« Credit demand and credit supply, response | Main | Deflationary expectations »
Credit Demand and Credit Supply
We all now seem to agree that credit in the United States is actually growing during this "credit crunch," albeit at a slower rate than a year ago. Tyler and others argue that growing credit is actually a sign of the credit crunch. A credit crunch may show up "counterintuitively as a spike in borrowing" as firms draw on lines of credit. Contra Tyler this view is certainly "convenient" but I do agree with him that this view is not unfalsifiable.
To wit, let's falsify it. The last time we had talk of a big credit crunch in the United States was during the 1990-1991 recession. Was credit growing during this time as firms drew on lines of credit? No. Most of the credit measures that today are growing were in 1990-1991 flat or shrinking. You can look at the pictures here or look at Table 1 of Ben Bernanke and Cara Lown's well known paper (Google preview, JSTOR here). In 1990-1991, for example business loan growth was zero while today it is well above 10% (the same thing was true in 2001).
Peculiarly, Tyler argues that lack of credit is a leading cause of the crisis but a lagging indicator! As a result, he needs to resort to non-verified conjectures about credit options to support the credit crunch story. I have a simpler story, credit is a lagging indicator because it's credit demand not supply that is the problem. My story also makes sense of the fact that credit usually lags on the upturn as well - a fact which option value has difficulty explaining.
One error that I believe Tyler is making is to assume that skepticism about the credit crunch implies that one must be downplaying the seriousness of current economic conditions. Not true. First, it's quite possible to have a very serious recession with growing credit - we had this in 82, for example. Second, if Tyler is correct that the credit crunch is the primary cause of our current conditions then bank recapitalization should restore the economy to good working order. In contrast, I think the Paulson/Bernanke plan is in trouble because credit demand is shrinking faster than credit supply.
Addendum: In response to Tyler (below) and several people in the comments. Interest rates are not unusually high, certainly nowhere near as high as you would expect given a "credit crunch." In fact, interest rates on say 30 year mortgages are falling and are lower now than at the height of the boom and no higher than in 2002 near the beginning of the boom. I suspect that real interest rates are even lower than nominal rates suggest - inflation expectations anyone? I wish that more people would present their arguments with data and not with anecdotes.
Posted by Alex Tabarrok on October 27, 2008 at 07:05 AM in Economics | Permalink
Comments
Alex, if credit demand is shrinking faster than credit supply, why is the price of credit rising? Isn't supply-and-demand supposed to work the other way?
Posted by: K. Williams at Oct 27, 2008 7:15:31 AM
I have a simpler story, credit is a lagging indicator because it's credit demand not supply that is the problem.
As a business owner, I agree.
As business slows my need for credit is declining. And I continue to receive offers for unsecured lines of credit at attractive rates.
A data point of one, but I'm not seeing any downturn in availability of credit, just a downturn in my need for it. But my business is also not on the ropes, like automakers, big retailers, chain restaurants, etc.
Now, those of you who have money (I'm looking at you government employees and contractors!) should be out there supporting your local businesses, especially small businesses, including local restaurants. Here in the DC area you can find good candidates on Tyler's Ethnic Dining Guide.
Now go, go forth and eat good food!
(No, I don't own a restaurant....)
Posted by: at Oct 27, 2008 7:30:03 AM
Alex,
You're making no sense to me. Zero.
I probably don't know as much as you but I strongly expect I'm more educated and informed than the average MR readers. So, you'll need to be clearer and back things up with a few more facts to convince me, and I suspect, other readers.
Uhm, if demand for credit were shrinking faster than supply wouldn't that mean market interest rates were falling? They're not. Witness the LIBOR, mortgage rates, whatever. Tbill rates are down and everything else is up, b/c folks are hoarding cash.
You say there are no reports of people not getting credit. I'm reading these accounts everywhere. I see everyone, not just here but all over the world, hoarding dollars and buying treasury bills. I see a financial crisis larger than anything I've seen or read about.
Please help me see another viewpoint. So far, your stuff strikes me as an extreme form of self delusion.
Posted by: mike at Oct 27, 2008 7:31:13 AM
Here's another data point. Do with what you will.
BofA has been pushing their 0% balance transfers (for 15 billing cycles) very heavily lately. They'll deposit the money straight into a checking account like a cash advance. It doesn't have to pay off another credit card.
3% fee up front, 0% for the next year and change.
Miss a payment or two and it goes up to 29% (!!) interest.
(I took out $30k. 3% money is 3% money.)
Check out the card offers. It's general, not limited to certain customers.
http://www.bankofamerica.com/creditcards/index.cfm?context_id=marketing_list&category_id=2002
Is this because of cheap funding from the government?
Runs counter to some of the other stories of hard to get credit.
They were falling over themselves to get me to take it.
Posted by: paddyd at Oct 27, 2008 7:40:14 AM
Alex, on your response, clearly interest rates have been *rising* (the relevant comparison, not "high") and the correct expectations are for *deflation*, not inflation.
Posted by: Tyler Cowen at Oct 27, 2008 8:16:37 AM
I probably don't know as much as Alex either but at least I'm more educated and informed than mike. For example, I know not to assume things about averages I can't possibly take.
For the past several years risk has been way underpriced. Partly from century-low rates, partly from hubris. I think Alex makes a good point that even at today the cost of borrowing is historically low. Right now anything with the words "inter bank" in it is proabably not a great way to gauge what's happening outside of the financial sector.
Posted by: David at Oct 27, 2008 8:35:12 AM
Tyler, what you say is incorrect on three counts. First, I said rates on 30 year mortgages have been falling and in the most recent data that is correct. Second, it is very relevant to compare rates across periods - everyone is talking credit crunch when rates are similar to those in the boom when everyone agrees there was a flood of credit! Third, you provide no data on expectations. Here it is. The consensus is inflation not deflation:
http://www.actionforex.com/long-term/long-term-forecasts/global:-inflation-expectations-monitor-2008090358548/
Posted by: Alex Tabarrok at Oct 27, 2008 8:39:18 AM
Two points:
1.) Alex is right that credit demand is down. Speaking with several car dealers from across the country on Friday, they say the problem is getting consumers on their lots rather than getting those customers financed.
2.) One factor that needs to be taken into account is CD rates, which are out of whack with the prime rate. Banks are tapping consumers for cash.
Posted by: Ted Craig at Oct 27, 2008 8:49:48 AM
Miss a payment or two and it goes up to 29% (!!) interest.
========
Regulatory alert!
Had these "penalty rates" been capped, as was hoped by some, the card companies ... would have seen more risk.
The "free-markets" regulatory ideology cuts both ways. Arguably, it made consumer lending companies feel too safe. In this instance, too safe that they could run-up a balance in advance of a recovery proceeding, with cumulative late-fees or variable 'default' rates, and thereby help their "recovery rate" assumptions...
Posted by: Amicus at Oct 27, 2008 9:06:48 AM
LIBOR still rises because banks need a global term structure that can be used as a reserve holding. Banks are waiting for global bond opportunities, and individual economies will be paying a premium for loans until that happens.
The risk facing banks is their inability to sterilize global imbalances. They want to loan globally, but are ringed in by the US dollar as the reserve currency.
Posted by: MattYoung at Oct 27, 2008 10:02:09 AM
By looking at bank lending you are looking at the wrong side of the banks balance sheet.
The growth in bank lending does not show the crises. Rather it reflects the Fed success in offsetting the impact of the credit crunch.
To see the crises you need to look at the other side of the banks balance sheet, how they fund their loans and/or investments. To keep it simple, they do it in three ways. One is deposits. The second is borrowing in the money market. The third is borrowing from the Fed. Clearly, the drop in the volume of financial commercial paper and other short term instruments demonstrates that there is a financial crises. Offsetting this is the massive growth in the Fed balance sheet
that has provided the banking system with an alternative source of funding to offset the drop in money market borrowing.
If you look at the data from this balance sheet perspective you can clearly see that their has been a crises and that the growth in bank lending reflects the Feds success in its lender of last resort in counterbalancing the negative impact of the crises and providing the banks with the credit they need to sustain lending.
The growth of bank lending reflects its normal lagging indicator role. Why are firms borrowing? One to draw on their existing lines of credit because their normal direct access to short term markets has contracted. Second, the early stages of a business cycle is exactly when business credit demands surge as their normal large positive cash flow from sales contract while at the same time their need to finance unusually large inventory holding and to meet their other normal everyday expenditures such as payroll expands. This is an absolutely normal cyclical development and is a major reason bank lending is a lagging indicator.
Posted by: spencer at Oct 27, 2008 10:53:54 AM
By looking at bank lending you are looking at the wrong side of the banks balance sheet.
The growth in bank lending does not show the crises. Rather it reflects the Fed success in offsetting the impact of the credit crunch.
To see the crises you need to look at the other side of the banks balance sheet, how they fund their loans and/or investments. To keep it simple, they do it in three ways. One is deposits. The second is borrowing in the money market. The third is borrowing from the Fed. Clearly, the drop in the volume of financial commercial paper and other short term instruments demonstrates that there is a financial crises. Offsetting this is the massive growth in the Fed balance sheet
that has provided the banking system with an alternative source of funding to offset the drop in money market borrowing.
If you look at the data from this balance sheet perspective you can clearly see that their has been a crises and that the growth in bank lending reflects the Feds success in its lender of last resort in counterbalancing the negative impact of the crises and providing the banks with the credit they need to sustain lending.
The growth of bank lending reflects its normal lagging indicator role. Why are firms borrowing? One to draw on their existing lines of credit because their normal direct access to short term markets has contracted. Second, the early stages of a business cycle is exactly when business credit demands surge as their normal large positive cash flow from sales contract while at the same time their need to finance unusually large inventory holding and to meet their other normal everyday expenditures such as payroll expands. This is an absolutely normal cyclical development and is a major reason bank lending is a lagging indicator.
Posted by: spencer at Oct 27, 2008 10:54:45 AM
By looking at bank lending you are looking at the wrong side of the bank's balance sheet. The point that bank lending is expanding is not a sign that their is no credit crunch. Rather it is an indicator that the Fed actions over the last year to provide large scale financing to the banking system is working.
The crises is not on the asset side of the banks balance sheet. Rather it is in the liability side of the balance sheet where they raise the funds to finance their loans and/or investment. To keep it simple this consist of three items.One is deposits. Two is borrowing in the money markets. Three is borrowing from the Fed.
The crises has been the contraction in the banks ability to borrow in the money markets as evidence by the drop in financial commercial paper and other short term instruments. Everything the Fed has done over the last year to provide special financing to the banks has been to offset or counterbalance the banks inability to funds their operations in the money markets. The fact that bank lending is still rising demonstrates the success of the Fed undertaking its lender of last resort. So again, the growth in bank lending does not demonstrate that their has been no crises. Rather it demonstrates the Fed success in dealing with the crises.
Why are firms borrowing? One of course, is to draw on lines of credit to offset their inability to raise funds in the money market. The second goes to the point that bank credit is a lagging indicator. In the early stages of a business downturn business credit demands typically surges. This stems from the point that their normal source of a positive cash flow, sales are drying up as demand contracts. But because sales are contracting they have to finance an unusual surge in unwanted inventories and their normal day to day expenses such as payroll. Until firms can dispose of their unwanted inventories and cut expenses they have to expand their use of credit. This is why credit demand normally expand sharply in the early stages of a business downturn and why bank lending is typically a lagging indicator. This typical early business cycle behavior is exactly what we are now seeing. This did not happen in the last cycle because it was not a typical cycle. It was caused by a collapse in capital spending, not by a contraction of consumer spending as we are now seeing.
Posted by: spencer at Oct 27, 2008 11:15:54 AM
OK, it's a blog, but still we need to distinguish different parts of the financial market.
Take commercial paper. There's a chart on C1 of the dead-tree WSJ today (Monday Oct 27)showing commercial paper outstanding, dividing it into 3 groups.
(1) Financial commercial paper is tanking -- practically falling off the table. (2) Asset-backed commercial paper is trending downward. (3) Nonfinancial commercial paper is growing.
This suggests people are willing to lend, but not to everybody. But isn't that how things are supposed to work?
Posted by: ZBicyclist at Oct 27, 2008 11:18:31 AM
The phrase "credit crunch" needs to be defined. I don't believe that looking at prices and quantities alone can determine if we're in a "credit crunch". Suppose that there are 4 states in the economy: high, low, normal and crisis. And suppose further that we are currently in a crisis state. A "credit crunch" is the gap between the current (crisis) quantities (or prices) and one of the 3 other states. I would be conservative and say that a credit crunch should be defined as the gap between "crisis" and "low-state" quantities and prices. If we are going to be in a recession, is the current quantities/prices lower/higher that they "should" be? Going into a recession, is a business owner that would have qualified for loans in a low-state not currently able to get a loan? This is the measure that I think is more interesting.
Posted by: bccheah at Oct 27, 2008 11:19:32 AM
"In contrast, I think the Paulson/Bernanke plan is in trouble "
Alex,
I'm afraid you have a hopelessly naive view of the goals of any governemnt plan. Their is always a stated goal which is used to sell the goal to hopless idiots and then there is always a real goal. The two are never the same, to assume such would be the same as assuming that politicians are honest in their advertising.
The real goal is to increase the power of those who are elite enough to get legislation pushed through. The plan has been a great success, the treasurey and the Fed have vast new powers that are centralized and more easily controlled by a small group than previously existed. The poltiically connected banks have decreased competition and are in position to further consolidate their industries. The "crisis" is not over so they will still have much more opportunity to shakedown those have yet to pay their dues and the rank and file taxpayers will be pressured into giving up much more before the situation improves! what is not to like?
On top of all of this the current administration will be conveiently blamed for anything the public finds unpopular as the new president wil have legions of dedicated followers to stand by him for at lest the first 12 months because "we must give him a chance to overhaul the system".
Posted by: Gabe at Oct 27, 2008 11:35:58 AM
I'm still not sure if we have a "credit crisis" or not, but we certainly have a "credibility crisis." And, I'm not just talking about the politicians or finance whizzes now. The economics profession itself must earn some credibility. This means that we need to put aside our pet beliefs that the current situation may or may not be good evidence of (e.g., bailout = moral hazard = cronyism; or government mandates for home ownership is the core problem, etc.) and provide some real data and real analysis. This would seem to call for some straightforward measures of new loans being made - and, if the data is not publicly available, a cry from the profession than we don't have the data we need to do our jobs. It also calls for some clarity about how much of the burgeoning crisis is psychological and how much reflects real fundamental.
I'm not optimistic on the last point, however. I've been an economist for 30 years and I never understood macro and still don't. I'm not sure anybody else does either. When I first studied the subject, I was taught standard Keynesian theory that we could fine tune the economy by calculating the correct government budget deficit. In recent years, Keynesian analysis has become an optional subject in some textbooks. Now, it appears that we are rediscovering Keynes' belief that mass psychology drives business cycles. For all the mathematics and sophistication of our theories, I really have to wonder if we have gained any understanding at all. This is what I mean by a credibility crisis.
Posted by: dale at Oct 27, 2008 12:01:55 PM
If you skipped by Gabe's comments above, go back and read them slowly.
Add this: Neither McCain nor Obama has indicated in any meaningful way that they will reverse this extraordinary increase in executive power.
Add this: Community banks, which generally didn't get involved in the complicated stuff, are now very afraid that they will be taken over by giant banks -- who are now allowed to get bigger than they were allowed to before AND have federally subsidized capital. Sure, the intention is to have big banks buy weak banks, but there's no requirement that it be limited to those.
The crisis wasn't created in order to allow these power grabs, but the crisis allows them to happen because of panic.
Posted by: ZBicyclist at Oct 27, 2008 1:54:36 PM
gabe, you're so right, this is all just a ruse to increase the power of the executive, and in particular the treasury, which makes so much sense for bush and paulson to want to do for obama and whomever he picks for treasury (because the current administration and obama's administration share so many of the same financial goals).
Posted by: dj superflat at Oct 27, 2008 2:00:59 PM
dj superflat,
If you are brainwashed enough to believe that the big democrat donors at Goldman Sachs and the big republican donors at Exxon are honest to god rivals then you must have also believes Rowdy Roddy Piper and the Junk Yard Dog had no common interests.
let me guess, you support the idea that the government should give out monoply rights on money creation to a private group of bankers?
Posted by: Gabe at Oct 27, 2008 2:52:24 PM
Hey DJ,
When I was elected president I gave thanks to a man named Carrol Quigley who was a Georgetown professor.
Ever read his books? didn't think so.
He revealed in his book that as part of his 20-year study of the power structures of the U.S. and Great Britain, he had an opportunity to examine their "papers and secret records."
His book was published in 1966 by Macmillan, which Quigley believed was systematically suppressed. Plates were destroyed to ensure it would not see a second printing, according to a taped interview discovered in Quigley's archives at Georgetown University by Dr. Stanley Montieth. Apparently some of Quigley's benefactors thought the secrets he revealed were better left untold.
But before the book was deep-sixed, Quigley exposed the little-understood fact that both socialist and communist movements in the United States were funded by the Morgans and the Rockefellers and other financial interests. Quigley was amused by the fact that right-wing populists in the United States mistakenly believed that Communist Party subversion was the root of the threat to national security in the 1950s. In fact, he said, it was simply a symptom of the political manipulation of foreign and domestic policies by the financial elite.
"There is, however, a considerable degree of truth behind the joke, a truth which reflects a very real power structure," Quigley wrote. "It is this power structure which the Radical Right in the United States has been attacking for years in the belief that they are attacking the Communists. ... These misdirected attacks by the Radical Right did much to confuse the American people."
Now listen to what Quigley says about the two-party system and its one plan for control of the population: "Hopefully, the elements of choice and freedom may survive for the ordinary individual in that he may be free to make a choice between two opposing political groups (even if these groups have little policy choice within the parameters of policy established by the experts) and he may have the choice to switch his economic support from one large unit to another. But, in general, his freedom and choice will be controlled within the very narrow alternatives by the fact that he will be numbered from birth and followed, as a number, through his educational training, his required military or other public service, his tax contributions, his health and medical requirements, and his final retirement and death benefits."
Posted by: Bill Clinton at Oct 27, 2008 3:36:19 PM
"A credit crunch may show up "counterintuitively as a spike in borrowing" as firms draw on lines of credit. "
If the weather gets warmer, that's global warming. If it gets colder, that's global warming, too. Y'all east of the Mississippi think funny.
Posted by: Tom Hanna at Oct 27, 2008 3:41:50 PM
at least the price of tinfoil for your hats is likely coming down.
Posted by: dj superflat at Oct 27, 2008 3:49:58 PM
Forget about terminology. If Alex is right, this "credit crunch" is not caused by a lack of confidence in the global financial system. Instead, the crisis is the nasty byproduct of a wrenching readjustment of the global real economy. Financial stress is a symptom, not a cause.
Posted by: Mike Mandel at Oct 27, 2008 4:13:53 PM
http://www.nytimes.com/2008/05/09/business/09loan.html
I don't know if this rises to the level of "data", but it may give some color and scale to the credit line issue we have been discussing across other threads here.
It also contains this tidbit:
Loans to companies with risky credit ratings are down 70 percent this year, according to Dealogic, a financial services research firm.
This seems far more indicative of my personal experience in the credit markets.
And this article was written in May before the stuff really hit the fan.
Posted by: diz at Oct 27, 2008 4:16:57 PM
