Thursday, October 23, 2008

When Will We Get Back to Normal?

We’ve watched as credit markets have seized up and world governments have pumped trillions of dollars into the banking system. Many of us want to know whether these efforts are working, and when we’ll get back to normal.

According to Business Week, bank-to-bank lending rates in the US have dropped eight straight days (the web page with this article has disappeared since the time of writing). This doesn’t mean that the problem is solved, but we are headed in the right direction. This is as close as I can get to answering the question of whether government intervention is working.

As for the question of when we’ll get back to normal, I don’t think we will get back to normal. For many years, “normal” was to lend money to people who couldn’t pay it back. It was normal for investors to buy packaged loans for much more than they were worth. Until we have another bubble that leads once again to lending madness, we won’t go back to the way things were before.

There is nothing sustainable about making unprofitable loans. When banks lend money to a collection of borrowers at interest rates too low to compensate them for the ultimate default rate, someone has to lose money eventually.

Hopefully we will be creating a new normal where the credit worthiness of borrowers matters. People with the best credit should be able to borrow at rates similar to those rates available to them before this crisis. Those with mediocre credit should see an increase in the interest rates they pay, and those with the worst credit should not be able to get loans at all.


  1. Hopefully we'll see an end to some of the worst derivative and debt products (CDOs, credit default swaps). However, I think the derivative genie is out of the bottle, and they will periodically cause major systematic problems.

    American politicians seem more willing to let the free market run rampant, which causes huge excesses. Maybe we can't argue with success though? The US has been an economic super power for a long time now, despite it's periodic blow ups.

  2. A big factor in this mess was the inability of bank shareholders to make bank executives act in the long-term interests of the banks. It was during the housing bubble that we saw the biggest gap between the interests of executives and shareholders. Regardless of how big the bubble got, shareholders were destined to be left with nothing after it burst. However, executives were able to justify enormous bonuses based on imagined success while the bubble lasted. Once the party was over, these executives were able to ride into the sunset with their millions leaving shareholders in the dust.

  3. The shareholders got tons of dividend payments and capital gains and cheered from the sidelines.

  4. Anonymous: It's all fun and games until your capital is gone. Dividend payments aren't much comfort once your shares are worthless. It's not surprising that most shareholders were unaware of the risks and were enjoying the party. The big problem is that bank executives were not taking the same risks personally.