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Market commentary May 2008

By May 8, 2008No Comments

SUMMARY. The “credit crunch” is covered by the media every day, but few attempt a definition. Yet, by definition, it is arguable that there has been no credit crunch.

It might not be like the 1970s, as we highlighted last time, but you undoubtedly still need to be on your toes. At this stage in the cycle it is relatively easy to identify those companies that you would wish to avoid e.g. those with high levels of debt that might struggle to renew terms with banks at acceptable levels or at all, or companies exposed to customers that have this predicament.

Though covered every day by the media, few have attempted a definition of “credit crunch”. Ben Bernanke, now Chairman of the Federal Reserve, defined a credit crunch back in 1991 as an abnormal reduction in the supply of credit. For example, whereas in a typical economic slowdown you should expect banks to lend less, as many applicants will naturally be less creditworthy, this reluctance or inability to lend becomes abnormal when a creditworthy applicant is turned away by the bank. The latter would mean there is something wrong with the banking system, not the economy at large.

By this definition it can be argued that there has not been a “credit crunch” in the UKas creditworthy consumers and companies do appear to be able to access the borrowing that they require. Consider the mortgage market. Clearly some mortgage applicants are being refused mortgages because they are not creditworthy – the fact that they might not have been refused if they had applied 12 months ago simply means that some sanity has returned to lending standards. Yet our mortgage expert tells us that he has little problem finding mortgages for creditworthy clients, just fewer choices.  Some companies that are already heavily indebted are struggling to get any lending terms, and those linked to property and retail markets are having similar problems. In contrast, fund managers meeting larger quoted businesses are reporting back that, on the whole, creditworthy companies can still borrow sufficient for their needs, though the smaller and more cyclical the business, the tougher are the terms.

It was a non-functioning banking system which meant that the recession of 1931 became the Great Depression. Ben Bernanke understands this, perhaps better than anyone else in the world, hence the authorities in the US being so proactive. Eventually the Bank of England also acted, allowing lenders to swap mortgage assets for gilts, and further initiatives should be expected to oil the banking system. This is not about boosting the housing market again, the lessons on that count have been learnt, at least for this decade. This is more a damage limitation exercise so that a cyclical downturn doesn’t become something worse.

Dennehy Wealth