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Where is the Credit Crunch? III
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. In September I once again pointed to data showing that bank credit continued to be high (even if growth was slowing.) At that time I also discussed how bank loans were not the only source of funds for business investment and that many substitute bridges exist which transform and transmit savings into investment. I suggested that despite the panic the problems which exist in the financial industry may be relatively confined to that industry.
Three economists at the Federal Reserve Bank of Minneapolis, Chari, Christiano and Kehoe, now further support my analysis pointing to Four Myths about the Financial Crisis of 2008.
The myths
- Bank lending to nonfinancial corporations and individuals has declined sharply.
- Interbank lending is essentially nonexistent.
- Commercial paper issuance by nonfinancial corporations has declined sharply and rates have risen to unprecedented levels.
- Banks play a large role in channeling funds from savers to borrowers.
Each of these myths is refuted by widely available financial data from the Federal Reserve. It's a short paper, read the whole thing.
None of this means that everything is cheery. Like most people I think that we are in a recession which is likely to get worse but we need to remind ourselves that recessions are normal. What is not normal is the current level of panic. The panic feels to me like an availability cascade.
Hat tip to Mike Moffatt.
Addendum: By the way, I wouldn't be surprised if credit does start to go down but it will do so because of a fall in the demand for credit not primarily because of a fall in the supply, again an entirely normal aspect of all recessions.
Posted by Alex Tabarrok on October 22, 2008 at 07:41 AM in Economics | Permalink
Comments
Alex:
Have you reconsidered yet your argument in your April 7, 2008 post? Just curious.
Posted by: Dave Prychitko at Oct 22, 2008 7:59:08 AM
Somehow I'm reminded of the Black Knight segment of Monty Python and the Holy Grail, with Alex as the Black Knight and Mr. Credit Crunch as King Arthur.
Posted by: at Oct 22, 2008 8:01:51 AM
Hah! If you click through the link, the paper is titled "Working Paper 666."
were all gonna die.
Posted by: pants at Oct 22, 2008 8:10:30 AM
Sure, sure, I didn't use all dem fancy footnotes an' such, but I said some of the very same things less than three weeks ago.
http://epicureandealmaker.blogspot.com/2008/10/time-to-climb-off-ledge.html
The data is out there, people.
Posted by: The Epicurean Dealmaker at Oct 22, 2008 8:13:23 AM
Now for my less-stupid commentary:
I take issue with the "myths". I never believed that interbank lending was nonexistent, and I don't think most people did. LIBOR shot up past 4% yes, but it wouldn't become nonexistent. It almost is as the paper sets up a straw man or two...
Other things I take issue with:
In the consumer loans graph, I think I see a dip at the end. Maybe it is too early to tell what will happen in the cosumer sector. Additionally, in the commercial paper graph, it *looks* like the nonfinancial sector rates are tracking the financial sector with a lag.
"Thus, roughly 80 percent of such business borrowing is done outside of the banking system. The claim that disruptions to the banking system necessarily destroy the ability of non
nancial businesses to borrow from households is highly questionable."
20% isn't really small potatoes.
Posted by: pants at Oct 22, 2008 8:22:01 AM
If you look at the charts at the back of the paper there is weird movement right at the end. A lot of the time it is spikes (1A, 1B, 2A, 3A, 3B, and 5A), but some of it is downturns (5B). It just seems weird to see spikes in credit availability -- to what extent are the spikes driven by Fed policy? To what extent are these measures of credit is endogenous to Fed policy so that the observed level can't be read off as a sign of "things are fine"?
Posted by: no at Oct 22, 2008 8:27:35 AM
On the individual borrow side, I'm guessing I'm like most people, and I am paying all the interest I want to. The only way I'm going to borrow is with lower fixed rates.
Posted by: aaron at Oct 22, 2008 8:32:55 AM
This seems pretty obvious. The current crisis can be best characterized, in a phrase, as a panic in the shadow banking system (i.e., the system spawned by disintermediation). Thus, securitization has withered, corporate bond issuance has declined sharply, two major investment banks have failed and a third been merged out of existence, the mortgage market GSEs have failed, money market funds have suffered significant problems and one has failed, the CP market has suffered major disruptions, as has the interbank market, etc. Pointing to healthy areas, of which there remain many, within the "regular" banking sector (as opposed to the shadow banking system) may be relevant to describing the precise extent of the crisis (i.e., it primarily affects the shadow banking sector, with only modest spillover so far to the regular banking sector), but that is hardly the same thing as saying that there is no crisis.
Posted by: y81 at Oct 22, 2008 9:09:35 AM
You'll notice an increase in lending around Lehman's bankruptcy. Curious. What's going on is that banks are lending, but they're just lending from facilities that they committed to years ago but never thought they would ever have to lend to (revolvers, liquidity backstops to CP and municipals, consumer lines of credit).
Re: supply of credit, look at the FRB's Sr. Loan Officer Survey. Lending standards tightesxt on record.
Posted by: MDR at Oct 22, 2008 9:11:10 AM
Alex,
What do you think of adding to your common-sense list some incentives to convert traditional IRAs and 401(k) to Roth in 2008/2009?
I think that you have to have additional funds to pay the taxes incurred upon conversion and are not allowed to pay the taxes out of the converted traditonal IRA. I don't see why this rule makes sense in the first place and now would be a great time to waive that rule.
Posted by: Andrew at Oct 22, 2008 9:28:44 AM
Why anyone would *want* to convert a traditional IRA to a Roth in this environment is beyond me.
You'd willingly outlay capital (pay taxes) on underwater investments when the economy is going down the toilet? Really?
Posted by: meter at Oct 22, 2008 9:44:40 AM
I think so. I already lost the drop. I can convert the same number of shares while paying taxes on ~70% of the sticker price. I think the short-term stock price recovery is a wash.
Then, I re-buy in the Roth and don't have to worry about future taxes. I don't see a likely scenario where future taxes are significantly lower than todays taxes. If it is, then I'll be happy anyway.
So, it's kind of like comparing the lost gains on the tax bill compared to what it would be like to take the equivalent of a drop in value on the whole amount of the future tax rate upon withdrawal of the traditional.
I also have personal reasons that make this a good time. I'm not intending to convert all my traditional IRA holdings and pay a huge tax bill. The vast amount of growth is ahead of me and for a few thousand bucks I can make it free and clear. I also think I'll want the flexibility of a lump sum upon retirement. I figure personal jets will be affordable by then.
Seems like a win-win for the gov't too. At least it kicks the can a little further down the road.
Posted by: Andrew at Oct 22, 2008 10:08:50 AM
Seriously. Are you saying that there is no credit crunch? Here is some evidence to the contrary.
(1) Net mortgage equity withdrawals by households have dropped to zero.
(2) The Fed's Senior Bank Loan Officer survey finds the net percentage of respondents who are tightening lending standards is one of the highest, if not highest, on record for mortgages, C&I loans, and consumer credit.
(3) Commercial paper outstanding has collapsed, particularly in asset-backed and financial.
(4) Commercial paper yields have risen (until past few days).
(5) Jumbo mortgage rates are 7.8%, the highest in years, despite a near record low on the 30-year Treasury.
(6) Junk bond yields exceed 10%, the highest since the WorldCom bankruptcy.
(7) Even highly-rated corporate bond yields are at a six-year high, despite a 1.5% fed funds rate.
(8) LIBOR is so high, it is as if the Fed never eased.
The argument about C&L loans on the balance sheet misses the point that banks have been forced to absorb liabilities that were kept off their balance sheets. The system balance sheet is shrinking, even though the record balanc sheets are not. The public sector balance sheet is expanding to compensate.
We are in a serious credit crunch, and it has caused a recession. Let's get beyond denial. If the public sector balance sheet had not been expanded to compensate, we would have the worse recession in 70 years.
Posted by: B.H. at Oct 22, 2008 10:19:03 AM
B.H. -- Did you even read Alex's piece, or the article he cited? He and the paper are talking about conditions in the commercial and industrial (i.e., non-financial) space. Virtually all of the evidence you cite pertains to financial or consumer borrowers.
No-one in their right mind denies that we are experiencing a credit crunch, and most of us expect it to spill over into the "real" economy sooner or later. The point of Alex's post, on the contrary, is that we have not seen very much evidence that it has yet, at all.
Non-financial corporate clients I deal with every day are finding funding in the current environment volatile, difficult, and more costly than in the recent past, but it is not frozen or shut down the way lending in the financial sector (and perhaps the consumer sector) seems to be. Should it truly freeze the way the financials have, we will all be in deeply serious trouble, as you suggest.
Posted by: The Epicurean Dealmaker at Oct 22, 2008 10:34:50 AM
B.H. it's important to put things in context. Commercial paper outstanding from financial firms has dropped but to the levels of say 2004-2005, same thing with yields. Not the end of the world, not the end of capitalism, not the Great Depression.
Posted by: Alex Tabarrok at Oct 22, 2008 10:36:40 AM
It seems that so far the financial crisis has done even less damage to the real economy than we thought. Enouraging, even though any economic modelling that I am acquainted with (just acquainted, I don't know them well enough to call them friends) suggests that the main effects can be expected to have about a 2-4 quarter lag.
Posted by: Diversity at Oct 22, 2008 10:49:12 AM
Alex,
I think this reinforces the view that the bailout was another "let's get those WMD"-type operations. I.e. surely you don't think the Paulson was ignorant of these types of facts when he was scaring the heck out of people, saying small businesses were going to miss payroll.
Posted by: Bob Murphy at Oct 22, 2008 11:13:14 AM
The commercial paper rates cited are aggregates that hide the dramatic shift: rates for less creditworthy nonfinancial corporations have exploded. I put up a graph a few weeks back. The latest data from the Fed shows the same thing, rates above 5% for short-term commercial paper for nonfinancial companies without a perfect credit rating compared to 1-2% for companies with perfect credit catings. Usually, the spread is less than 50 basis points.
Posted by: Archit Shah at Oct 22, 2008 11:17:48 AM
It doesn't get much clearer than this that our credit stimulus plan without a stimulus was negotiated by the government with far too generous a deal. From the Washington Post:
http://www.washingtonpost.com/wp-dyn/content/article/2008/10/21/AR2008102102520.html?hpid=topnews
"When the Treasury's program was announced last week, some bank executives said they didn't need the money and resented the federal intrusion. But in a number of earnings calls and interviews in recent days, several bank executives were more receptive.
The federal deal is relatively sweet in financial terms -- it requires banks to pay 5 percent interest annually on the investment over the first five years -- and some bankers said they would not pass it up.
A number of local banks are strongly considering applying for the Treasury program.
Virginia Commerce Bank, which has 26 branches and $2.2 billion in deposits, said it is looking to add $25 million to its capital base by the end of the year. In the past, the company said it was considering issuing stock to raise that capital, but the bank said yesterday that it may apply to the Treasury's program.
"Quite frankly, it is a very attractively priced alternative," chief executive Peter A. Converse told analysts."
How about this, from the NY Times:
http://dealbook.blogs.nytimes.com/2008/10/21/gmacs-hope-lies-in-future-as-a-bank-hedge-fund-says/#comment-382536
"Only a week after the government announced $250 billion in capital for banks, some investors are getting creative in their suggestions on who should qualify.
David Bullock, managing director of Advent Capital Management, wrote a letter to the chief financial officer of GMAC on Tuesday, suggesting that the former General Motors financing arm turn itself into a bank holding company so that it can grab some of the cash.
In Europe, Mr. Bullock pointed out, parts of the auto industry are benefiting from bank rescue.plans. So why not in the United States?."
I'm not making this up. Here's my comment:
“Only a week after the government announced $250 billion in capital for banks, some investors are getting creative in their suggestions on who should qualify.
David Bullock, a hedge fund manager in New York, wrote a letter to the chief financial officer of GMAC on Tuesday, suggesting that the former General Motors financing arm turn itself into a bank holding company so that it can grab some of the cash.”
Come on ! How onerous can the terms of TARP be that people who don’t need it are starting to line up to receive it? What more proof do we need that the government negotiated a terrible deal for the taxpayer?
The next thing we know, Google and Apple will be turning themselves into banks. Can I have myself declared to be a bank?
— Posted by Don the libertarian Democrat
Maybe they're not using the money for lending because they don't need it for that.
Posted by: Don the libertarian Democrat at Oct 22, 2008 11:30:53 AM
The information from Archit Shah is useful - but if the aggregates are hiding the dramatic shift this can only be because most firms are not facing exploded rates.
One thing I don't like about focusing on rates/price is that what we ultimately care about is quantity not price.
Posted by: Alex Tabarrok at Oct 22, 2008 11:31:28 AM
If you look at the yield spread for long term bonds, things are not looking pleasant (graph till 2008-10-17):
https://research.stlouisfed.org/fred2/fredgraphfile/?graph_id=9122
I'm not convinced that this spread will come down as easily as that of commercial paper market, the more so because a lot of debt is maturing in 2009, compared to 2008.
Posted by: kurt at Oct 22, 2008 12:18:59 PM
I provided some related and supporting data in an Oct 1 piece for Forbes.com called "Bank Credit Has Not Dried Up."
http://www.cato.org/pub_display.php?pub_id=9685
Turn on CNBC, however, and you are sure to hear someone wondering what it will take to "get banks lending again." This is just one of many cases in which the Fed, Treasury and/or Congress rush to fix something, regardless of the expense, before figuring out if it's really broken.
Posted by: Alan Reynolds at Oct 22, 2008 12:28:58 PM
As a different look at the health of the commercial paper market, note that much more issuance than usual is in the 1-4 day maturity range.
Posted by: Tom Maguire at Oct 22, 2008 12:50:50 PM
The paper is probably drawing the wrong conclusions from the available data.
1. Bank lending is rising at least in part because of past commitments to lend under revolving credit facilities that are now getting drawn upon when corporations are unable to access the CP markets.
2. Absolute rates are irrelevant, one needs to look at relative rates, e.g. how much more than the Fed funds rate do corporations have to pay. That is the best measure of risk appetite.
3. The data on rates says nothing about the volumes, e.g. 3 month rates may not move, but it may only be the very highest quality borrowers who are issuing commercial paper, everybody else might only be able to raise funds in the overnight. That scenario would see no movement (or even a tightening) in rates, but be indicative of deteriorating credit conditions.
Three instant ones I could think of, there are probably more... and not to be disrespectful, if that came out of the New York Fed rather than Minnesota, would be more inclined to accept its conclusions.
Posted by: Damian at Oct 22, 2008 1:03:38 PM
This data simply doesn't square with the reality companies are facing right now.. or at least my company is facing right now.
Why is the CP rate reflected in their chart way less than LIBOR? Perhaps the author's data primarily reflects 3 month CP rates issued prior to the crisis and still outstanding. Or perhaps since company's are using CP less, the overall blended rate hasn't increased very much.
My company's CP is now well over 6%, relative to 3% prior to the Lehman failure. I find it hard to beleive that the data would show a rate as low as 2.5% were it to simply show new issues over the last few weeks, rather than an average rate including pre-lehman CP that hasn't matured yet.
The data might also be skewed by the fact that only the highest quality borrowers still have access to the market.
Also, note Mr. Maguire's correct comment that there is a big dif between overnight CP and 90-day CP... many companies have been forced to go with very short maturities.
Lastly, not sure we should compare current levels to historical levels w/out also considering historical market conditions. A better measure might be looking at rate spreads, for example.
Posted by: Whit Stevens at Oct 22, 2008 1:04:15 PM
