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The credit crunch: I still cannot agree with Alex and Bryan
Alex is a very good truth-tracker but on credit I remain stubborn in my belief that there is a credit crunch. Here is one report:
How is trade finance coping with the credit crunch
Badly. Steve Rodley, director of London-based shipping hedge-fund Global Maritime Investments, puts it bluntly: "The whole shipping market has crashed." The trouble is that credit is the lifeblood of commerce, but it is built entirely on trust. And that has evaporated. As such, many ship owners can't get banks to issue letters of credit, particularly on cargoes of price-volatile commodities that no longer look like adequate collateral. Even those who can get letters of credit are finding that their counterparties may no longer trust the credit rating of anything other than large, well-established banks, many of which are now charging big premiums. Letters now cost three times the going rate of a year ago, according to Lynn.
Here is another report. Here are other reports. Or read this account:
What's more, the dollar-denominated trade finance lines that exporter companies rely upon to do business are drying up in dramatic fashion amid the global credit crunch. In Brazil -- the world's top exporter of beef, iron ore, sugar and coffee and the No. 2 exporter of soy -- total outstanding trade lines have fallen by half this month to around $18 billion.
Here are simple and in my view decisive quantitative indicators of the current domestic credit crisis. Or here is another report:
According to experts interviewed by Bloomberg, "letters of credit and the credit lines for trade currently are frozen," and as a result, "nothing is moving".
Or here is a recent survey of U.S. retailing CFOs:
Some 41 percent of US retailers are seeing tight credit as a result of the crisis in the banking sector, and many will cut staff and reduce buying as a result...
Many other surveys paint a similar picture. I can only repeat my earlier words that immediate credit flows are demand-driven and they do not measure bad credit conditions concurrently because they stem from prior bank commitments. To suggest, as commentator Tom does (and Alex endorses), that we have no credit crisis until lines of credit are exhausted, is in my view sheer logomachy (I like that word). Nor is my view "convenient" or unfalsifiable as was suggested. Here is Wikipedia on lagging indicators and yes it tells you that standard forms of credit fall into this category and this has been understood for some time. Look instead at the currently informative pieces of the evidence and you will see that they point in a very consistent direction.
It is true that many credit channels have not shut down. But the ones that are shutting down are enough to cause a severe global recession.
Addendum: I added this comment to the discussion: "People, financial markets and financial institutions around the world are falling apart. I'm not pulling this stuff out of a hat or from a few crazy journalists. There is massive disintermediation going on right now, much of it in the shadow banking system. I am trying not to be dogmatic but it is hard for me to see on what grounds anyone would deny this."
Posted by Tyler Cowen on October 25, 2008 at 02:38 PM in Current Affairs | Permalink
Comments
Might I suggest that the proper way to solve a "trust" problem is with transparency. One might be able to successfully break through the logjam by creating a new kind of information market.
The alternative would seem to be to allow the crisis to continue until the government acts to nationalize the "non-trusted" institutions and solves the information problem by owning it all, not to mention all the assets as well. Highly wasteful, not to mention a strategy that exposes taxpayers to an enormous amount of risk and imposes immense deadweight losses on positive economic activity.
Posted by: Ironman at Oct 25, 2008 3:42:07 PM
Alex's account of the non-existent "credit crunch," with its reams of data, is much more conclusive than yours. You can stop beating the "world is going to end" drum anytime you like.
Posted by: alejandro at Oct 25, 2008 3:45:21 PM
I'm still having a hard time sensing the big difference. Lending could still be going on, yet, at the same time, businesses and banks could be preparing to cut back in the near future because of concerns that:
1) Funds will dry up
2) Fewer people will borrow
3) Banks will be very tight in lending.
It could well be that there is no crunch or severe contraction showing up so clearly as yet because no one is sure what the government's actions will be or accomplish, and it's not clear how severe the downturn might be. It seems like your data, which you and others understand better than me, points to an impending crunch, while Alex's is showing that the crunch hasn't hit as yet, or not to the degree that some have predicted.
Posted by: Don the libertarian Democrat at Oct 25, 2008 3:58:56 PM
Here's some anecdotal evidence, for whatever it is worth: I work for a retailer that imports ~$300 million/year in merchandise. I haven't heard of any snags at getting goods into the country as a consequence of this "crisis"...
Posted by: jb at Oct 25, 2008 4:12:11 PM
I've been reading these exchanges with great interest. I can well believe that there is a crisis, and that it could get (unnecessarily) worse if we do not take dramatic actions. However, I do think it is reasonable to ask for some evidence - and the more supposed evidence that appears, the more skeptical I get. The latest evidence that Tyler posts is not convincing to me. Of the 5 powerpoint slides, 4 of them show interest rates (not quantities) and one shows the quantity of overnight commercial paper - clearly something that has collapsed but does not match the rhetoric about credit throughout the economy drying up.
The statistics from shipping are pretty dramatic. The collapse in the Baltic Dry Index is scary - but it has dropped to levels last seen in 2005, when I don't recall anybody talking about a crisis. Can somebody please explain why it is crisis for that index to reach levels not seen for 3 years? Where is the new mortgages issued data? The only "evidence" I've really seen is the Minneapolis Fed data. Sure, it may miss the point (although the comment that it might be believed if it was from the NY Fed was pretentious and insulting and unfounded), but at least it is evidence. Why is it so hard to find some clean data that shows just how hard it is to get credit now? And, I'd like data on how it is hard to get credit if you are a good risk. The fact that risky borrowers are having a hard time getting credit sounds more like a solution than a problem to me.
Posted by: Dale at Oct 25, 2008 4:31:45 PM
Plus, if this "shipping market has crashed" scenario was anything more than anecdotal wouldn't (those) commodity prices be spiking?
Posted by: RLH at Oct 25, 2008 4:37:41 PM
Even those who can get letters of credit are finding that their counterparties may no longer trust the credit rating of anything other than large, well-established banks, many of which are now charging big premiums. Letters now cost three times the going rate of a year ago,
Oh Noes!!!!1 You might have to pay 3% for a letter of credit instead of 1%. That will have HORRIBLE side effects because OBVIOUSLY consumers could never handle a 2% increase in grain prices. I mean, I've paid 4% more per year for the last three years, but OBVIOUSLY the market couldn't possibly sustain 2%.
This is just like the ATROCITY of banks having to pay .2 bps more on interbank loans (5% instead of 4% annualized on a one-month loan). Obviously, banks are entitled to pay .2 bps less than they are now, and they are ENTITLED to that rate, and we must do everything in our power to prop up businesses models that sensitive to small changes in interest rates.
*rolls eyes* *jerk-off gesture*
Posted by: Person at Oct 25, 2008 4:40:55 PM
small scale similar situation:
in Romania in the last 3 years there was an intense 'easy credit' policy;
What happened? the realestate industry was doing great, most Ro bilionaires appeared.
what's happening right now? recession, the realestate industry is down.
____________________________________
What happened to US?
A generalized such policy;
Will it contnue? No.
Why? The world can't afford it and especially the US (in other words, the winners have been already chosen, now we want some loosers to make it look like a democratic system)
Posted by: Danut at Oct 25, 2008 5:05:23 PM
I gotta say, Alex's analyses are looking much more compelling right now. Most of what you just posted is good evidence for the statement "a lot of people think there is a severe credit crunch right now". Alex argued (successfully imo) that those people are wrong.
Posted by: MikeF at Oct 25, 2008 5:59:06 PM
"According to experts interviewed by Bloomberg..."
How many times have you cited the fallibility of the press on your blog? When economists cite news media, it usually means actual data is scant. Who says LOCs & trade credit are frozen? In all sectors? In all countries? I went to the market yesterday. They were stocked. Retail in general seems to be able to get trade credit.
Banana exporters? Who can't get it?
Posted by: Max Rockbin at Oct 25, 2008 6:02:00 PM
People, financial markets and financial institutions around the world are falling apart. I'm not pulling this stuff out of a hat or from a few crazy journalists. There is massive disintermediation going on right now, much of it in the shadow banking system. I am trying not to be dogmatic but it is hard for me to see on what grounds anyone would deny this.
Posted by: Tyler Cowen at Oct 25, 2008 6:19:43 PM
Here's anecdotal evidence from commenter "GA", writing elsewhere at MR, that undermines Tyler Cowen's anecdotal evidence about Letters of Credit: "The circumstances I work in show letter of credit usage going UP, not down. Effectively, open export (where the exporter simply takes the risk the importer won't pay) and other less formal forms of "trade finance" are under severe pressure, and largely cut off for many markets. This is forcing importers/exporters that have rarely used L/Cs to start using it (and other more formal documentary credits)." That is a very different scenario from a credit crunch.
Posted by: parviziyi at Oct 25, 2008 6:25:32 PM
Yep, the level of insouciance is striking. Anyone who has been reading the WSJ with any level of attention for the last month has seen lots of reports of tighter trade credit. I would rather not wait until the point that we're fighting for canned beans at the Safeway.
Posted by: Colin Danby at Oct 25, 2008 6:41:34 PM
I think what Tyler and Alex are both trying to say is that credit markets are a lot like Lloyd Bridges' character in "Airplane!"
Posted by: David at Oct 25, 2008 7:18:03 PM
The "decisive quantitative indicators" are not decisive at all, at least not in answering the question at hand. The 3-Month T-bills and High-yield bonds are not really relevant here. The other three, in so far as they are related to credit, are only about banks lending to one another. No one is denying that banks are having trouble lending to one another, that is a market signal we should not attempt to go around.
The bottom line is that these are banks that have taken very bad decisions and are now in deep trouble. No one wants to lend to them, and they shouldn't be forced to.
People who deserve to be lent money have been hit only a very little. I got a new credit card last week with excellent rates. Many industries have not reported any trouble, and the evidence Alex presented is pretty convincing. That the banks that should be bankrupt can't get credit doesn't show that there is a credit crisis, it shows that they're bad institutions.
However, because of the bail-out and all the extra tax burden and inflationary effects it is likely to have, there will probably be a credit crunch in the rest of the economy soon. At that point, the end of the world drum-beaters will have gotten the world to match to the reality they've been telling us about.
Posted by: sindibad at Oct 25, 2008 7:27:21 PM
a credit crunch does not mean credit is unavailable for everyone, but for a significant enough minority.
if one person presents anecdotal evidence that people are getting along fine, and another presents anecdotal evidence that the credit crunch is real, then in total you now have evidence that the credit crunch is real.
it's shocking to see how many people here seem so invested in the idea that this is all made up. it's possible this will turn out to be not as bad as most think, but the preponderance of the evidence right now suggests a recession is inevitable.
Posted by: sean at Oct 25, 2008 7:33:44 PM
A few distinctions might be helping, to avoid "logomachy" (thanks for that) and just simply talking past each other.
- Credit collapse: inability to lend, at any price, because of capacity wipe-out
- Credit disaster: price of lending is at economically destructive levels, even though the capacity to lend exists
- Credit dislocation: a sudden, panic-driven, temporary financial revaluation causing credit prices to spike (or fall)
- Credit adjustment: an economic dislocation, driven by event, perceived or real, that causes a step-up in the assessment of all credit risks (or a step-down), with serious, but not severe, economic adjustment
- Credit tightness / scarcity: temporary restrictions in lending *levels*, that may or may not crimp real activity in a mild way
- Credit pinch: paying slightly more for the same amount of credit, just enough to squeeze profit margins and be a real pain
Globally, all of these seem to be happening or have happened to various degrees.
Everyone is correct. Yet, no one is "right". :-)
btw, this is just an informal listing
Posted by: Amicus at Oct 25, 2008 7:37:26 PM
Tyler Cowen's five "simple and in my view decisive quantitative indicators of the current domestic credit crisis" are all beside the point. Let's do them one by one:
(1) Very low rate on 3-month Treasuries. Indicates panicky market sentiment, but market sentiment is not a fundamental indicator of anything other than market sentiment.
(2) 3-month LIBOR. The banks are not engaging in 3-month interbank lending because (a) loads of money is available for interbank overnight lending, at vastly lower interest rates than the 3-month rate, and any solid, well-managed borrowing bank is able to get most of its needs through recurring overnight loans, and (b) last December the Fed introduced the special "Term Auction Facility" for 30-day and up to 84-day loans, "designed to address elevated pressures in interbank lending", which today acts as a replacement for the money-center banks nonovernight interbank lending. (A few weeks ago the Fed expanded the Term Auction Facility further.) As Tyler knows well, the Minneapolis Fed document in Chart 5A shows that interbank lending -- as of October 8 -- is higher than at any time during the years 2002 through December 2007, and is about the same now as six months ago. This interbank lending statistic includes overnight lending as well as 3-month lending. Right now, I think no sound bank would wish to be in the 3-month LIBOR market as a borrower because of the attractive alternatives.
(3) The TED spread. See (1) and (2) above.
(4) High yield bonds. The prices of outstanding high-yield bonds have gone down a lot recently (meaning their interest rates have gone up) because, yes, we're about to have a recession. Corporate bonds as a group and high-yield especially are much more susceptible to default in a recession, and it's only fair that there prices should go down at the start of a recession. Obviously, this has absolutely nothing whatsover to do with a credit crunch.
(5) Overnight commercial paper. The graph pointed to by Tyler Cowen here shows the interest rate on overnight commercial paper, and shows the rate droped significantly in October, going to a low of 1.15% earlier this week. I'm unsure what Tyler's point about that is. Anyway here's from a news item dated Oct 24: "Overnight commercial paper... jumped 1.03 percentage points to 2.75 percent." That puts it back now to the rate it had last June. So, whatever Tyler's point might have been, it seems it has been annihilated by a couple of days trading. (http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aY4F0Fk0CLLw). The same news item also says the recent fall in the overall volume of commercial paper has been pretty dramatic. The collapse is scary - but it has dropped to levels last seen in 2005, when I don't recall anybody talking about a crisis. Can somebody please explain why it is crisis for commercial paper volume to reach levels not seen for 3 years? (Thanks for the laugh, Dale!)
Posted by: parviziyi at Oct 25, 2008 7:42:33 PM
@parviziyi
In response to your (2) point, I don't think you're taking into account the supply side of inter-bank loans. If LIBOR is too high compared to other funding sources then this is an arbitrage opportunity. All banks must do is:
(1) borrow from the Fed at low rates
(2) lend to banks at higher LIBOR reates (pushing LIBOR rates back down)
Therefore I can think of two reasons that LIBOR is still high:
(A) banks are afraid other banks will fail
(B) banks have lost more money or will lose more money than they have admitted and just don't have enough cash to pursue the arbitrage
Either way, high LIBOR remains an indication that banks are in bad shape and that their credit is scarce/costly.
Posted by: Brian at Oct 25, 2008 9:00:40 PM
The cause and the effects are reversed time and again.
Credit crunch. Bad policy. Bad policy. Credit crunch.
The question is: how were the toxin's developing during Oct 2007 and Aug 2008? And how were they doing during the last two months and since the bailout?
Posted by: Cowcup at Oct 25, 2008 9:03:03 PM
I recently incorporated my consulting business, mostly for health care reasons. (As in, insurers wouldn't give my son a policy, even with a rider, because of his heart murmur.) I opened my business checking account about 2 weeks ago. Because of this argument between the Titans of MR, I decided to apply for a credit line with my bank, even though I don't really need one.
I'm sure you are all waiting with baited breath to hear the answer. I have to turn in the form on Monday. We'll have to see, but the lady gave me no indication that I might be denied.
So in addition to all of the measures Alex has reported, and all of the anecdotal stuff people like David Henderson (and my next door neighbor, a very successful businessman in our city), I will have yet another data point, assuming they give me a line of credit. And keep in mind, I haven't proven jack squat to them. It's not like they can look at eight years of sales data for my business, or that they read MR and realize I am a genius.
Finally: If they deny me a credit line, then I will side with Tyler...
Posted by: Bob Murphy at Oct 25, 2008 9:38:31 PM
Has anyone else noticed the URL of this thread? Did Tyler initially title it, "Do not listen to my moronic colleague!!" and then decide to lighten the tone?
Posted by: Bob Murphy at Oct 25, 2008 9:40:16 PM
Alex's account of the non-existent "credit crunch," with its reams of data
Reams of data are worthless without insight.
Posted by: ogmb at Oct 25, 2008 10:09:40 PM
@Brian re: Interbank lending and the Term Auction Facility. Why the Libor rate is totally meaningless
The following is from http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a7dTUjE8xx9c
Oct. 21 (Bloomberg) -- Results of the Federal Reserve's $150 billion auction of one-month loans through the Term Auction Facility (TAF) on October 20.... Banks and securities firms bid for less than the entire amount offered, for the second consecutive auction. The immediately preceding auction was on October 6. Until October, financial institutions had bid for more than the amount offered at each auction since the Fed began the auctions in December 2007.... Earlier this month the Fed increased the amount on offer.... The rate for the loans yesterday was 1.11 percent, matching the minimum allowable bid. [By contrast], Libor one-month dollar loans were 3.75 percent yesterday.... The minimum auction accepted bid set by the Fed, a rate based on a measure known as the overnight indexed swap rate, is based on traders' expectations for what the overnight fed funds rate will average over the term of the credit being auctioned [i.e. the cost of one month of recurring overnight loans]. Financial institutions submitted $113 billion in bids for the $150 billion offered, resulting in a bid-to-cover ratio of 0.755. This compares with a 0.92 bid-to-cover ratio at the auction for three-month loans on October 6. There were 74 bidders yesterday, compared with 71 bidders at the Oct. 6 auction.
In the October 6 auction, where the three-month TAF loans were offered, the interest rate accepted was 1.39 percent, the minimum allowable bid. To repeat, the banks didn't take up all of the offered 3-month TAF money at 1.39 percent. The banks already have more money than they know what to do with! For Bloomberg's news report on the auction of the 3-month loans see http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aFoF49XHQ7_k
Posted by: parviziyi at Oct 25, 2008 11:01:13 PM
I say we all just agree to tie the question to Bob Murphy's impending credit line (or lack thereof). If he gets it, Tabarrok was right; if not then Cowen wins.
Posted by: MikeF at Oct 25, 2008 11:49:21 PM
