Crunchy Credit
Robert Higgs has offered several very interesting posts about the supposed “credit crunch,” (here, here, and here) noting that this is not in fact a technical economic term but rather a phrase invented by journalists and pundits. He asks the important question: if it’s a “credit crunch,” why aren’t real interest rates soaring? Then, after identifying the crunch as a phenomenon that is mostly affecting high-risk borrowers, he asks why the crunch manifests itself in stricter lending requirements rather than higher interest rates.
I’ll offer a tentative hypothesis, but first, I’ll offer an illustration to show why I don’t believe there’s a general credit crunch apart from the fact that interest rates remain low. On two recent trips to our local Kroger, I have completed a transaction and noticed that there was an application for the 123 Rewards Mastercard at the bottom of my receipt. I did a double-take the first time because I thought it was just a customer satisfaction survey and noticed that yes, in fact, it was a credit card application. I was so surprised that I walked off and left a just-purchased bunch of bananas on the self-checkout scanner. I hope that whoever followed me in line was able to enjoy an unexpected windfall (a banana bonanza, perhaps). That I could enter the grocery store to buy bananas, carrots, and apples and leave with thousands of dollars in new credit makes me very, very skeptical that there is a general credit crunch.
Something similar showed me how tight the job market was in the late 1990s. I was looking for a summer job in May or June of 1999, when the civilian unemployment rate was around 4.3% and the median duration of unemployment was about 6.3 weeks (by comparison, the unemployment rate now is around 5.5% and the median duration of unemployment is around 8-9 weeks; all data from the Saint Louis Fed). I went to McDonald’s one day for lunch and asked for a job application. The cashier told me “it’s on the bag.” Sure enough, I looked and there was a job application printed on the bag. I didn’t go for food service, though; I ended up supplementing my tutoring income by putting protective laminates on books at the University library for minimum wage.
And now to the hypothesis. As I understand it, many states have complicated usury laws that prevent banks from charging the interest rates that would allow high-risk borrowers access to credit. This has had two effects. First, banks have to use different means to separate people by credit risk. Tighter reporting standards are likely to affect high-risk borrowers much more severely than they will affect low-risk borrowers. This creates a vicious cycle where one’s inability to establish a reliable credit history restricts access to future credit. Second, these laws combine with interventions like the Community Reinvestment Act to make it prohibitively expensive for banks to serve high-risk borrowers. Therefore, we have a profusion of title pawn and payday loan establishments that serve as the only access to credit for the poor.
To the best of my knowledge these hypotheses have not been tested anywhere. My prior belief, though, is that the credit crunch facing the poor is the manifestation of the unintended consequences of government interventions that were supposed to help them. As is usually the case with such interventions, with friends like these, who needs enemies?
