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What We Need to Kick Start the Economy
I have enjoyed reading both of Steven Levitt’s Freakonomics books. They highlight how there are unforeseen stimuli that produce certain results we think happen for another reason.
O’Keefe works with middle market companies that sometimes experience financial difficulties; they are unable to pay the bank and their trade creditors upon the terms they agreed. Many of our referrals come from banks who hate to have troubled credits. I often tell the banks we are like the light bill: if they are making loans, some will go bad. It is an ordinary and regular event in business. However, since the credit crunch, the government has overregulated the financial markets. Today, many of the regional banks who were favorable to middle market lending opportunities can’t seem to find ways to apply Big Company credit policies to middle market credits. As a result, while there is much liquidity in the market, the credit box for underwriting middle market credits is so small, many good companies with growth plans or start-ups simply cannot find credit.
I believe one of the reasons this is true is because interest rates are too low. This is counter intuitive, but I will apply this thought to the housing industry, which can’t seem to get kick started in any meaningful way. Interest rates have never been lower for mortgages. Some 15 year products have rates at 2.5%, making mortgage money almost free to the consumer, yet housing continues to flounder. The problem is you have to have a great credit score (over 720) and a large down payment. One would argue that this is just a good lending practice. The problem is only a small section of the population (less than 20%) meets such criteria. However, if the banks could raise interest rates to, say, 5-6%, or over double where they are today, they would make a better spread on their lending and could afford to take some losses.
My simple solution: raise interest rates. I believe this would loosen the liquidity in the market, making money more available for economic expansion. Money for almost free isn’t working because the spreads are not there for the banks to take any risks. At 2.5%, the banks can’t afford to take any losses. The government needs to let lenders lend. It was not commercial lending that got the banks in trouble. It was reckless Wall Street financial engineering in the housing market. Unfortunately, the Heartland of America, the closely-held middle market business is paying the price.