Credit Crunch Impacts Financial Markets

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Mike Larson explains how the credit crunch is impacting every corner of the financial markets. In this issue of Money and Markets, Mr. Larson takes a closer look at how investors don't really understand how the credit crunch works.

Mike Larson explains how the credit crunch is impacting every corner of the financial markets. Mr. Larson takes a closer look at how investors don't really understand how the credit crunch works.

According to Larson, it boils down to two key forces. The first force is many lenders lack the desire to lend. In general commercial and investment bankers do not like to take chances and they tend to follow the lead of one another. When one bank or lender comes up with a new loan product that generates volume and profits, others quickly pile in and copy it. When one lender gets more aggressive with its qualification standards, it doesn't take long for others to do the same thing. And when it all goes badly? The bankers seem to suspend lending altogether.

The tightening trend has spilled over into commercial real estate, where almost 81% of those polled said they were tightening standards. Two-thirds of respondents were tightening standards on credit card borrowers, more than double the level of just three months earlier, and the highest ever.
The second force is banks that want to lend don't have the capacity to do so.

Banks are required to maintain a minimum cushion of capital. Think of it as the last line of defense against bad loans and other problems. It also serves as a base upon which banks can build a book of loans and other assets. When capital levels are healthy, banks have a huge capacity to lend. But when capital is being eroded banks have to react by cutting back on new lending.
In normal times, banks can replenish capital by generating and retaining earnings over time. Or they can go out and sell common shares, preferred shares, or hybrid securities that have characteristics of both equity and debt.

But if investors don't want that kind of paper, lenders have to pay a lot to raise money. Some institutions can be shut out of the market entirely. That's exactly what is happening now because potential investors know that profits across the banking industry plunged 86.5% to just $5 billion in the second quarter, according to the FDIC. They know that we're going to see a big wave of bank failures in the next 12-24 months. And they don't want to get swept up in it.

More importantly, the sovereign wealth funds in Dubai, Singapore, and elsewhere, and other private investors have seen their prior investments in U.S. banks sink dramatically in value. So they're increasingly reluctant to throw good money after bad.

"If this were all just a financial crisis, you could arguably avoid the pain by just staying away from bank and broker stocks. But that is no longer the case. The credit crisis that began in housing, and then infected the financial sector, is now spreading throughout the economy. Credit is becoming harder and more costly to obtain across the board. That is making it more difficult for consumers to boost spending, and for businesses to borrow and invest in their operations. This is having a real, measurable, and severe impact on the overall economy," Larson states.

To read this issue online, please visit:
http://www.moneyandmarkets.com/Issues.aspx?Two-Forces-Driving-the-Credit-Crunch-2186

About Mike Larson and Money and Markets

Mike Larson joined the company in 2001, and has more than 10 years of experience researching and writing about personal finance, investing, and the housing and mortgage industry. In 2003, Mr. Larson was named associate editor of the company's monthly Safe Money Report. In this role, he is responsible for writing and editing as well as analyzing trading opportunities for clients. Mr. Larson is also a regular contributor to the company's daily e-letter, Money and Markets.

Before joining Weiss Research, Mr. Larson was a personal finance reporter for Bankrate.com, where he wrote extensively on mortgage lending, banking, residential real estate, and Federal Reserve Board policy. His responsibilities included analyzing economic data and interest rate trends for a weekly column and developing rate forecasts for a regular index feature. Previously, Mr. Larson held positions at Bloomberg News and the Boston Herald.

Recognized as an interest rate and mortgage market expert, Mr. Larson's views have been quoted in the Washington Post, Chicago Tribune, Dow Jones Newswires, Reuters, Sun-Sentinel and the Palm Beach Post. He has also appeared as an investment expert to discuss the housing market on CNBC, CNN, and Bloomberg Television. His writing has been acknowledged by both the National Association of Real Estate Editors and the Massachusetts Press Association.

Among the first analysts to call the housing slide, Mr. Larson's new policy paper, "How Federal Regulators, Lenders and Wall Street Created America's Housing Crisis: Nine Proposals for a Long-Term Recovery" has received broad media coverage following its July 2007 submission to the Federal Reserve and FDIC. Mr. Larson holds B.A. and B.S. degrees from Boston University.

Money and Markets (http://www.moneyandmarkets.com) is a free daily investment newsletter from Dr. Martin Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Weiss Research, Inc. is located in Jupiter, Florida. For more information about our editors, or to set up an interview, please contact Jennifer Moran at 561-627-3300 or visit http://www.moneyandmarkets.com.

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