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Credit demand and credit supply, response
I don't agree with much of Alex's take. Is he suggesting that the crisis started because *borrowers* lost their appetite for loans? If so, why in his view is the measured credit aggregate doing fine? In terms of what really happened, the core story is that the financial systems of many countries have been hit by solvency shocks, some credit markets (not all) have frozen up, we have zombie banks, asset prices tank, and now yes the demand for credit will be going down as well.
Does Alex deny the "solvency shock"? Or does he think you can have such a shock without some credit markets freezing up? His post does not tell us but I find either position extremely implausible.
By the way, LIBOR and many other interest rates are rising, not falling; that is not what you would expect if falling credit demand were the key problem. Nor does Alex mention the "shadow banking system," a core part of the current disintermediation. There is no way to explain away what is happening there and of course that is not counted in the aggregates Alex consults. There also has been a massive liquidity scramble in some sectors which again is inconsistent with falling credit demand as the problem.
The current punishment of the banking system goes far beyond the early 1990s; today's credit crisis is driven by insolvency and potential insolvency but the 90s did not devastate finance or anything like that. And I'm not especially sanguine about bank recapitalization, as I've indicated in numerous posts to date. For one thing, politicization has its own costs but more importantly there is no guarantee that recapitalized banks will lend on the appropriate scale.
I can at least say with confidence that either Alex or I is totally wrong on this matter.
Posted by Tyler Cowen on October 27, 2008 at 07:01 AM in Economics | Permalink
Comments
"The current punishment of the banking system goes far beyond the early 1990s;" and yet, as I show, credit aggregates are stronger now than in the 1990s.
Posted by: Alex Tabarrok at Oct 27, 2008 7:56:58 AM
Have either of you bothered to talk with anybody in finance? Especially anybody outside New York? And I don't mean a stock analyst. I mean somebody involved in day-to-day operations.
Posted by: Ted Craig at Oct 27, 2008 8:09:53 AM
Alex is totally wrong. He doesn't seem to know of the existence of disintermediation or the extent of the growth, over the past ten years, and collapse, over the past 18 months, of the shadow banking system.
Posted by: y81 at Oct 27, 2008 8:49:37 AM
LIBOR still rises because banks need a global term structure that represents the best estimate of global productivity growth. If they had such a term structure they could park their funds by investing along this term structure, and thus hedge the global imbalances.
With the dollar as the reserve currency, the USA term structure always pokes its head up and distorts any effort for a global bond strategy. In essence, by not having a global term structure, they pay extra duty in the equity premium by relying on the US term structure.
Banks are waiting for an orderly demand for global loans to emerge, unrestricted by the smaller, shorter term structure of the USA. They have reached the point in which global imbalances risk their position.
The answer is not to kick start the individual economies, but to create a time limited global fund, large enough and profit oriented such that each national economy could see positive returns from term investing in the best estimate of global productivity. If such a thing existed, then sterilization of imbalances would be more rapid and leakage between the pseudo global term structure and the real global term structure would slow way down.
So, you are both correct, there is a lack of structured global demand for loans, and their is a solvency crisis. Both result because national banks do not have a global bond term structure to use as reserve capital.
George Selgin would agree with me, I suspect, so ask him to arbitrate.
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