Is a 100% Credit Freeze in Our Future?

October 23, 2008

I got this email from a long-time AFM reader earlier this afternoon (modified slightly to protect anonymity):

Through a reliable source, I was told that there is a strong potential for a credit freeze come January 2009. According to this source, absolutely NO loans will be granted…for anything (mortgages, vehicles or otherwise). Although I would appreciate you not listing the bank’s name [which I deleted], I thought this may be an interesting ‘what if’ scenerio for you to write about. I don’t have any other details, but thought you’d get a kick out of the topic and possibly want to dig a little deeper into the idea of a 100% credit freeze.

I followed up with this reader to see if I might be able to interview the source anonymously and this was the reader’s response:

As for the guy I spoke with, he won’t talk to you – nothing personal. It was a social situation when we spoke, but he wasn’t exactly open to comment. I tried (on your behalf, of course). He just said that if anyone needs a loan, they needed to get it within the next 90 days – or they won’t get one at all. I assume he was speaking of things going on with his bank, but you never know.

Interesting. Possible? Maybe so. But, I can’t imagine it lasting for any length of time. But, you never know…

What do you guys think? Anyone with any authority out there want to offer up an opinion?

Oh, and for what it’s worth, I trust the reader who sent me this information.

24 responses to Is a 100% Credit Freeze in Our Future?

  1. Institutions will always be willing to loan money; however, loans might be secured with underlying assets of the loanee, and with unreasonable (depending on your perspective) interest rates.

  2. I find this pretty unlikely, especially given that the government has decided to put some skin in the game by offering to loan money directly to companies and not just to financial institutions. It’s possible a bank may do that but I think that would be short sighted and a profit losing gamble. The way they make money is off of loans. The bad loans on the books are the issue and the lack of oversight which lead to bad loan practices.

    If the “credit freeze” came from US banks, US institutions would just got to overseas banks and financial markets for money. The strength of the dollar would weaken even further. Not a good spiral.

  3. and after all, he then said, i know this because when i was abducted by aliens some years back they placed an all knowing chip in me.

  4. sorry, that doesn’t make any sense. Unless it comes from the federal govt. Banks are chartered to hold deposits and make loans. Further, the bailout money that they have been given is meant to grease the wheels of credit moving. There have been some banks that are thinking about sitting on their bailout money, but they should be threatened by the govt with losing their license.

  5. sounds like a classic internet myth to me. I’d classify it w/ the “Obama is a Muslim/McCain is going to bomb Iran” trash.

  6. Seems highly unlikely, but who knows in our current situation. This would have major implications that I just don’t think the government will allow to happen. It would freeze all home buying for one thing.

  7. Interesting to think about, but I agree with others that it will not happen across the board. Maybe just his bank is taking this measure, but all banks will not do this.

  8. It’s possible that certain banks may elect to quit loaning money for a period of time, but unless the government bans it there is NO WAY that you will see a 100% credit freeze. There will always be people who need/want a loan, and therefore there will always be lenders wanting to profit from making it.

    Some banks are in a very good liquidity and capital position, especially larger regional banks (small community banks and huge conglomerates are the ones facing the most hardship). I work at a bank as a lender, and if any credit freeze is on the horizon we sure aren’t planning for it.

  9. Lots of good comments. I agree that this banker may have been talking about their part of the country, which is surely possible. However, I don’t see this as a possibility for the entire US. My part of the country is in pretty good shape, financially, and I don’t see something like that happening here (although it’s always possible).

  10. Not gonna happen. IF things got that bad, I’d started lending money and break the logjam, at a nice high interest rate.

  11. Credit freeze is not going to happen as Libor rate is slowly dropping, banks are starting to lend to each other again, central banks are lowering interest rates and governments have guarantees on bank debt.

    We had the credit freeze.

  12. If you believe this, I bet the source has a bridge to sell you.

  13. But banks make money by lending money, right? If they put a credit freeze, how are they going to stay in business?

  14. Can you imagine? No mortgages…. realtors are basically out of business (not to mention mortgage professionals). No auto loans…. dealerships cannot stay afloat. No credit card lending… Americans won’t buy things and businesses shut down. A credit freeze couldn’t possibly help anyone, banks included. You’d see a major uproar from the National Association of Realtors, National Association of Mortgage Brokers, and any number of other professional associations.

  15. If there are no loans how will banks make any money? What will the banks do – take your money, put in a vault then pay you interest at a loss to themselves? Then, they might as well change their title from “bank” to “charitable organization”.

    Loans is the way banks make money. In banks’ speak deposits are liabilities and loans are assets. So if banks suddenly stop giving all loans – mortgage, credit card, business, etc. – they’ll have to stop paying you interest. Then you’ll not want to deposit your money or will want to take your money away. Then the bank may just have to close because it probably doesn’t have money in reserve to pay the depositors anyway since it cannot just take back all existing loans at a moment’s notice.

    A particular bank the article refers to must be in real trouble. It probably over-leveraged and wants to increase its reserves to meet its obligations. So it has to stop lending for a while until it has enough in reserve to protect itself from further losses.

  16. You know, what jdh wrote makes sense considering where things are, but really, is that how they should be?

    No mortgages… the people who have built up savings will buy homes and rent them out to people who haven’t. No auto loans… people will have to save up and buy the car. No credit cards, people will first save and then buy (as do many people right now who only use their credit cards for rewards and pay off the bill every month).

    It would be harder for those just starting out, and would reduce demand across the board, probably reducing prices… even businesses who need big loans for factories or equipment could turn to the equities market. It’s not impossible to imagine a good life without bank credit, but it’s getting from here to there that will be wrenching.

  17. Depends what you mean by “loans”. My wife is traveling overseas tomorrow and I just got off the phone from informing the bank so they won’t block the credit card when she uses it there. They practically begged me to use my card more. Offered to increase my limit, reduce my rate – declined both, I pay off each month, eminded me I have rental car insurance, extended warranty at no charge, blah, blah, blah. Finally, they doubled the cash back for the next 6 months. So are they loaning money? Are they going to stop doing so on 31 December? I think the answersare yes and no respectively. They basically offered my an unsecured loan for more than I care to borrow.

  18. So absolutely not possible. here is a small example.

    credit freeze stops all lending. That means banks cannot or would not foreclose because there would be virtually no one to buy the forclosure, defeating the purpose. So everyone would stop making their payments. Banks wouln’t care because all depositors would withdrawal their money to live on.

    This “rumor” is one of the dumbest things I have ever heard. They might freeze gravity next.

  19. Bob,

    The source of this rumor was an executive at a bank and the person who relayed this information to me has been a long-time reader of this blog so I don’t know how dumb this rumor is.

    I don’t see what this banker had to gain by passing this information on to the AFM reader.

  20. JLP – it is possible temporarily because of the current credit crisis but not forever. It is possible with a particular bank because they may be over-leveraged. They may have a lot of outstanding loans, a lot of mortgage-back securities on which they may need to report losses: because of the “mark to market” rule the banks need to report paper losses i.e. loss in market value of securities even if they don’t plan on selling these securities. This bank may need to build up its reserves so that a) they have enough money to pay depositors who want to withdraw b) they don’t report too large of a net loss next quarter. Because of current credit crisis which is still not over the bank may have problems getting interbank loans, so it needs more money to cover if too many people want to withdraw.

    It is completely impossible “forever” because all banks will simply go out of business: they cannot keep paying you interest on your deposits unless your deposits are invested into loans and bring them more money.

  21. I’d say this is complete hogwash. In fact I just refinanced my home this week and the bank was willing to loan me 10% more than my home was worth. Sounds like not much has changed. Granted we have virtually perfect credit and no debt other than our home, but the bank was willing to offer us more debt than we wanted 🙂

    Look at Toyota and other car makers (Acura comes to mind) that rarely offer low interest rates on car purchases. Their credit agencies have money to loan (to qualified individuals) and they are offering 0% interest deals. There are also responsible banks and credit unions that have plenty of money to loan (BB&T) – they have always been conservative in their lending practices and will continue to (in others words bring 20% down to the closing!)

  22. KC,

    This particular person was talking about the beginning of the year (2009).

    I don’t see this happening, but you never know. That’s why I mentioned it–so that we could discuss the likelihood of it happening.

  23. “Through a reliable source, I was told that there is a strong potential for a credit freeze come January 2009.”

    At “one” bank unlikely, but anything’s possible.

    At “all” banks.. no way. Anyway, how could this one source possible know something like that?

  24. No, that is very unlikely. Effectively what you’re saying is that banks will sacrifice all their income, whilst still paying out interest on deposits!! the only situation that this is possible is where the bank in question is having capital adequacy issues, in which case, all bets are off. However, that would be an individual bank as opposed to a complete freeze which is near impossible… then again, they said house prices would never fall so…..