For several years through last summer, aggressive financial leveraging produced too much credit.  The result was inflated real estate prices and a large amount of capital loaned unwisely to build houses for people without the sustained income or repayment commitment usually needed to get a home mortgage. The credit bubble was not unnoticed but the consensus view of the credit market was that it was OK because asset prices and incomes were bound to keep rising.

Washington encouraged asset speculation and ever more risky loans.  Many business managers overleveraged their operations on the same hype. Hence, the event of September 2008 and the resulting six month credit freeze.

During this period there was a severe shortage of credit. Planned consumer, and even more so investment spending was deferred or cancelled.  Initially, the cutback was mostly for lack of credit. But eventually cutbacks due to lost income or fear or imminent loss of income became more significant. This included lots of construction work. Where did the credit go? Some was destroyed by defaulted loans or higher reserves for expected higher default rates.  Some was destroyed by financial de-leveraging. Some was destroyed by asset value write downs. Some was destroyed as previously marketable assets became unpricable and hence unsellable when the extent of needed asset write downs was not yet known. And some was hoarded by lenders to protect their own solvency when the eventual solvency of potential partners and borrowers was still unknown.

This period ended gradually beginning last spring with massive liquidity injections by the Federal Reserve Board and the Treasury Department. Today, rate spreads over low risk government rates have dropped 85-90% of their abrupt rise last fall. There is no credit shortage now. Banks have $1 Trillion in excess reserves on deposit with the Federal Reserve Board. The typical amount of excess reserves is a few billion.  This is a low yield investment. Lenders have the capability of expanding loans by up to $10 Trillion.

< p>But they choose not to do it. They do not like the repayment prospects of the loans available to them. The current whining that there is too little lending to homeowners, small business and real estate investors comes from very real credit access problems in these sectors. But the loan denials are mostly due to the loss of income and profits at the bottom of the recession and not to the credit freeze which is long over.

Washington is again misreading the credit market. Federal agencies are borrowing to make residential mortgage and “green” loans that private lenders will not make.  Some business managers are blaming their loan denials on a credit shortage rather than their unlendable income and balance sheets.

As early as a year ahead, there will again be a credit shortage. This will result from the usual surge in demand for loans in an expanding economy. How soon and how deep the credit shortage will be depends on how quickly the Federal Reserve Board withdraws the emergency liquidity injections and how much capital the President and Congress manage to divert to bad loans that private lenders have shunned. Who will get credit when the supply is again short?,

Two sets of borrowers will get refinancing and expansion credit.  The first set is those who arrange favored treatment in Washington. This is an increasingly risky gamble after the shock of the tripling of the federal deficit in the last year. The second set is borrowers with income and balanced sheets attractive to private lenders.

The consequence of the evolution of the credit market over the next year will be a surge in business failures. Be careful who your suppliers and customers are.

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