Here's what a credit crunch is...

[Red Rock]

smilingcat-thankyou for your explanation for this.

Yes-we wish Mr. Silver is doing ok through all of this mess. Hope things are ok.

Red Rock

[Mr. Bloom]

Mr. Silver - Alive and Kickin' in Indiana! This is the third time in my 20+yr career that I've dealt with the "business" cycle, so I keep things in perspective.

It's like driving in a snowstorm...you trust your abilities, but it's the other crazies on the road that concern you...

Ok, I understand all the basics of all of this but my question goes to what smilingcat had to say.

On your last post you say that if you pay off your credit card-no matter what the balance is-they(the company) will cancel it for no apparent reason? This seems a bit strange to me. That or I am not understanding this fully. Why not reduce the amount that can be used-or something to that effect?

Red Rock

My favorite quote from "Out of Africa":

Those darned bankers. Always running to give you an umbrella on a sunny day, but when the clouds come, they want their umbrella back

It is counterintuitive, but here's a simple explanation:

- Banks have to maintain reserves (aka capital) for each loan they make even if you don't use your availability.
- If you have a $20,000 credit card, they are likely maintaining an $800 reserve (4% of the unused availability...and more on the balance outstanding)
- Banks want to make a return on their capital. For a credit card, that's north of 20% - in this case, $160 (it's likely much more, but I'm keeping it simple).
- If you don't use your card, they're not getting a return on capital. (although, if you use it a lot and pay it off each month, they don't get interest, but they get the substantial fees the merchants pay...and that counts). I'm sure RunningMommy will attest to that being A LOT!
- So when credit is tight and they can't fund their needs, they ration availability to the most profitable customer...because they exist to make money.

Hope that helps.

[Dogmama]

OK - so the way I understand it is this:

To get credit, you need to prove you don't need it.

I'm one of those who doesn't revolve - I pay all CC's every month. When I bought my house (20 years ago) I qualified for a ridiculously high amount that I knew I'd never be able to pay. I was amused, but I didn't bite.

Good credit is secondary to peace of mind. I treat my cc's like cash. I don't buy anything I cannot pay off that month. I sleep OK at night, except for hormonal shifts. I don't have a lot of whizz-bang stuff. Heck, I'm still recording TV on a VCR. I do feel sorry for those in dire straits & hope that those who couldn't resist the newest gadgets will learn. I don't buy into the "predatory lender" stuff. I'm the one who puts her signature on the bottom line.

Just my $.03.

[Flur]

I just wanted to point out that as Mr. Silver mentioned in his last post, this is part of the normal business cycle. Sometimes the pendulum swings a bit further than we're used to, and of course swings back to the other side almost as far, but this is all relatively normal and will settle down as long as people expect it to.

The market is not really a "thing". It's a collection of individual people's actions and all those people have a choice. If we, as consumers, stop believing the market will turn around, and tighten down even further because we expect it to fall apart, we'd be encouraging it to do just that. So it's important that we fight that trend and plan for a turnaround. The market will respond to it. I'm not saying to spend irresponsibly. I'm saying to spend responsibly, use your credit responsibly and not horde all your cash in a mattress for fear of what will come next.

[OakLeaf]

I don't buy into the "predatory lender" stuff.

There are a lot of things that went on on that front, but high among them:

- Unsophisticated borrowers. And really, define "sophisticated." I took Real Estate and Consumer Law in my second year of law school, but never practiced in the former area. I doubt whether I really understood a lot of what was in our mortgage papers, for the simple fact that the common meaning of the language isn't necessarily the legal meaning. Someone without a lawyer or legal training would probably be completely at sea... someone without high-level language skills, forget about it. And our current educational system isn't producing a lot of people with high-level language skills. Most borrowers (in the recent past anyhow) were likely going to trust what the lender told them about what their payments would be, what the future held for interest rates, etc. And in many cases, what the lender told them was completely false.

- Lack of sophistication about facts of life other than mortgage papers. There are many, many people in my area who bought houses in the town where they were born, even though they knew they would have to drive 75-100 miles a day to get to work, but believed that this was a sustainable way to live. The media, their employers, their education, nothing disabused them of this idea. Now that the price of gas is beginning to approach its real cost (or at least was, before election season), they literally can't afford to get to work. Something has to give, and just selling their house and moving closer to work doesn't happen that easily even in the best of markets, let alone now. Never mind the emotional issues involved to a person with a strong sense of home.

- Redlining. A large percentage of subprime mortgages - I don't remember what, exactly - was made to borrowers who were actually a good credit risk, but because of their chosen neighborhood (read: race), could not get a mortgage at market rate.

- Desperation. Trust me, no one gets caught in these payday lending traps because they want to. Certainly lack of sophistication plays into it, but loan sharking is probably the world's second oldest profession. When it's a week before payday and someone needs to feed their family, buy medicine or keep the heat on, they're not going to look too far into the future. They can't afford to.

I do believe in the abstract that people can help themselves, but they have to know how, first. If you're not born into a family of a certain level of sophistication, there are d*** few resources that truly help people learn to understand their surroundings and manage their lives in a real way. Yes, there are resources that help people be better employees, better cogs in the machine; very, very few that help them understand the "Matrix" and break out of it. And there's a reason that those resources that do exist are vilified by the "powers that be" to the extent that many of the people who need those resources the most are afraid to take advantage of them.

[redrhodie]

When I was trying to get a mortgage, I only needed/wanted a small loan. The mortgage originator told me the bank didn't like to lend so little, so I was going to have to pay a higher interest rate, unless I took out a larger loan.

The deal fell through, but I'm wondering now if this was predatory?

[Irulan]

When I was trying to get a mortgage, I only needed/wanted a small loan. The mortgage originator told me the bank didn't like to lend so little, so I was going to have to pay a higher interest rate, unless I took out a larger loan.

The deal feel through, but I'm wondering now if this was predatory?

It's pretty standard. We wanted to refinnace the balance of our mortgage when it was less than $50K and we got the same story.

[smilingcat]

There are a lot of things that went on on that front, but high among them:

- Unsophisticated borrowers. And really, define "sophisticated." I took Real Estate and Consumer Law in my second year of law school, but never practiced in the former area. I doubt whether I really understood a lot of what was in our mortgage papers, for the simple fact that the common meaning of the language isn't necessarily the legal meaning. Someone without a lawyer or legal training would probably be completely at sea... someone without high-level language skills, forget about it. And our current educational system isn't producing a lot of people with high-level language skills. Most borrowers (in the recent past anyhow) were likely going to trust what the lender told them about what their payments would be, what the future held for interest rates, etc. And in many cases, what the lender told them was completely false.

- Lack of sophistication about facts of life other than mortgage papers. There are many, many people in my area who bought houses in the town where they were born, even though they knew they would have to drive 75-100 miles a day to get to work, but believed that this was a sustainable way to live. The media, their employers, their education, nothing disabused them of this idea. Now that the price of gas is beginning to approach its real cost (or at least was, before election season), they literally can't afford to get to work. Something has to give, and just selling their house and moving closer to work doesn't happen that easily even in the best of markets, let alone now. Never mind the emotional issues involved to a person with a strong sense of home.

I do believe in the abstract that people can help themselves, but they have to know how, first. If you're not born into a family of a certain level of sophistication, there are d*** few resources that truly help people learn to understand their surroundings and manage their lives in a real way. Yes, there are resources that help people be better employees, better cogs in the machine; very, very few that help them understand the "Matrix" and break out of it. And there's a reason that those resources that do exist are vilified by the "powers that be" to the extent that many of the people who need those resources the most are afraid to take advantage of them.

Current place of employment have highly educated staff down to those without high school diploma. Current work place has 2 of us with advanced engineering degree. Mine is from an Ivy league the other guy has his from Stanford and Caltech. 5% of of the workforce has masters in engineering 15% has BS degree. Then we go down all the way to the unsophisticated workers who do low level work like visual inspection (may not have high school diploma/GED I don't either but that's another story)...

They the "unsophisticated" drives in a Hummer, Merceds, BMWs which they can not afford. They sign lease on these cars. We try to straighten them out but its usually after the fact and ink has already dried. The unsophisticated always tell us the guy who rammed the loan down their throat is a nice guy and they trust the loan officer and that the loan officer was looking after their best interest ... So unsophisticated here implies gullible.

Yet even I have problem on the language of the contract. I read B2B engineering contracts occasionally . Customers have a boiler plate contract and so do we. These we understand without too much difficulty. It's pretty straight forward contract, things you learn in first year law (contract law) but the mortgage loans and credit line Oh myyy... I have to say here I would have to claim unsophisticated because the thing is soo convoluted and I have to take notes... even the preamble is soo convoluted. They give me huge migrane.

Loan brokers hate me because I always insist on taking the contract home and reading it. When I refied my loan about 5+ years ago to a 15 year mortgage, he casually mis-typed the loan rate. He said just sign it and he'll fix it. We exchanged some pretty good words. He guessed very wrong. I didn't sign. Loan brokers like to fast talk. I tell them to be quiet! because only thing that matters is the contract and I've told them that they are annoying and distracting me from reading the contract.

Sooo, to me, anyone not directly involved in writing and originating the contracts then you are unsophisticated. They made it that way.

[smilingcat]

an interesting observation about car loans.

go to a regular car dealer Toyota, Ford, GM... and the car salesmen argue with you about a what a good deal you are missing by not signing up for a lease. They also ask what you can handle for a payment.

I'm not in a mood at any time to argue with them about the bad deal nor am I interested in monthly payments. So I politely tell them to drop it. They don't. I tell the general manager that they've lost sale and I walk off.

Then I go to places where there are receptionists. Places like Jaguar, Porche, Lexus, Lotus... at these places the salesmen will start in but when you tell them that you are not interested, they usually drop it. Some of them don't then I tell them firmly to drop it and they do. They ask if I want to finance. I usually say no. And they are not shocked nor do they start on some diatribe. This is good. And this is why I own an Audi station wagon.

smilingcat

[Dogmama]

an interesting observation about car loans.

go to a regular car dealer Toyota, Ford, GM... and the car salesmen argue with you about a what a good deal you are missing by not signing up for a lease. They also ask what you can handle for a payment.

smilingcat

When I bought my Honda Pilot (before the gas crunch) it was very straightforward. No financing, give me your best bottom line because that's the figure I'm walking out with. Ended up in Scottsdale (from Tucson where we have lots of Honda dealers) because they shot straight from the hip. Even had a Tucson salesman say he's never lost a deal because somebody underbid him. Guess there's always a first time.

[OakLeaf]

It is counterintuitive, but here's a simple explanation:

Doesn't a large part of this also have to do with the bond ratings? When the banks' reserves get downgraded, then they are required to re-make their reserves with higher rated securities? So not only because of profit motive, but also by law, they can invest only in the least risky investments?

Then there's the whole securitization thing, by which risky mortgages were parcelled up with stronger ones and sold to investors as a package, ultimately bringing the whole market down?