Nouriel Roubini has been the most prominent Cassandra for the financial crisis, especially when it comes to his understanding of the fundamental drivers. In the 90s he studied banking and deficit induced international economic crises and then used his understanding to predict that the United States was most likely the next victim. Of course no one listened to him as it was right smack in the middle of the real estate bubble and as Keynes famously noted: “The market can stay irrational longer than you can stay solvent.” While I agree fully with Roubini’s prescription of the problem, I have always felt that he was a bit blithe about the extent of damage that would ensue if his predictions came to fruition. Even now his policy proscriptions don’t really seem to mesh well with his writings on the root causes, but at least he is getting play in mainstream discourse.
The person that has been the best at detailing and predicting the financial sector in particular has been Meredith Whitney. She has nearly been a crystal ball when it comes to reading balance sheets and macro-economic reports and then predicting exactly what banks would do. It is with that in mind that I introduce her newest prediction: the severe curtailing of credit card lines. It would definitely make sense as banks haven’t been keeping credit card debt on their books, but instead turning them into securities to sell off (the modern bank really is little more than a massive hedge fund) and now the demand for those has dried up. This is why the government has committed to buying several hundred billion of credit card securities. As Roubini and others have consistently pointed out, the consumers that actively use credit lines are tapped out, and with rising unemployment banks are going to be looking to reduce exposure…so I think Meredith has a good chance of being correct on this as well.
The sum is staggering though and I don’t think people appreciate how much deflation will be caused by reducing consumer credit $2 trillion. I would recommend taking an honest assessment of finances and job security, and if you have little debt and are even slightly worried about your job, then I would start carrying a balance to preserve cash. The Age of Plastic has ended.
Update: Yves Smith, as always, provides an insightful view into how credit card reductions will affect small businesses.
Per Michael’s post below, the problem is that the government has focused on trying to prevent the economy from tanking by focusing on long term consumption and asset value. What they are calling the “credit crunch” isn’t a credit crunch at all, it’s a solvency problem where there are too many bad loans.
The real “credit crunch” is when small businesses can’t get easy credit to use for temporary needs, or when consumers can’t buy large ticket items that they plan on paying off over the course of only a few months. That crunch is going to be what kills deserving and nimble businesses, even as trillions flow to banks and other businesses that made awful decisions.