Monday, August 4, 2008

Suffering from a $1.9 Trillion Dollar Shortage in Credit

The Fed has cut its target interest rate 3.25 percent since last September, but interest rates remain stubbornly high. Rates on 30 year mortgages went for 6.6% last week, compared with 6.4% on the day the Fed started cutting rates. Corporate borrowing rates have risen to 6.1% from 5.9%. The Wall Street Journal quotes David Rosenberg, Merrill Lynch's bearish chief North American economist saying in a note to clients, "In over two decades of experience on the Street, let's just say I have never seen this condition before, and [Ben] Bernanke has only read about it."

Why this divergence? The biggest reason is the credit crunch. Says the WSJ:

Banks have lost roughly $480 billion in the past year, but have raised only about $345 billion in new capital, estimates James Bianco, president of Bianco Research. Assuming they weren't overcapitalized before, that leaves them about $135 billion undercapitalized.

With leverage, that capital translates into roughly $1.9 trillion in lending capacity now off the market, he estimates.

In short, Supply and Demand: an absence of $1.9 trillion in lending supply has driven up the price of borrowing, despite the federal funds rate.

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