the nation, resulting in more hundreds of thousands of jobs.

We would not only solve our energy problems for the future, but any problems that could have been generated by a recession would disappear.

E. Ralph Hostetter, a prominent businessman and agricultural publisher, also is a national and local award-winning columnist. He welcomes comments by email sent to eralphhostetter@yahoo.com.

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