By DAVID MOON, Moon Capital
August 20, 2006
In the last three years, the Fed funds rate has increased
from 1 percent to 5.25 percent. How effective was this dramatic rate escalation
at dampening the supply and demand for credit?
Not at all.
Not only are debt levels not
decreasing ' or even leveling off ' but consumer debt is actually growing faster
this year than in any year from 2001 to 2005.
Consumer debt increased at a
seasonally adjusted annualized rate of 5.7 percent in June, according to the
preliminary estimate. That's more than twice the 2.5 percent annualized increase
in our real gross domestic product in the second quarter of 2006. Our debt is
growing twice as fast as our economy.
This, despite a quintupling of rates
by the Federal Reserve Board.
standards of most financial institutions.
I recently visited with the head of
an industry-specific lending division of a major regional bank. He explained
that his competitors had lowered the amount of collateral they were requiring
borrowers to put up or were eliminating certain types of loan guarantees.
This had the effect of instigating a
sort of price war among competing banks. It also provided credit to a bunch of
borrowers who, only a few years ago, would not have qualified for these loans.
Short-term interest rates have
increased much more than longer-term rates. In this type of interest rate
environment, the profitability of bank lending typically declines. One reason is
that the spread shrinks between banks' cost of funds and the rates they can
charge borrowers. Yet with the recent exception of mortgage activity, bank-loan
profits remain high ' and are still increasing.
Because of an increase in loans. If
your margins decline, you're tempted to make it up with more volume. And if the
pressure to increase quarterly earnings is great enough, you increase your
lending volumes by dipping down to a lower-quality borrower.
During the Great Depression, massive
numbers of Americans lost their jobs. Unemployment reached 24.9 percent, real
estate prices fell 53 percent and more than 40 percent of the banks in the
country went bankrupt.
In the depths of that depression,
1932 and 1933, Americans actually spent more money than they earned. With a
quarter of the population not earning anything, that shouldn't be a
The next time Americans spent more
than they earned was in 2005. Unemployment was only about 5 percent throughout
An old Spanish proverb says, 'He who
has four but spends five has no occasion for a purse.' The handbag department at
Saks should be worried.
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).