source for article: Wall Street Journal, December 9, 2009

DECEMBER 9, 2009 Lending Squeeze Drags On
By LIZ RAPPAPORT and SERENA NG

Consumer lending shrank 1.7% in October, the ninth consecutive drop, extending the dramatic decline of financing available to help fuel the U.S. economy.

The $3.5 billion decline, calculated by the Federal Reserve, caps a 4% drop in consumer lending from its July 2008 peak. Before then, borrowing by U.S. consumers — including credit-card debt and auto loans, but excluding mortgages — had been growing for more than a half-century.

Consumer activity accounts for about two-thirds of U.S. economic growth. Curtailed lending to consumers could hurt the chances for a strong recovery.

How markets have changed since the start of the recession
Federal Reserve Chairman Ben Bernanke emphasized Monday that the economy is unlikely to experience a “vigorous” recovery. Even though unemployment for November was better than expected, he said, the picture for U.S. job growth remains unclear.

It’s not just consumers having trouble borrowing. For all the talk of a revival in financial markets and a perception that the economy is on path to recovery, many companies lack easy access to borrowing.

“Despite the general improvement in financial conditions, credit remains tight for many borrowers,” Mr. Bernanke said in a Monday speech, “particularly bank-dependent borrowers such as households and small businesses.”

In the process of adapting to post-crisis realities, the nation’s lending markets have changed significantly. In particular, markets where the U.S. government is either a big borrower or a de facto guarantor are ballooning, while some corporate-lending and consumer-finance markets have shriveled.

A Wall Street Journal analysis of data from the Federal Reserve and private research firms shows that these corporate- and consumer-credit markets have shrunk in size by 7%, or $1.5 trillion, in the two years through early November.

The financial markets that support credit-card lending, auto loans and home mortgages not backed by the government are between 10% and 40% smaller than they were in the second half of 2007.

On the other hand, Treasury debt outstanding has jumped about 40% as the government races to finance its deficits and investors seek the safety of U.S.-backed debt. The market for securities backed by mortgages that are effectively guaranteed by the government has expanded by 21%.

Credit markets have healed considerably, after having nearly shut down more than a year ago at the height of the global financial crisis. In the process, prices of almost every type of bond have bounced back from their historic crisis-era lows.

But the rally in prices doesn’t mean borrowers have more money available. “Most of the money that’s going into the markets is not flowing through into the economy yet,” says Thomas Priore of ICP Capital, a small investment firm in New York.

“ It appears that lenders have now gotten back to using sound business principles and trying to actually determine if borrowers can repay their loans. ”
— Edward Harris

One measure of the retreat in consumer lending: In 2005, over six billion credit-card offers flooded consumers’ mailboxes. This year just 1.4 billion have been sent out, according to Synovate, a market-research firm. Earlier this year, Visa reported that people for the first time were using their debit cards (which draw cash out of a bank account) more than credit cards (which use borrowed money).

The result of tighter lending: Consumers spend less and businesses are more reluctant to hire and invest. The changed credit markets, says Mohamed El-Erian, chief executive of bond-investing giant Pacific Investment Management Co., will mean the economy grows only 1.5% to 2% a year, a slow pace compared with the 3% that typically defines healthy expansion in the U.S.

“The idea that we will reset to where we came from is false,” Mr. El-Erian says. “It is a bumpy journey to a new destination with significant long-term effects.”

Some of the decline in lending is also due to lower demand as borrowers focus on paying off the debt they already have.

In the past 25 years, household debt has exploded. It now stands at 122% of total disposable income, up from just over 60% a quarter-century ago. At the end of last year’s third quarter, household debt started to decline as Americans began belt-tightening.

The hardest-hit markets since the crisis were ones at the heart of the financial problem — the “securitization” markets where loans for everything from mortgages to credit-card debt get sliced up and repackaged into complex securities.

The size of the market for securities backed by loans tied to homeowners’ equity has shrunk more than 40% since the second half of 2007. The market for securities backed by auto loans has shrunk 33%. For securities backed by riskier mortgages, the decline is about 35% since the end of 2007, according to the Federal Reserve and data provided by FTN Financial.

These securitization markets provided as much as 50% of consumer lending in the years leading up to the crisis, says Tim Ryan of the Securities Industry and Financial Markets Association, a financial-industry trade group. “Without [the securitization markets], it’s very difficult to replicate the amount of money moving into the economy,” he says.

Classic short-term credit markets serving businesses have also withered. Commercial paper sold by businesses to finance payroll and other short-term cash needs has slumped by 35%.

The shrunken markets for short-term debt are also complicating life for investors in money-market funds.

These funds invest in short-term debt and have a reputation as being safe places to park cash. Worried investors (both individuals and corporations) have piled money into these funds. Money-market funds still have nearly $1 trillion more in assets than they did in mid-2007 before the credit crisis kicked off, according to iMoneyNet.

But the shrinking market for corporate short-term debt has limited the funds’ investment options and forced them to funnel cash into government-issued Treasury bills that mature in three months or less. This heavy demand helped drive yields on some Treasury bills into negative territory last month.

In the corporate-credit markets, a strong rebound has created haves and have-nots. The market for investment-grade bonds, including debt sold by banks and backed by the Federal Deposit Insurance Corp., expanded by about 13% from November 2007 until November this year, while the junk-bond market receded about 7%.

Even companies that are able to borrow are being hurt because their suppliers are struggling. To help, Wal-Mart Stores Inc. is telling lenders it is standing behind its suppliers and encouraging lenders to let the suppliers use Wal-Mart purchase orders to obtain cash advances if needed.