The sub-prime crisis and the credit crunch are fundamentally about the failure of a lending system created by Wall Street. Instead of banks keeping loans on their balance sheets, they pooled them and sold them off in the form of bonds and other securitized investments.
Banks can only lend based on the amount of equity (deposits, cash, etc.) they have on their balance sheet. This is regulated and they must adhere to these ratios or risk being closed down or fined by their respective government agency or central bank. By removing the loans from their balance sheet via securitization, they created more space to do more lending. One way to look at it is like a garage. You can only fit so much in your garage. But if people come and take things out, you can keep filling it up.
Securitization is dead. Numerous articles are being written about it as we speak. What does that mean? Banks will have to go back to on-balance sheet lending. They won't be able to bundle their loans and get rid of them. This means their garage will fill up much quicker. Once a garage is full, banks can either stop lending, or expand the garage.
But to expand their garage, they will need more capital. Capital from most banks comes from depositors, shareholders, investors, etc.
The Implication for Depositors
There will be a huge demand for deposit dollars. As banks bring loans back onto their balance sheets, they are going to need deposit dollars to support those loans and deposits are among the cheapest ways to get them. Look for banks to start increasing the rates they pay, especially for longer-duration CDs.
The Implication for Borrowers
It will become harder to get a loan, mortgage, home equity, credit card, etc. Before, banks could hand out money almost free. They weren't as concerned about the quality of the lender because they weren't holding the loan. Now they will. They'll also have less money to lend. Tighter standards and less money will mean higher rates. Look for higher rates on almost every type of loan product.
It will be awhile before the full implication of the credit crunch becomes known but it appears that the recent way of doing business is over.
Related Articles:
Credit Crunch Crisis Guide by Amelia - Aug 14, 2007
The Fate of the Financial World Rests with the Montes by Cindy Daniels - Aug 16, 2007
Fed Cuts Discount Rate by 50 Basis Points to 5.75% by Sam Cass - Aug 17, 2007
Yale Economist Robert Shiller Discusses The Housing Market by Cindy Daniels - Aug 17, 2007
You Will Lose Your Shirt, Pants and Underwear with Emerging Markets Here by JRodgers - Aug 24, 2007
Credit card defaults are on rise by soczie - Aug 27, 2007.
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