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Where is the Credit Crunch?
Back in February I pointed out that despite all the talk of a credit crunch commercial and industrial loans were at an all-time high and increasing. At the time, Paul Krugman and others responded that this was just temporary as firms drew on previously existing lines of credit. Well here we are in September and bank credit continues to look very robust. As Robert Higgs points out consumer loans are up, commercial and industrial loans are up, even real estate loans are up. Overall, total bank credit is up with just a slight sign of leveling off in recent weeks. So where is the credit crunch?
A credit crunch does exist in the sector of the market based on short-term, asset backed securities. In addition, interbank lending is unusually risky. But in light of what I have just said the "credit crunch" takes on a new meaning and potential new solutions are suggested. The first question I have is this. Investment banks were selling these securities and using the money to lend to whom? I do not know the answer. But let's suppose that the money being raised in these markets was being lent to productive businesses. If so, then any solution should focus on feeding those businesses that are starved for credit.
I look at the situation as follows. Banks are bridges between savers and investors. Some of these bridges have collapsed. But altogether too much attention is being placed on fixing the collapsed bridges. Instead we should be thinking about how to route more savings across the bridges that have not collapsed. Government lending may be one way of doing this but why lend to prop up the broken bridges? Instead, why not lend directly to the investors who are in need of funds? After all, if these investors exist and have valuable projects that's where the money is! Let the broken bridges collapse, taking the shoddy builders with them. Instead focus on the finding and rescuing the victims of any credit crunch, the investors who need funds.
Now here is a hypothesis. It may be that there just aren't that many firms in need of funds. First, one reason that bank lending is up may be that firms with good projects have already turned to the substitute bridge of ordinary bank loans. Second, I wonder how much real lending was actually being generated by asset backed securities. Could it not be that most of the funds generated were used to buy more asset backed securities? (The growth in these securities is certainly suggestive of that possibility). If that is the case then it explains why the real economy has been remarkably resilient to the "credit crunch."
Now perhaps I am wrong about all this. Bernanke has access to a lot more data than I do and he seems very worried. I'd still like to know, however, which credit-worthy firms are credit starved. And I'd suggest that we ought to think more about alternative bridges that will connect credit-starved firms with savers.
Posted by Alex Tabarrok on September 24, 2008 at 07:37 AM in Economics | Permalink
Comments
If banks are repatriating securitizations on their balance sheet, "total bank credit" goes up without any new loans.
I would treat the claim that "consumer loans are up, commercial and industrial loans are up, even real estate loans are up" with a lot of caution, this is more a case of out the shadow (banking system) and into the light.
Posted by: jck at Sep 24, 2008 7:51:25 AM
The Fed and the ECB have been absolutely flooding the markets with liquidity at an unsustainable rate, and some of that inevitably finds its way into the real economy (that is, after all, the whole point of the exercise).
However, they are now running out of ammunition, and there is no sign that the private sector will pick up the slack. Thus, the credit crunch soon hit the real economy very hard.
Re: your "alternative bridges" idea, maybe we should have a Chinese-language version of Kiva.org, where Chinese households can browse profiles and photos of individual American consumers and choose to sponsor them.
Posted by: at Sep 24, 2008 8:00:11 AM
Well thought out, nice post.
Posted by: Speedmaster at Sep 24, 2008 8:03:28 AM
Bravo,
Kiva.org may be on to something. There is a lot of residual energy out there and it could be used for loan verification.
In fact, w/ regards to alternative bridges, my thesis is that once people finally decide that they can't make money leveraging up on illusionomics, they will have to invest in the real economy and it will be a boon.
Is monetization not helping the banks on the bubble because they really do own garbage?
This can't be about the real economy. These guys aren't in trouble for chasing down healthy investments. They are sick because they binged on credit crack.
Posted by: Andrew at Sep 24, 2008 8:30:47 AM
Good hypothesis.
"Investment banks were selling these securities and using the money to lend to whom?"
Here's mine: see Wall St. bonus figures last year.
Posted by: meter at Sep 24, 2008 9:05:48 AM
Very thought provoking, particularly in reminding us that banks are fundamentally intermediaries.
If banks are starved for funds to lend, why are CD rates so low?
Posted by: ZBicyclist at Sep 24, 2008 9:19:21 AM
Here's one very recent example: http://acrossthecurve.com/?p=1687
Posted by: Nick Rowe at Sep 24, 2008 9:29:31 AM
The current situation strikes me as dumping money on the market to deal with a bubble.
Posted by: aaron at Sep 24, 2008 9:57:39 AM
Interesting hypothesis but I am having a hard time looking at things like interbank lending, and the crunch facing investors, in a vacuum.
I am thinking it just hasn't hit the masses as hard yet. Maybe we can expect to see credit card limits drying up, more difficulty getting car loans, etc., in the future.
So I say focus on rebuilding the broken bridges to keep the money flowing before the worst hits.
Posted by: pants at Sep 24, 2008 10:13:52 AM
Opportunity Cost:
How else could $700 billion be used.
We now have the idea,
"lend directly to the investors who are in need of funds"
for which government would compete with financial institutions in lending.
Good idea.
$700 billion, spent in one of many ways, could go a long way to alleviating the failure of problematic financial institutions.
How else could $700 billion be spent/invested?
Posted by: jamesonburt at Sep 24, 2008 10:30:26 AM
Superb analysis. I haven't checked your links to confirm your claims, but given the premises your conclusions must follow.
Posted by: J Thomas at Sep 24, 2008 10:34:08 AM
This (good) post brings up several thoughts, but first, please see not this: http://www.clevelandfed.org/research/PolicyDis/pdp21.pdf, which discusses the Swedish bailout in the 1990's. They make four points about the structure of a good bailout, one of which is that lending to the real economy needs to be restored--your point. However, I think that they correctly note that the practical way to do this is to preserve the institutions that have the lending relationships with the real economy (see Note 7 on page 8 of 15), hence the focus on the "bridges."
However, the paper explaining derivatives that you helpfully pointed out in an earlier post (thanks) raises another question. Since the 1990's has the growth of a large derivatives market changed the nature of banks as knowledgeable lenders? Do they, in fact, have the relationships that allow them to know where the strength remains in the real economy that allows them to make good loans, or has several years of reliance on (now failing) derivative protection for their loans led them to become money factories that simply chase lending fees by issuing any loan that can be adequately insured?
Posted by: Angus Hendrick at Sep 24, 2008 10:39:53 AM
So, what happens when all the bridges collapse?
Because that seems like a realistic scenario!
Posted by: Robert Olson at Sep 24, 2008 10:48:38 AM
The only reduction in credit I have seen first habnd is that JP Morgan Chase shut down my familie's line of credit. It wasn't a problem because if you have reasonable expectations of earning cash flows well above your expected cash outlays and you can show a lender this it is easy to get more loans. Collateral is also useful. It seems this is how credit is supposed to work.
I say goldman and JP morgan can go bankrupt and it will actually benefit the average person in this country. More intelligent people will be available for innovative productive work...there will always be companies out there who can figure out how to do the appropriate paperwork to do a bond offering or help two companies merge. that ain't rocket science.
Anyone else notice how Buffett bets 5 billion on Goldman then goes on CNBC to do a 20 minute infomercial promoting the Paulson bailout?
This is open thievery.
Posted by: Gabe at Sep 24, 2008 10:52:52 AM
Why do you use quantities instead of prices? I look at prices. If LIBOR minus OIS is record high, if
3-month Tbill was at zero, if junk bond spreads are close to record highs, if even AAA spreads are
wide, if the dollar is trashed, if gold is soaring, doesn't that give self-evident data on the credit
crunch?
How about this for an alternative to the Paulson plan. It might have a gross cost of $1 trillion. The
government goes to all low-income households owning a house with a subprime mortgage. The government
gives the household a voucher to payoff the entire mortgage. In exchange, the goverment gets 50% of
the value of the house whenever it is sold. A debt for equity swap. The restriction: participating
households may not take out another mortgage or HELOC on the house.
Households always have a repayment option on their mortgages, and that risk is known to MBS buyers.
The repayment of the subprimes means that MBS buyers get their principal back. They will be very
happy about that. It would recapitalize the banking system, which is the goal of the Paulson plan
anyway. But we don't have to nationalize the banks to accomplish it.
It would mostly eliminate subprime delinquencies and foreclosures. It would keep houses filled, rather
than empty. It would keep low income people in houses. It would preserve neighborhoods from the
impact of vacancies and foreclosures.
Moral hazard would be limited by the requirement that half of the equity be surrendered to the government.
Only those facing foreclosure or who are underwater would want to participate in such a program.
The McMansions crowd would be on its own.
I bet the program could be wrapped up in a year.
Yes, it is unfair and interferes in markets. So is every other plan, be it Paulson's, Dodd's, or
just letting the FDIC close all the insolvent banks.
Posted by: B.H. at Sep 24, 2008 11:02:12 AM
"Instead focus on the finding and rescuing the victims of any credit crunch, the investors who need funds."
Government is very bad at this. Cf. Small Business Administration.
Posted by: Gary Leff at Sep 24, 2008 11:04:53 AM
There are, broadly, two types of loan: portfolio loans, held by a bank or other intermediary on its balance sheet, and securitized loans, originated by a financial intermediary and sold to special purpose entities which issue securities. The volume of the second type of loans has shrunk to essentially zero, thereby greatly decreasing the volume of originations that financial institutions can handle. The volume of the first type is flat, meaning that portfolio loans are not remotely replacing the reduction in loan availability occasioned by the collapse of the securitization market.
Incidentally, securitization proceeds are generally used to acquire existing loans, which then move off the balance sheets of financial institutions, freeing up their capital for new originations. Securitization proceeds are not generally used to originate loans.
Posted by: y81 at Sep 24, 2008 11:06:03 AM
"Incidentally, securitization proceeds are generally used to acquire existing loans, which then move off the balance sheets of financial institutions, freeing up their capital for new originations. "
you are using a bastardized definition of the word "capital"...just becuase a counterfeiter prints up money, it does not mean that "capital is freed up for investmnet"...no bulldozers were conjured, no humans gained new programming skills, no additional ore was mined. All this conjured of currency by some fractional reserve bank has done is increased the number of people bidding on certain kinds of real finite capital.
Posted by: Gabe Harris at Sep 24, 2008 11:29:43 AM
Not all lending is equal. There may be plenty of loans still being made, but not to the lowest tier consumers and that's affecting a lot of businesses.
Posted by: Ted Craig at Sep 24, 2008 11:40:42 AM
Whoa, the Paultards are here. I will let Alex or another person with a degree in, you know, economics explain why eliminating fractional reserve banking, fiat currency and the Federal Reserve actually isn't a good idea. Also, why it is very unlikely that UFO people are trying to communicate with us. And why you are, in fact, legally obligated to pay income tax.
Posted by: y81 at Sep 24, 2008 11:41:36 AM
What are you basing the "UP" on? I consult in the real estate industry and it is very difficult to get financing for commercial and multi-family real estate deals right now.
Posted by: P&M at Sep 24, 2008 11:41:49 AM
Where you inject the funds in the real economy matters (Cantillion effects and all that). The banks are "filters" as much as "bridges" - the federal government could not take up the task of screening companies and individuals on a case by case basis. Too few filters means some "good" companies would be left without credit, in the short run at least.
Don't you just love metaphors?
Posted by: sd at Sep 24, 2008 11:43:49 AM
y81,
why let alex do it?...why don't you explain how this statement is false?
"just becuase a counterfeiter prints up money, it does not mean that "capital is freed up for investment"...no bulldozers were conjured, no humans gained new programming skills, no additional ore was mined. All the new currency by some fractional reserve bank has done is increased the number of people bidding on certain kinds of real finite capital."
maybe you consult your copy of the communist manifesto to explain why a central bank is so vital.
Posted by: Gabe Harris at Sep 24, 2008 11:55:20 AM
What P&M said. I think Alex is neglecting to consider that whereas before, a bank might originate $100 million a year for its balance sheet and $100 million for securitization, now it is only doing the first part, thereby reducing available capital by 50%.
Posted by: y81 at Sep 24, 2008 12:08:28 PM
"thereby reducing available capital by 50%." The only capital destroyed comes when the bombs are blowing up factories or we double our prison population in a span of 20 years. Making fewer loans does not reduce the real capital available.
The very idea that making loans is good for it's own sake, just because it "creates capital" is the type of thinking that led to incentivizing people to make liar loans in the first place.
Posted by: gabe at Sep 24, 2008 12:30:26 PM
