Preventing Financial Stroke

Tightening Credit Snares the Healthy, Too

Without doubt, credit was extended too freely over the past 15 years, and a rationalization of lending is unavoidable. What is avoidable, however, is taking credit away from people who have the ability to pay their bills. If credit is taken away from what otherwise is an able borrower, that borrower's financial position weakens considerably.

--Meredith Whitney, "Credit Cards are the Next Credit Crunch"; The Wall Street Journal (3/10/09)

Just like in a real stroke, in a financial stroke, the key to recovery is preventing damage to healthy "cells" far removed from the source of the damage.

As the financial melt-down weakens banks and tightens credit, one of the side effects is that heretofore good credit risks are finding their access to credit curtailed.

To pick just one of the multiple ways that can happen: lenders are now flagging credit files by zip codes. So if you live in a zip code where housing prices are falling especially fast, the bank issuing your credit card may dramatically raise your interest rate, or even cut you off altogether. Even if your credit is spotless.

Locking Barn Doors

Is there some logic to screening credit card customers by zip code? Sure.

For most families, home equity is one of their biggest assets (or at least, it was). If that's under siege, it's not a big leap to guess that the affected families' finances are also weakening, potentially putting creditors at risk.

But what sense does it make to give such families a downward shove?

Certainly, banks need to take defensive measures to guard against promiscuously issuing credit: one of the reasons we're in this mess is that banks exhibited far too little discretion a couple years ago (especially in hot housing markets).

Now, however, banks are predictably overshooting the other direction. Their actions take an already bad situation and make it much worse.

Ultimately, the best way to avoid stroke damage is prevention. If it's too late for that, then the next best course of action is to break the clot with blood thinner, the faster the better.

That's why getting credit flowing again is so critical to the economy's health.