The Fed sees a looming credit crunch. What's that?
STORY: Federal Reserve Chair Jerome Powell said at the central bank's March meeting that recent banking sector turmoil could result in banks becoming more strict in extending credit.
"...events in the banking system over the past two weeks are likely to result in tighter credit conditions for households and businesses."
In other words: a credit crunch is coming.
But what is a credit crunch?
Mark Zandi is chief economist at Moody's Analytics.
"A credit crunch is the inability of households and businesses to get the credit that they need."
Zandi says the concern stems from the recent collapse of Silicon Valley Bank in California and Signature Bank in New York, which both failed when a flood of customers rushed to get their money out.
"Of course, those deposits are critical to the ability of those banks to make loans. You know, they take the deposits, the banks, they turn around and they lend out those deposits to households and businesses. If there's no deposit and the deposits are leaving, then they can't make loans. They can't make loans. That's a credit crunch. A definition of a credit crunch."
As access to credit shrinks, businesses can get squeezed and that can have a domino effect.
Here’s Ross Gerber, president and CEO of Gerber Kawasaki Wealth and Investment Management.
“Now actual banks are changing their credit standards. And like in the state of California, where First Republic Bank and Silicon Valley Bank were huge players in many specialty markets, not having them actively lending will definitely affect the economy here in California, which is one of the biggest economies in the world. And so now we're going to see some real pain coming to small business owners and innovation companies and lost jobs because of the lack of lending that will go into these areas that were traditionally serviced by these banks.”
Zandi agrees, as tighter credit could put the overall economy at risk.
"If businesses can't get a loan, they can't pay their employees, they can't pay their bills, they can't go out and expand. They can't invest. If households can't get a loan, they can't get a car, they can't get a mortgage, they can't buy an appliance, they can't do a home improvement. And of course, that means the economy is going to be weaker, struggling because of all that."
So what does this all mean for the Federal Reserve?
The Fed’s chief concern right now is fighting inflation so it’s been raising interest rates, making it more expensive to get loans.
A credit crunch might help tamp down inflation but it risks a host of other problems.
“So the Fed's actions now are having and will have a much more dramatic effect on small businesses than they've had in the past. And it's certainly a shame to see them damaging so many entrepreneurs trying to grow their businesses."
But putting a potential credit crunch in perspective: it's not like 2008.
"In this case, the problems are largely amongst small and mid-sized banks here in the United States. In the financial crisis, it was every financial institution on the planet. Small, mid, big, big financial institutions. So the scale of what we're experiencing right now is nothing in comparison to what we suffered during the financial crisis back in 2008, '09 and '10."
In other words: A credit crunch is when banks won’t lend to you. A credit crisis is when banks won’t lend to each other.
"The '08 and '09 financial crisis is in a league of its own. What we're experiencing now doesn't feel very good. It's very uncomfortable. But it's nothing compared to what we suffered back in that crisis."
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