Archive for November 21st, 2008

US Small Business concern- lack of credit or demand?

November 21, 2008

Fed Governor Ronald Krozner has given an excellent speech on the status of small business lending in US. I had pointed to a few papers on the issue of whether bank lending has declined or not in US. 

This speech pretty much confirms that bank lending situations has worsened in US. Krozner does not rely on the statistics but various surveys conducted by Fed and other agencies. He even looks at whether large firms are facing similar concerns to small firms.

To summarize our conclusions, the information that we have received since April from both banks and small businesses suggest, rather convincingly, that over the last six months it has become more difficult for small businesses to access credit, but that at the same time, small business demand for credit has declined. 

Commercial banks, the most common source of credit for small businesses, have generally both imposed more-stringent credit standards and increased interest rate spreads and fees.  In addition, deteriorating financial positions in both the small business and the household sectors are almost surely reducing the creditworthiness of many small businesses and thereby constraining their access to credit.  That being said, the information we have on the volume of small business loans suggests that credit is generally available, albeit on significantly stricter terms.

In the previous post, I had said there were concerns over whether this decline in bank credit was demand driven or supply driven? Krozner throws some light on the matter:

In addition, small businesses generally report that reduced demand for their products and services caused by a lower level of economic activity is a more serious concern than is the tightening of credit supply conditions.  Put differently, while credit supply concerns are real, the weakened state of the economy appears to be the more serious challenge facing most small businesses in the current environment.  Importantly, there is some evidence that concern over access to credit is relatively stronger at larger businesses. 

 So, Krozner indicates the concerns have indeed moved to demand side where the small businesses are expecting overall demand to decline. Hence, the decline in credit could be demand driven as well.

This speech points US has plenty of data sources to access the situation. In India’s case (and other economies) we hardly have any sources of this type.  And it is so difficult to assess the situation.

Indian real-estate sector – victim of irrational exuberance

November 21, 2008

I have been reading a lot of news and developments over India’s real estate sector. All I can say they created all the problems for themselves. I can’t say much about commercial real estate but in residential real estate market one could see problems right through. I have written plenty of postson how difficult it is to buy property in Mumbai and how expensive it had become.

In Navi Mumbai, builders were either busy building luxury properties or those with penthouses, 5 bedroom apartments. The reason they said was demand was for such properties.  One could never understand who would buy those properties? If people had that kind of money they could very well buy property near the area of work (which is usually South Mumbai) and save travel time as well.

The people wanting to live/shift in Navi Mumbai were those that could not afford housing in Mumbai. There was a need to develop smaller flats at reasonable prices but at times of exuberance (no matter how irrational it could be) basics are ignored.

Each of these properties became highly  expensive and beyond budget for most of the people.  The high prices were then pushed across sector and most of the properties started quoting at rates never seen before. There were properties which were almost 20 years old and quoted same rates as a new one and one wasn’t sure whether it could last another round of rain. The concept of depreciation wasn’t applicable at all.

The exuberance fed itself and there was a huge bubble in the making. This trend was seen across Indian cities. The builders , brokers etc all behaved as if the market would go on like this, huge demand is there etc. The prices used to rise every week by almost 500 Rs per sq feet in some cases (amounting to additional Rs 5,00,000 for a 1000 sq ft property in a week!!) They forgot that incomes of individuals are revised usually once in an year and not everyone is a millionaire in India.

The real estate dream is over. In the euphoria they had come out with grand equity share offers which were prices at a huge premium. Now all are down by almost 70-90% and are still reeling. Their collapse also led to a huge concern on mutual funds whose fixed maturity plan offers weer on the brink of default. There are concerns on banks over increase in real asset non-performing loans as well.

Very cleverly, the real estate sector seemed to have passed the collapse to the global crisis. They are asking for help from RBI, government and whichever source. They are threatening that without support there would be massive unemployment etc.

However, despite all the mess, we hardly get to hear about any reasonable decline in housing prices. At the most you hear is builders planning to offer a 5%-10% decline when prices have increased by almost 300-400% in past 3-4 years!!  This discount was available as it is even in good times.

The government should only assure support if they reduce the prices substantially. Otherwise, it will not solve the problem. The builders need to be taught a lesson and understand building homes for others isn’t only about crazy profits and that too forever.

BIS strategy to address banking crisis – anything new?

November 21, 2008

 In a press release Basel Committee on Bank Supervision says it plans to issue a comprehensive strategy plan to address the banking crises. The objective:

to address the fundamental weaknesses revealed by the financial market crisis related to the regulation, supervision and risk management of internationally-active banks

The so called building blocks of strategy are:

  • strengthening the risk capture of the Basel II framework (in particular for trading book and off-balance sheet exposures);
  • enhancing the quality of Tier 1 capital;
  • building additional shock absorbers into the capital framework that can be drawn upon during periods of stress and dampen procyclicality;
  • evaluating the need to supplement risk-based measures with simple gross measures of exposure in both prudential and risk management frameworks to help contain leverage in the banking system;
  • strengthening supervisory frameworks to assess funding liquidity at cross-border banks;
  • leveraging Basel II to strengthen risk management and governance practices at banks;
  • strengthening counterparty credit risk capital, risk management and disclosure at banks; and
  • promoting globally coordinated supervisory follow-up exercises to ensure implementation of supervisory and industry sound principles.
  • In all, pretty much the same thing applicable to all banking crisis.  The same guidelines apply to banks all the time irrespective whether there is a crisis or not.

    I would suggest more crucial is to understand why weren’t these basics of banking/finance applied? Why did banks take the kind of risks they did? What was risk management doing when traders/loan-makers were taking risks?  Where did corporate governance, business ethics go? It doesn’t help in any learning.

    After understanding the actual practices from the assumed only we can make some progress on designing appropriate policies. There is no point restating things which have been well-known and are obvious.

    Assorted Links

    November 21, 2008

    1. Krugman says it is economic emergency now. Mankiw says we need a prayer now

    2. WSJ Blog points to Irving Fisher paper that started discussion on deflation.

    3. WSJ Blog points to an interesting discussion comparing Lehman woes with US Automakers. IGMB points to a view from Luis Zingales on saving US automakers

    4. ICL Blog points rating the raters

    5. MR points to concerns in China

    6. Rodrik on French sovereign wealth fund

    7. DB Blog on how Georgia became a top reformer


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