Don’t Kill Credit

Unemployment will be over 10 percent soon, the economy remains fragile, and despite bursts of optimism the recovery looks like it is going to be long and slow. Weighing down on the economy is the fact that many consumers and small business owners are having trouble borrowing. Lots of people are finding that credit card issuers are reducing credit lines and raising fees while home equity loans (what equity?) have gone kaput and other sources of consumer and small business lending are drying up up as the NYTimes recently pointed out. Some might say that’s all for the good because people need to save and they were borrowing too much. That mixes up two different things dangerously. Some people did overextend themselves in the heady years leading up to the crisis but mainly in subprime mortgages. And we can debate what should have been done to prevent that. But the problem now is the economy is in major hurt and we need to fix it. For that purpose the last thing we want consumers to do is to stop spending money. No spending, no jobs, no recovery: it is as simple as that. Most importantly we want small businesses that often rely on consumer credit to start hiring again.

Unfortunately, an awful lot of the proposals that are being floated in Washington these days focus on making it harder for people to borrow—sometimes indirectly as in the case of the CARD Act that was passed by making it more expensive for card issuers to lend money, and sometimes directly as in the case of the proposed CFPA Act of 2009 which was developed by law professors who believe quite earnestly that a lot of consumers just shouldn’t be borrowing money. Josh Wright and I have shown under plausible assumptions that the CFPA would raise interest rates at least 1.6 percentage points and kill more than 4 percent of new jobs as a result of denying credit to the new small businesses that account for the preponderance of new jobs in the economy. See The Effect of the CFPA Act of 2009 on Consumer Credit. We argue that the CFPA Act would harm the economy in the long run but more importantly it would impose yet another lead weight on an economy struggling to recover.

I’d like to propose a moratorium on any and all legislation that’s likely to reduce the supply of credit to consumers and especially small businesses. We should consider any and all proposals after the economy recovers. For now we should focus on government initiatives that will help reopen the credit lines that consumers and small businesses depend on.

Now’s not the time to kill credit.