The Credit Crunch & What it Means For You

Hi All,

Miel and I are heading back to Oregon for a few days to visit family. Before we take off, here are some thoughts on how things are going with the economy. Specifically, we wanted to address the credit crunch and how it might impact your personal finance. For most people, the crunch means that it will be harder to get a credit card.

First, no joke it really is harder to get credit. The Federal Reserves' July Loan Officers Survey indicates that 80% of banks have tightened up their Home Equity Lines of Credit standards and 65% of banks say they've toughened consumer lending rules (1).

Okay, so what?

Well, if you are an investor there are several implications.

First, consumer durables are most sensitive to credit. This means that if you are looking to pick up some shares you might consider avoiding companies that produce these products. Consumer durables are things like RVs, cars, apparel and shoes, computers and stereos. According to a report we obtained from CitiGroup, there should be a least a 5% downside impact on the earnings from these companies due to the credit crunch.

Second, avoid investing in credit card lenders. There are many reputable and profitable credit card companies, such as Visa, MasterCard and American Express. However, the consumer finance companies are going to get pinched in the tight credit environment. In addition, there is a strong correlation between home price declines and card loss severity. Basically, because consumers can't borrow, they are going to have harder times paying their bills. Accordingly, these companies won't be able to juice earnings.

If you aren't investing in stocks, there are at least two implications.

First, payoff high interest debt. This is always a good move, but under the credit crunch its an especially good one. Since the economy is in a recession and inflation is relatively high (4%), paying off high interest debt will improve your cash flow and pad your bottom line without any risk at all. It will also improve your credit score and make it easier to refinance should you need to do so. Plus, you can brag to your friends that you're debt free - everyone secretly respects that.

Second, think outside the box for credit. The impact of the credit crunch on new and emerging aspects of credit markets is less clear. While traditional economic models would dictate that companies like peer to peer lenders such as LendingClub and Prosper.com would behave the same as brick and mortar institutions, this is the first major economic downturn the peer to peer industry has faced. In addition, traditional sources of funds like family or kin networks may still be possible to tap if borrowing is required.

Best,

James