Warning: This is a village idiot post. I am utterly unqualified to be talking about business cycles.
We all know that the U.S. economy is in a bad way. The signs of mayhem are all around: rising unemployment, falling sales, failing businesses. This Thanksgiving my family besieged me with questions about why, and I gave the standard answer. “All these credit institutions invested in this crazy sludge, which may have no value. So they’re rebuilding their balance sheets in order to protect themselves, a fancy way of saying that they’re not lending. No lending, and businesses go under when they can’t borrow to meet lumpy expenses.”
It sounded good, a short unified field theory of financial collapse. It certainly convinced my relatives, all of whom run or work for small businesses in metro Miami. But was it true? I got on the internets and downloaded some data to check it. What I found perplexed me.
For those of you who don’t want to be bothered by the full chain of discovery, I’ll cut to the chase: I was surprised to find little evidence of a credit crunch, even more surprised to be told that a bunch of economists at the St. Louis Fed had gotten there first … and then rather relieved (in a perverse way) to learn (courtesy of Dante Roscini) why there was in fact plenty of evidence that a lack of credit is in fact directly slapping around the real economy.
Details below the fold.
Energized by my relatives, I went over to the Fed’s website to check out the figures on the volume of credit out there. And what did I find? The following:
Which sort of stonkered me. The volume of outstanding non-financial paper has barely budged? Really??
Well, what about the volume of bank loans? Up. Consumer credit? Stable. Interest rates? Stable. Sure, spreads have exploded, which is a sign that something is wrong with the credit market … but from the point of view of a borrower, who cares about the spread? The gross figures seemed to indicate that the same amount of credit was available at more or less the same price. How could that jibe with all the mayhem in the real economy?
I had three hypotheses.
(1) The bailout worked. Sure, huge spreads indicate that the underlying stresses are still there, but the credit markets have been kept in operation. The recession is due to the construction industry falling off a cliff consumers running for the hills in the face of declining house prices. It is not due to otherwise healthy firms packing it in due to a lack of credit. Please note that this is still a pretty bad situation, especially considering as the huge spreads are an indication that the American economy has fallen right into a liquidity trap. My simple story is wrong.
(2) The bailout has worked … so far. Huge spreads indicate that the underlying stresses are still there, and everyone expects the shoe to drop at any moment. (For example, see this suggestion that the credit card market is about to implode.) The recession is due to consumers and investors running for the hills in anticipation of the coming credit crunch, not otherwise healthy firm packing it in due to a lack of credit. (Please note the same caveat as above.) My simple story isn’t quite wrong, but it’s more complicated.
(3) I’m looking at the wrong things because I’m not very bright.
When I asked my colleagues about the discrepancy between the tranquil quantity data and the madness in the real economy (let alone the insanity in the data on spreads), Matt Weinzierl informed me that, sadly, I wasn’t the first person to notice that credit volumes seemed to be holding up. He cottoned me on to this paper. It went through more-or-less the same thing as my ad hoc Thanksgiving analysis, adding graph after graph to make the point that neither bank lending nor interbank lending nor commercial paper issuance has declined. Take a bow, Messrs Bernanke and Paulson! Maybe you could’ve done the rescue cheaper and fairer, but rescue you did. Huzzah.
Niall Ferguson, however, suggested that I might be looking at the wrong thing. “The banks’ balance sheets are a nightmare precisely because they can't contract lending (too many pre-agreed credit lines still open) and their capital is vanishing. So new credit is harder to come by than your figures indicate.”
And, finally, Dante Roscini explained exactly what it was that I was missing. It came to a lot.
(1) That crash in asset-backed commercial paper in the above picture? It isn’t an epiphenomenon. The banks used to be able to sell their mortgages (and certain other loans) on for cash. Now they have to stick with them on their balance sheets. The volume of outstanding bank credit might not be falling, but net new lending is off a bloody cliff. In short, what Niall said.
(2) The other thing Niall said. The ratio of the value of all commercial and industrial credit lines authorized by banks to the value of outstanding credit lines has steadily fallen from around 1.5 in mid-2007 to 1.3 by the middle of 2008, and has certainly fallen even more since.
(3) The cash assets of commercial banks have skyrocketed from $298 billion in August to $854 billion by November 19th. (I’m sure mattress assets have skyrocketed even more, but that’s not really relevant to the issue at hand.)
(4) Commercial paper issues have held up. Issues of less than gold-plated companies, however, went cliff-diving in September.
There really is a credit crunch. Barack Obama was correct in the second presidential debate, when he said that thing aren’t as bad as they could have been because of the rescue package (and aggressive Fed action), but they’re still bad.
Plus, of course, the problems caused by bad expectations, the construction collapse, and the liquidity trap are all still operative.
“Black Man Gets Worst Job in America.” Indeed.