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Money Crunch! How Can An Economy Built On Debt Function If Nobody Can Get Loans?

Over the past several decades, the U.S. economy has become increasingly reliant on debt.  The vast majority of people take out a mortgage when they purchase a home, the vast majority of people require a big loan in order to buy a vehicle, and the number of Americans who use credit cards to make purchases at retail stores has skyrocketed over the years.  It has gotten to the point where credit is the life blood of the U.S. economic system.  Unless your business is a convenience store or a fast food joint, being able to accept credit cards or arrange credit for your customers is absolutely crucial.  In fact, the economic boom that the United States has experienced over the last 30 years has been largely due to a rapidly expanding pool of credit.  Americans have gone deeper and deeper in debt with each passing year as they pursue the American Dream.  But now that so many lending institutions have substantially tightened their lending standards and now that so many Americans have such low credit scores, how is the U.S. economy going to function?

That is a very good question.

The truth is that U.S. economic growth is very highly dependent on consumer spending, and consumer spending is very highly dependent on the ability to get credit.

But today there is a money crunch.

Banks and lending institutions, having been burned so badly by the reckless lending during the early and middle part of the past decade, have really, really tightened their standards.

So now it is much harder to get a home loan, a car loan or even a credit card.

In addition, as a recent USA Today article pointed out, a record number of Americans now have very low credit scores….

Figures provided by FICO show that 25.5% of consumers — nearly 43.4 million people — now have a credit score of 599 or below, marking them as poor risks for lenders. It’s unlikely they will be able to get credit cards, auto loans or mortgages under the tighter lending standards banks now use.

Historically, only about 15 percent of Americans have had credit scores that low.

That means that the number of “bad credit risk” Americans is getting pretty close to doubling.

And that is very bad news for the economy.

If Americans can’t get loans then the U.S. economy is going to grind to a standstill.

Just consider this quote from that same USA Today article….

“I don’t get paid for loan applications, I get paid for closings,” said Ritch Workman, a Melbourne, Fla., mortgage broker. “I have plenty of business, but I’m struggling to stay open.”

If you have tried to get a home loan over the past year, then you know how frustrating that can be.  On our sister site, a reader named John (who actually has very good credit) described the infuriating experience that he went through when he tried to get a mortgage….

I was just turned down for a home loan. My credit score is 799, my wife’s 804. We had $40,000.00 to put down, which was almost 30%. BUT! Our bank turned down our application! Why? They required us to have 6 months “operating expenses” in the bank after all closing costs were covered. They came up with an arbitrary number on their own, based on our bills and such. We had that amount and more on top of our closing monies. Then why were we denied the loan? Several thousand dollars were from “cash” and the bank required that “cash” be in the bank for at least 60 days or they wouldn’t consider it fluid funding. Needless to say we didn’t make the closing date and are hiring an attorney to avoid being sued (by the seller).

Can you imagine?

Now remember, this is someone with a credit score of 799.

If the process is that frustrating for him, what is it going to be like for the rest of us?

The truth is that the credit markets are broken.

In an attempt to rectify the mistakes of the past, the lending pendulum has swung all the way from “anyone can get easy credit” to “virtually nobody can get a loan”.

So now we are facing a massive money crunch.

If people can’t get loans, homes won’t be purchased, car dealerships will close, retail stores will have a horrific holiday season and the economy will come to a standstill.

The sad thing is that this is exactly the kind of thing that happened at the beginning of the Great Depression.  Credit was severely tightened and all of a sudden nobody seemed to have any money and the economy seized up.

Could history be repeating itself?

Feel free to leave a comment with your thoughts on this topic below….

Austin Coins

 

  • Ken

    Why is the US in this mess? It’s simple, just these three words: “Equal housing lender”.

  • non of your beeswax

    From Shakespeare’s Hamlet, 1602:

    LORD POLONIUS:
    Neither a borrower nor a lender be;
    For loan oft loses both itself and friend,
    And borrowing dulls the edge of husbandry.

  • Gary

    The problem is simple-wage stagnation caused by the republicans, along with many tax cuts for the rich, is why people need credit for most things. Tax the rich and spread the wealth. Working peoples productivity raises were stolen by the rich and CEO’s who make OBSCENE salaries, many hundreds of times the lowest paid employee. Thank you right wingers for another mess.

  • Fed Up

    Great Blog!

    I’m a loan officer at a small community bank. We’ve got around 90 million in assets, so we’re a small fish. As such, we service our own loans. We didn’t make risky subdivision and commercial loans, etc. That’s not to say we’re not suffering some like most banks are, but we’re in pretty good shape considering the situation. I’m making loans like I always have, but am turning down more people who have bad credit due to recent implications. We are still making loans, but have more OCC requirements within the last two years than we have ever had in the past. The OCC examiners are becoming extremely hard to work with regarding loan requirements. We’ve got long time customers that have perfect credit and have always paid as agreed, but may not cash flow on paper due to a rough 2009. The examiners are eating us alive because of their cash flow on paper, even though they are making their payments. We are, in some cases, required to reserve for these loans now. So to your post regarding lending restrictions, bank examiners are as much or more to blame than the lending institutions in many cases.

  • http://www.rickety.us rick@rickety

    Maybe it depends on where you live whether you can get loans. I live in Utah. My son just bought a really nice home as a first time buyer. I know several people who had no trouble getting car loans.

    Yes I know I am basing the situation on an unrepresentative sample but so is the author of this post.

  • Greg

    Gary, you are almost causing me to ruin my keyboard with the nausea that your blathering insanity causes. Are you ever going to admit the fact that the “left-wingers” you desire to have more control over your life could care less about you? Will you go to your grave remaining duped and gullible with the childish foolishness of thinking there will be benevolence in a government that is given even more power? Will you ignore all of the evidence that soaking the rich leads only to more poverty? Will you continue to refuse to believe that the people you hate will gain control of the Robin Hood government that you wish to install and line their pockets with even more money?

    And here is a challenge for you. Compared to many countries in the world, if you own a car, have more than one set of clothing, have more than the next meal in your pantry, have more than a dollar in your wallet or own a home you are, by their standards, “rich”. You who distort the Bible and claim that the rich should give all of their money to you are going to have address the reality with our Creator that you, too are rich by the standard of many people. Perhaps you should start practicing camel stringing if you want to go to heaven.

  • The III

    I have a small online business selling guitars and shipping them all over the world. We had taken out a small loan from Regions Bank to up our inventory in 2007. We made our payments on time and paid the loan off on schedule. Out of curiosity I contacted Regions Bank to see what it would cost to do the same type of loan for the same amount and even offered collateral more than the amount of the loan. Both my wife’s and my credit scores are above 700, we only have 5 years left on our mortgage and we have never been late with our payments on anything in the past 12 years. Our incomes combined are 10x’s more annually then the loan amount asked for. Regions came back and said online businesses were a high risk and would not be interested in doing a loan with us.
    Banks are not lending because they are insolvent and can’t. Yet they try to make us believe we are the problem. Yea, Riiiiiiight! They can hide their shame for now but not much longer. Sooner or later the accounting has to balanced.

    - The III

  • Mark …

    Things are still perfect in Canada, but that will change soon after reading these kinds of articles.

    The biggest mistake the U.S. made last year was to spent TARP money on the “too big to fail” institutions.

    They should have failed, and the TARP money should have been used to set up four brand new government owned banks with clean books.

    Precise strict, but fair, borrowing guidelines could have imposed by the governments on those new banks, and credit would have been available right now for the average American with a good credit score and (small) businesses.

    TARP is gone now, and so is the opportunity to make lemonade out of lemons.

  • Mr Carpenter

    Our society and western sillivization in general, has moved away from honest money and delayed gratification, to fiat money and instant gratification (via credit).

    Now it’s ending.

    I actually saw this coming some 3-4 years ago and when I wrote same online, I was roundly mocked and called rude things by people who obviously had their heads planted firmly up their derriere.

    Because it’s come true. No, I’m not psychic nor a prophet.

    I just figured that the powers that be had bled the people so dry that once the corpse (economy) fell over, they’d walk away.

    So we get to fend for ourselves, and try to get by with cash (which the powers that be will be outlawing some day soon in order to place even more control over the “unwashed masses” / “small people”).

    The survivors of the econocopalypse will do as our great grandparents did, and will have to establish some form of real money and will have to save for things wanted.

    My grandfather delayed getting married for almost a decade (early last century) in order to build a home and pay off a farm. As in, own everything outright.

    It’s a telling tale that my 2nd cousin has lost the family place 110 years later, by not being able to pay loans obtained on it.

  • Gary

    Greg-you are confusing absolute poverty with relative poverty. I would rather not explain so I would urge you to goggle. This you are rich compared to the poor in Africa is a worn out right wing talking point. I know you know I am right-we need to tax the rich and spread the wealth. Its ok if you do not want to admit it.

  • BlackDS

    History has already repeated itself.
    Maybe there will even be another hitler!

  • Elise

    Mark, you know what’s worse about the situation in Canada? We’ve all seen what happened in the US, yet it seems no one is paying attention, banks are still handing out loans to people buying homes regardless of their situation, it’s sad. When you tell them there’s a bubble here too, they just go on and deny. “Oh, it crashed in the States because of the bad loans, we don’t have that here”.

    The Canada Mortgage and Housing Corporation (CMHC), a governmental entity, has been buying up and insuring mortgages from banks at a faster pace since the recession started, especially mortgages of people who couldn’t cover the 20% down payment. From Wikipedia:

    The Canadian mortgage securitization market has grown from

    * 100 billion in 2006
    * 130 billion in 2007
    * to 295 billion by mid-June 2009

    CHMC plans to expand securitization of debt to 370 billion by the end of 2009 as per the Government of Canada request.

    Soooo basically, instead of playing safe, when the bubble hits it will be all the taxpayers’ money going up in smoke. These numbers might seem small compared to the US numbers, but let’s not forget that the US is at least 10 times more populated than Canada.

    My boyfriend and I have pushed back plans to buy until the bubble explodes, and we’re in no rush. We almost bought a house two years ago, and the bank was willing to offer us 450,000$ and the house we wanted at 340,000$ was already gonna be tight to pay. I can’t imagine people buying to the full extent of their loan!

    Kinda like having a blind brother on the rails of an incoming train who hasn’t yet noticed the nearby corpse of his brother.