Restoration of credit took center stage in President Barack Obama’s message to Congress last night. “The concern is that if we do not restart lending in this country, our recovery will be choked off before it even begins,” he said.
The president mentioned “auto” or “car” in his speech nine times last night. He talked about consumers’ ability to finance their cars, and a “re-tooled, re-imagined auto industry that can compete and win.” He pledged to invest $15 billion to develop, among other things, more fuel-efficient cars and trucks built in America.
Obama outlined a three-pronged approach to restart the flow of credit. The first initiative is the creation of “a new lending fund that represents the largest ever effort to help provide auto loans, college loans, and small business loans to the consumers and entrepreneurs who keep this economy running.”
The second proposal deals with housing and foreclosure. And the third involves propping up banks to enable them to lend, “even in more difficult times,” Obama said.
“When we learn that a major bank has serious problems, we will hold accountable those responsible, force the necessary adjustments, provide the support to clean up their balance sheets, and assure the continuity of a strong, viable institution that can serve our people and our economy,” he said.
The bottom line: “Slowly, but surely, confidence will return, and our economy will recover,” he said.
Hopefully, not too slowly.
To read a transcript of Obama’s speech, click here.
I would agree with that.
It is facinating how the risk-return paradigm has changed over the last decade. It used to be that the consumer would put 20% down on a home and use leverage (borrowing) to cover the remaining 80%. Leverage always magnifies gains and losses. If the home appreciates by 20% the consumer realizes a return of 100%. (their equity in the home has doubled). If the home depreciates by 20% then the consumer’s equity is wiped out. This is risk-and-return as it should be! With the lending standards over the last decade the consumer’s risk-return paradigm changed to that of an option. With an option there is no downside risk and only upside potential. Using the above scenario with no money down if the home appreciates by 20% the consumer’s return is infinite. If the home depreciates by 20% then the consumer walks away. No risk, only return.
The risk-return paradigm changed for banks as well. If I make a loan to Joe Blow and hold the loan on my balance sheet then I have to live with Joe for the next 7 years or so, depending on the loan duration. Risk and return as it should be! But if I know that I can slice and dice the loan into pieces (CDO, MBS, etc) and sell them to investors (lets face it, they were stupid!) then I really don’t care if Joe pays me back or not. No risk, only return.
Somehow the risk-return paradigm has to reinstituted where the consumer is at risk (he doesn’t merely have an option) and the bank is at risk (the bank doesn’t transfer its risk to others). Bailing out banks and bailing out insolvent borrowers proves one thing – Risk and return is no longer relevant.
Interesting points Gary. To add to your point…you state “No risk only return” How about the risk of ruining one’s own credit standing? I believe “Character” remains as one of the 5 C’s of credit. And it should be the most critical. Or have American values been reduced to levels so low that people don’t care if they do not fullfill their obligations? Since when did it become fashionalbe to “walking away”? Here at my Bank, we maintain a debtor’s prison deep inside the vault.
And to add to my rant; the true lifeblood of the US has always been hard work and risk taking – which in turn equated to potential rewards. But as our President made clear – he believes it is better for society if the wealth is shared – implying “regarless of effort of level of risk taken”. This is nothing short of Marxism. I don’t care for politics, but I do personally beleive that capitalism was the sole reason why the US emerged as the world’s only superpower. And China’s economy never became white hot until they embraced (albeit slowly) capitalism. And the cold war was won by the US due to the complete failure of socialsim. This opinion is only based on what I’ve read about world history. Of course, I could be right.
Thanks for all the comments, Chas and Gary. Realistically speaking, what do you propose we do to get lending back on track? Are there any avenues we should be pursuing that might mitigate some of the damage you suggest we’re in for?
The auto finance business has always been conducted in a responsible manner. I think that what we are seeing at the banks as far as the unavailability of credit goes is capital preservation at all costs. The banking business is a leveraged business. For every dollar I loan out (mortgage) I can borrow 95 cents from depositors at a risk-free rate and I only have to come up the remaining 5 cents out of my own pocket, which means that I am leveraged 20 to 1. Auto loans are 100% risk-weighted assets which means that for every dollar I loan out I have to come up with 10 cents so auto lending uses up capital that I would rather set aside to cover what might be massive, business ending losses in the mortgage arena. Remember that if I have a $100 million mortgage loan portfolio I only have $5 million of capital set aside to cover unexpected losses (mortgages are usually 50% risk-weighted). If I expect massive losses on my mortgage portfolio then this $5 million that I set aside (20 to 1 leverage) will be gone in a flash. I have a hard time believing that auto lending credit has dried up because of credit quality of auto paper. If banks are indeed preserving capital then there is nothing that you can to about that other than wait.
I think that from a structural perspective it all starts with the Rating Agencies. Have you ever looked at the ratings disclaimers? It basically says that while I rate this deal a triple A you can’t rely on my rating and must come to you own conclusions by doing your own research. What kinkd of nonsense is that? At then end of the day investors bought risky CDO tranches based on Agency ratings, which allowed banks to transfer their risks to investors, which allowed banks to ignore risk, which spawned irresponsible lending, which incented consumers to purchase homes as options rather than have any skin in the game. If it all starts at the Rating Agencies maybe you have them put up capital to cover losses above some point so that they have some skin in the game. If you are at risk then maybe you take your ratings more seriously.
As to Charles point about ruining ones credit standing, I think that this is the cost of the option from the consumers perspective. The price I pay for this option (if things go well I make a ton, it things go south I walk away) is the possibility of a bad credit rating should things go south.
Going to be interesting. I assume NADA will take an active role to assure dealers are in compliance and companies like RouteOne or DealerTrack?