There's No Such Thing As 'Easy Credit.' There's Only Abundant Production
Reuters reported over the weekend that J.P. Morgan Chase, “the country’s largest lender by assets, is raising borrowing standards this week for most new home loans as the bank moves to mitigate lending risk stemming from the novel coronavirus disruption.” One senses that readers in general, regardless of education, profession, or interests, would shrug at the report as a blinding glimpse of the obvious.
To most, news that a bank would tighten lending standards amid economic uncertainty is so logical as to not require mention, or reporting. Well, of course J.P. Morgan would pull back somewhat or a lot during an economic contraction. The contraction likely signals growing skepticism on the part of savers and the intermediaries of those savings about the ability of borrowers to pay monies borrowed back, plus it also signals reduced production of the goods and services that borrowers would seek dollars to attain in the first place.
J.P. Morgan’s oh-so-routine exhibition of prudence amid a shameful period of command-and-control from politicians only rates mention as a reminder that the Federal Reserve’s power to influence the cost and amount of credit is wholly rooted in dopey theory, as opposed to it being a signal of reality. The Fed can decree “easy” or “tight” credit? Let’s try to be serious.
Banks, and all financial intermediaries for that matter, have shareholders. They must achieve returns so that they can continue to have shareholders and customers. The idea that they would easily lend at or near zero just because the Fed decreed a near zero rate is too ridiculous for serious discussion. The idea that they'd lend aggressively at low rates when the odds of being paid back are quite a bit more unlikely just adds to the absurdity that surrounds Fed discussions. Except that such views are a constant source of conversation and analysis when it comes to the Fed, and that’s very odd.
For example, let’s consider Tad Rivelle, the Chief Investment Officer for Fixed Income at TCW, one of the largest asset managers in the world. There’s no doubt Rivelle’s understanding of debt instruments is endless, but when he writes about the Fed so much of his genius is seemingly pushed aside for simplistic fallacy. To read Rivelle is to think the Fed decrees the cost of credit, and markets comply. He writes:
“If central banks were more reflective, they might learn to practice what they sometime preach: that it is their very penchant for suppressing volatility through low rates and market interventions that encourages imprudence, leverage, and excesses in the use of credit and in risk-taking. Shield a business from its “natural” ups and downs, provide it with cheap and ready credit, and you can be pretty sure that, over time, such a business will “learn” to be under-equitized and hence ill-prepared for a downturn from which it cannot be so shielded."
Implicit in Rivelle’s commentary is that arguably the most important price in the world is set by a board of central planners at low cost, only for borrowers to line up and gorge. No, such a view doesn’t stand up to the most basic of scrutiny. Lest we forget, no one borrows money as much as they borrow what money can be exchanged for. In that case, an interest rate is the cost of borrowing to access all the economy’s resources; think office buildings, computer printers, smartphones, desks, and most crucial of all, labor. If the Fed could control this cost as Rivelle’s analysis presumes, the U.S. economy would be so small as to not be worth contemplating. Central planning failed in the 20th century, and it did so in murderous fashion. The Fed is not an exception to the truth that central planning always fails. "Easy credit" care of central banks is a myth.
As we all know from the most basic of basic economics, artificially low prices made artificial by government command invariably lead to scarcity. Reducing what’s absurd to the absurd, Los Angeles Mayor Garcetti could surely decree Ferraris cheap in Los Angeles, Mayor de Blasio could decree apartment rents cheap in New York, but it’s not as though the markets would comply. Assuming the declaration of artificially cheap Ferraris and Manhattan apartments, the lightning quick result would be scarcity of both. That the previous sentence is a statement of the obvious brings new meaning to obvious.
To which some will say central banks just “print money,” and they can make the money “easy” by doing so. Yes they can, but the same economic truths apply. Once again no one borrows money; rather they borrow what money can be exchanged for. Implicit in Rivelle’s thesis is that market actors aren’t just stupid, but they’re monumentally so.
Indeed, Rivelle’s analysis presumes that those who produce and own real resources (think again computer printers, office buildings, etc.) are just rushing to exchange those resources for paper easily produced by central banks, and loaned out for next to nothing. No. Not very likely.
Looking at the above in reverse, do those who borrow “money” do so blind to what it can be exchanged for? As in do they aggressively borrow dollars, thus setting themselves up for principal and interest (however low) payments, even though they know the money isn’t exchangeable for the real goods, services and labor that are the only reason to borrow?
Back to reality, all money flows are a signal that goods, services and labor are being exchanged. Meaning money is never cheap. No doubt money is periodically devalued by monetary authorities, the U.S. Treasury the miscreant stateside, but this just means the devalued medium is used less to faciliate exchange, or it's used in exchange for exceedingly fewer goods and services. Markets always speak, and they always reject attempts at "easy" anything.
Rivelle notes that interest rates have been low. Yes, so true. But not because of the Fed. The central bank is a follower.
Interest rates for some businesses also haven't been low for decades because the sky is blue, or because financiers have been feeling generous; rather they've been low because production has been abundant. And when production is abundant, it’s constantly being pushed to higher uses; loans and investment the transmitters of what's produced.
Sorry Fed obsessed, but markets aren’t nearly as stupid as your models presume. With lenders and borrowers, it’s always and everywhere an exchange of real resources; paper money merely the referee. The Fed is at best a producer of the paper that facilitates the exchange, as opposed to a credit allocator, Central planning yet again failed decades ago.
J.P. Morgan’s tightened lending standards are yet another basic reminder of how little the Fed controls anything. Thank goodness.