Businomics Blog

What Credit Crunch?

I keep reading about the credit crunch.  Can't find it myself.

Oh, if you're a sub-prime person who wants a house with nothing down and no income verification, then credit is not available.  But outside of real estate, I can't find a credit crunch.  I've been talking to my many banker clients, and they all tell me they are happy making regular old commercial and industrial loans to businesses.  Any company that still meets the standards banks were using two years ago will have no trouble getting a bank loan today.

On the consumer side, I don't see any troubles.  There may be fewer people meeting the standards, and some credit card companies are tightening their standards, but the average person with a good FICO can still get credit.  A good gauge of that is the car industry.  Most cars are sold on credit, and almost all of that credit is securitized in much the same way that mortgages are packaged and resold to investors.  You'd think that the market for securitized loans would have dried up, but that's not the case.  A good way to see that is the volume of car sales.  There's certainly a slowdown, but not a collapse.  And I think the slowdown is driven by consumer attitudes more than a change in credit availability.

Now for real estate.  Sub-prime mortgages are hard to get, and jumbos are much more expensive than they used to be.  Developers are having to put up more equity, but under they right conditions, they can still get credit.

My personal experience:  I was asked to investigate the possibility of the Willamette Sailing Club, a great small sailboat oriented club in Portland, borrowing a million dollars to build a new clubhouse.  I called three local banks, spoke to high-level officers, and found that all three were willing to do the deal.  Sure, they wanted an appraisal of our land.  They wanted to see financials and membership numbers.  But credit is available.  Cool.  Just wait to you see what we look like next year.

Boating Industry IS Sensitive to the Economy

In Businomics, I used the boat building industry as a case study for estimating an industry's vulnerability to recession, and also for an example of an early warning system.  (You can view the vulnerability study or the early warning system example.

Today the AP ran a story about boat sales being down, companies laying off workers and, in some cases, closing plants or boatyards.  I'm sorry to see it, but it does vindicate what I wrote earlier: that the industry is quite vulnerable to recession, and that managers in the industry need to watch an early warning system.  Two years ago I had pitched a couple of boating industry magazines an article about the industry's sensitivity to the economy, but they weren't interested.  Oh well.

If you are not a boat-builder, let this be a lesson to follow the four steps of economic contingency planning:

1. Assess your company's vulnerability to recession
2. Develop an early warning system
3. Sketch out a contingency plan for a significant change in the economy
4. Manage the business to preserve the flexibility to implement the contingency plan, if needed

Excess Housing Inventory Being Worked Off

We are working off the excess housing inventory that we developed during the housing boom.

This decline came despite a drop in new home sales; even after the drop, though, sales were higher than new construction.  (Keep in mind that the data have some significant deficiencies; take this as medium fidelity, not high fi.)

But put this data into a longer term perspective:

That horizontal line is the long-run average.  So far we've closed the gap from the peak of the housing inventory by 45 percent.  At the current pace by which the inventory is being worked off, we'll be back to an average inventory in 21 months, or roughly at the end of 2009.

Homebuilders, here's your new theme: 2010, gets better then.

The Economist During an Economic Downturn: Who Ya Gonna Call?

Oregon Business Magazine profiled yours truly, with this really cool picture. You can read the story here.

Small Businesses in an Economic Downturn

Jim Blasingame, the small business advocate, interviewed me for his radio show.  We talked about how small business owners should manage in an economic downturn.

Did Inaccurate Credit Scores Lead to Subprime Crisis

Over on Linked In, Sailaja Sivalenka asks a good question:

Recently, I have come across a few articles that state the reason behind the subprime crisis in USA to be the result of inaccurate credit scoring which could not sufficiently predict subprime default risk.

But, Dr. Makr Greene, CEO of Fair Isaac in his interview says it is wrong to blame the credit rating agencies - http://money.cnn.com/2008/02/08/markets/morningbuzz/?postversion=2008020810

What are your thoughts on this subject?

Inaccurate credit scores may be part of the problem, but you don't need that theory to explain subprime lending errors.

The biggest problem is out-of-sample estimation problems.  If you look at the performance of subprime borrowers when 1) the housing market is strong, and 2) there is very little subprime lending going on, and then you extrapolate to an economy where these conditions are not met, you're taking on huge risk.

You could lend to a dog when the housing market is booming and not get burned; the dog wouldn't make any payments, but he could either flip the house for a profit.  In worst case scenario (heart worms, distemper) the lender forecloses and sells the house for a price above the mortgage balance.  No problems.

Condition 2:  when few subprime loans are being made, they were probably to the best of the subprime lot.  Two people with identical FICOs have different stories; one's low score is due to an accident or hospitalization, but the person is bouncing back.  Another person with the same FICO is just irresponsible.  In early days, I think that lenders found the first type of subprimes.  As the housing market boomed, lenders widened their search for customers to the second kind.

Here's a simple way to think of it: think of an X-Y graph with some data points and a line fitted through the points.

You should be skeptical of your estimate of the slope of the line if you are looking at data points outside of the range of data over which the line was estimated.  You may very well be looking at a very different shape when you look at a wider range of data:

Four Mistakes Businesses Make in a Recession

The Small Business Trends blog has an interesting article, Four Mistakes Entrepreneurs Make in a Recession (the title of which I've modified for the title of this post, for SEO reasons).

I'm going to add another mistake, but first let's review Scott Shane's four mistakes:

1.  Failing to take advantage of decreasing costs.  [good point; I made this in Businomics]
2.  Thinking the only way to increase demand is to cut price [also a good point]
3.  Failing to recognize increased competition.  [sometimes true, especially across normal industry lines; for instance, residential contractors may move into non-residential work when their sector weakens.]
4.  Forgetting that some products, or even whole businesses are counter-cyclical.  [Bad point; I'd challenge Scott to show hard data on any industry being counter cyclical; however it's certainly true that some industries are pretty much immune to recession ( health care) and other have cycles of their own not correlated with the economic cycle (agriculture) ]

Now let me add my own candidate for top four mistakes: discouragement.    Sales people don't have success with their calls. The sales staff is cut back, so the remaining reps become order takers.  Nobody's making cold calls or following up with past clients.  When the economy turns around, the sales people are still discouraged, waiting around for the phone to ring.  But it rings in the offices of the people who kept hustling through the recession.  My hunch: the biggest swings in market share occur at economic turning points.

(For more on this topic, see my comment on Seth Godin's comments.)

Is Recession the Opportunity of a Lifetime?

It's so much fun to disagree with Seth Godin.  I spend so much time on his blog admiring his insights that it's very rare for me to disagree.  But here's what he said about recession:

So, there's plenty of bad economic news floating around. From the price of oil to Wall Street to bailouts to the death of traditional advertising.

Which is great news for anyone hoping to grow or to make an impact.

Change (and the fortunes that go with it) is almost always made during the down part of the cycle. It might not be fun, but it's exciting. (Where do you think Google came from?) The opportunity is to find substantial opportunities (in any field) that deliver real value and have a future. Those jobs/investments/companies/ideas are undervalued right now, but not for long.

I definitely agree that there are plenty of opportunities, but here's my little quibble:  the best opportunities are not during expansions or contractions, but during turning points.  If you figured out that home prices would not grow to the sky two years ago (as my smart nephew did), you pocketed big money and sat immune to current problems.  But think about the next upturn.  All of the country's sales people will be discouraged.  Their ranks will have been cut back, so the ones still on the job will be simply taking orders.  They will be so discouraged that they won't be calling on new prospects.  And then the economic turnaround will come.  A small handful of sales people will call a prospect for the eighth or ninth time and find--they've got an order.  The customer's previous vendor hadn't called recently, so why not give the business to the hungry young kid?  And the hungry young kids of the country will clean up.  When the turning point comes, the opportunities will be abundant for those who have been out hustling.

So I imagine Seth will say to me, "You and I don't disagree at all.  It's the foundation laid in the recession that will lead to the great opportunities of at the turning point."  The only problem is, I'd really like to find something to disagree with him about.

Which is great news for anyone hoping to grow or to make an impact.

Change (and the fortunes that go with it) is almost always made during the down part of the cycle. It might not be fun, but it's exciting. (Where do you think Google came from?) The opportunity is to find substantial opportunities (in any field) that deliver real value and have a future. Those jobs/investments/companies/ideas are undervalued right now, but not for long.

The 20-Teens: Business Challenges and Opportunities in the Next Decade

What are the big changes coming in the next decade? Demographics, globalization, finance and technology are covered with a focus on what businesses should do today to prepare for tomorrow.

This is a new speech topic for me.  I've been weaving the components of this into my other speeches and writing, but decided it's time to pull it all together.

By the way, my most popular topic is "Conerly on the Economy: The Economic Outlook for 2008-09."  I also speak on "Freedom and Prosperity: the Case for Optimism."

Call me if you'd like to talk about a presentation to your management team, clientele, or trade association.

Bear Stearns Bailout: It's Not Who You Think

The quick read from the press is that the purchase of Bear Stearns by JPMorgan Chase was a "bailout."

Jim Hamilton over at EconBrowser doesn't buy that story.  He says, "$2 a share is no bailout, but instead represents a fire sale price."

I buy that, because Bear had been selling for $57 a share two trading days before the buyout.

But there's more to the story from the New York Times (hat tip to Barry Ritholtz):

Holders of the more than $300 billion in Bear Stearns bonds, in the meantime, are purchasing Bear stock to strengthen their hand in voting for the deal, thus guaranteeing that their bond investments will retain the backing of JPMorgan and its guarantor, the Federal Reserve Bank of New York.

That's who is getting bailed out: Bear's creditors, clients, and counter-parties.  The people whose due diligence was not very diligent.  The people who could help us avoid another debacle by being very, very careful in their credit analysis.

But no, care need not be taken.  If you are doing business with a large investment bank, don't worry. The Fed will bail you out if you are stupid enough to lend credit to an insolvent institution, or if you ask an insolvent institution to hold your securities, or if you pick an insolvent institution to be your counterparty in a derivatives contract.

Dr. Ben rode to the fire in a big red truck.  But his truck was leaking gasoline all over town, setting up the street for another major conflagration that could be far worse than the Bear Stearns fire.

Someone should have pulled Bernanke aside and told him to chill.  The economy is pretty resilient.  It can withstand a lot of turmoil.   Instead, the chairman is too afraid of financial turmoil, and as a result, he's going to get more of it.