The Credit Duel, Part 2

The duel of the newsweekly pundits continues! The battle lines were drawn earlier this month, with Justin Fox of Time saying that the era of low interest rates is over, and Michael Mandel of BusinessWeek saying that in fact low interest rates are here to stay.

Mandel responded to Fox on Wednesday, pointing to low(ish) rates on the 10-year Treasury bond, and saying that credit isn't drying up across the board:

It is perfectly possible that we could have devastation in one part of the credit market, while borrowing continued along merrily in other parts. In fact, that's what you would expect in an efficient credit market.

Fox then replied to Mandel on Friday:

My article, being as how it was in Time and not Business Week, was almost entirely about the rates being paid by U.S. consumers. And guess what: short-term rates (ARMs, home equity loans, credit cards) are higher than or as high as they've been in years... I'm not predicting some kind of future credit Armageddon, just stating that, from the perspective of American consumers, the easy money days are over.

Is this an attempt to kiss and make up? Fox seems to be capitulating, here, despite the fact that he's on stronger ground than Mandel is.

For the fact is that credit is drying up – and drying up pretty much across the board. Unless you're the US government, you will find it much harder, or more expensive, to borrow money today than would have been the case last month.

On the other hand, if you take a bigger-picture view, credit is still very cheap by historical standards. Maybe that's one reason why the credit markets have dried up: the markets are willing to extend credit at vaguely sensible spreads, but borrowers have become so accustomed to life in the credit bubble that they're not willing to borrow at those levels. Hence the stand-off, which looks like a credit crunch but which in fact is probably just a discontinuous repricing of credit.

I expect that M&A bankers are likely to take a bit of a breather for the next month, and return in September with a fat pipe of deals. Which might not be quite as rich as they would have been in June, but which will still generate lots of fees all the same. The money's still there: it's just a little more selective than it used to be, is all.

So I certainly don't think that the current spread widening is reason for the Fed to cut rates. A rate cut would encourage spreads to stay tighter than they ought to be, which isn't sustainable. And it would have more effect on yields than it would on spreads in any event – and probably precious little effect on yields, at that. The Fed should stick to worrying about inflation first and unemployment second. The credit markets can look after themselves.