Where is the Credit Crunch?

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.  At the time, Paul Krugman and others responded that this was just temporary as firms drew on previously existing lines of credit.  Well here we are in September and bank credit continues to look very robust.  As Robert Higgs points out consumer loans are up, commercial and industrial loans are up, even real estate loans are up.  Overall, total  bank credit is up with just a slight sign of leveling off in recent weeks.  So where is the credit crunch?

A credit crunch does exist in the sector of the market based on short-term, asset backed securities.  In addition, interbank lending is unusually risky.  But in light of what I have just said the "credit crunch" takes on a new meaning and potential new solutions are suggested.  The first question I have is this.  Investment banks were selling these securities and using the money to lend to whom?  I do not know the answer.  But let’s suppose that the money being raised in these markets was being lent to productive businesses.  If so, then any solution should focus on feeding those businesses that are starved for credit.

I look at the situation as follows.  Banks are bridges between savers and investors.  Some of these bridges have collapsed.  But altogether too much attention is being placed on fixing the collapsed bridges.  Instead we should be thinking about how to route more savings across the bridges that have not collapsed.  Government lending may be one way of doing this but why lend to prop up the broken bridges?  Instead, why not lend directly to the investors who are in need of funds?  After all, if these investors exist and have valuable projects that’s where the money is!  Let the broken bridges collapse, taking the shoddy builders with them.  Instead focus on the finding and rescuing the victims of any credit crunch, the investors who need funds.

Now here is a hypothesis.  It may be that there just aren’t that many firms in need of funds.  First, one reason that bank lending is up may be that firms with good projects have already turned to the substitute bridge of ordinary bank loans.  Second, I wonder how much real lending was actually being generated by asset backed securities.  Could it not be that most of the funds generated were used to buy more asset backed securities?  (The growth in these securities is certainly suggestive of that possibility).  If that is the case then it explains why the real economy has been remarkably resilient to the "credit crunch."

Now perhaps I am wrong about all this.  Bernanke has access to a lot more data than I do and he seems very worried.  I’d still like to know, however, which credit-worthy firms are credit starved.  And I’d suggest that we ought to think more about alternative bridges that will connect credit-starved firms with savers.    

Comments

If banks are repatriating securitizations on their balance sheet, "total bank credit" goes up without any new loans.
I would treat the claim that "consumer loans are up, commercial and industrial loans are up, even real estate loans are up" with a lot of caution, this is more a case of out the shadow (banking system) and into the light.

Well thought out, nice post.

Good hypothesis.

"Investment banks were selling these securities and using the money to lend to whom?"

Here's mine: see Wall St. bonus figures last year.

Here's one very recent example: http://acrossthecurve.com/?p=1687

Interesting hypothesis but I am having a hard time looking at things like interbank lending, and the crunch facing investors, in a vacuum.

I am thinking it just hasn't hit the masses as hard yet. Maybe we can expect to see credit card limits drying up, more difficulty getting car loans, etc., in the future.

So I say focus on rebuilding the broken bridges to keep the money flowing before the worst hits.

Superb analysis. I haven't checked your links to confirm your claims, but given the premises your conclusions must follow.

So, what happens when all the bridges collapse?

Because that seems like a realistic scenario!

Why do you use quantities instead of prices? I look at prices. If LIBOR minus OIS is record high, if
3-month Tbill was at zero, if junk bond spreads are close to record highs, if even AAA spreads are
wide, if the dollar is trashed, if gold is soaring, doesn't that give self-evident data on the credit
crunch?

How about this for an alternative to the Paulson plan. It might have a gross cost of $1 trillion. The
government goes to all low-income households owning a house with a subprime mortgage. The government
gives the household a voucher to payoff the entire mortgage. In exchange, the goverment gets 50% of
the value of the house whenever it is sold. A debt for equity swap. The restriction: participating
households may not take out another mortgage or HELOC on the house.

Households always have a repayment option on their mortgages, and that risk is known to MBS buyers.
The repayment of the subprimes means that MBS buyers get their principal back. They will be very
happy about that. It would recapitalize the banking system, which is the goal of the Paulson plan
anyway. But we don't have to nationalize the banks to accomplish it.

It would mostly eliminate subprime delinquencies and foreclosures. It would keep houses filled, rather
than empty. It would keep low income people in houses. It would preserve neighborhoods from the
impact of vacancies and foreclosures.

Moral hazard would be limited by the requirement that half of the equity be surrendered to the government.
Only those facing foreclosure or who are underwater would want to participate in such a program.

The McMansions crowd would be on its own.

I bet the program could be wrapped up in a year.

Yes, it is unfair and interferes in markets. So is every other plan, be it Paulson's, Dodd's, or
just letting the FDIC close all the insolvent banks.

There are, broadly, two types of loan: portfolio loans, held by a bank or other intermediary on its balance sheet, and securitized loans, originated by a financial intermediary and sold to special purpose entities which issue securities. The volume of the second type of loans has shrunk to essentially zero, thereby greatly decreasing the volume of originations that financial institutions can handle. The volume of the first type is flat, meaning that portfolio loans are not remotely replacing the reduction in loan availability occasioned by the collapse of the securitization market.

Incidentally, securitization proceeds are generally used to acquire existing loans, which then move off the balance sheets of financial institutions, freeing up their capital for new originations. Securitization proceeds are not generally used to originate loans.

Not all lending is equal. There may be plenty of loans still being made, but not to the lowest tier consumers and that's affecting a lot of businesses.

What are you basing the "UP" on? I consult in the real estate industry and it is very difficult to get financing for commercial and multi-family real estate deals right now.

y81,

why let alex do it?...why don't you explain how this statement is false?

"just becuase a counterfeiter prints up money, it does not mean that "capital is freed up for investment"...no bulldozers were conjured, no humans gained new programming skills, no additional ore was mined. All the new currency by some fractional reserve bank has done is increased the number of people bidding on certain kinds of real finite capital."

maybe you consult your copy of the communist manifesto to explain why a central bank is so vital.

"thereby reducing available capital by 50%." The only capital destroyed comes when the bombs are blowing up factories or we double our prison population in a span of 20 years. Making fewer loans does not reduce the real capital available.

The very idea that making loans is good for it's own sake, just because it "creates capital" is the type of thinking that led to incentivizing people to make liar loans in the first place.

Mr. Taborrak, Ms. McArdle. Ms. McArdle, Mr. Taborrak:

http://meganmcardle.theatlantic.com/archives/2008/09/how_close_was_the_financial_sy.php

Discuss.

CI loans are up because no one is buying privately-issued securitized debt.

I have a hunch that when banks write-down a lot of their consumer and residential portfolio, there will be revisions to this series.

You bring up interesting points, but I think you may need to look at the data more thoroughly and expand your data set.

My own hunch is that this is a sounding board for another 'There Was No Housing Bubble' article ;)

B.H., for all the government intervention ideas mooted in the last weeks that I've seen, yours is the only one that rivals the Paulson/Bernanke reverse auction plan as not being obviously flawed. It has a number of very nice features which you point out, such as injecting needed capital into banks. (A few months ago, I was urging people to put their "stimulus" checks into their bank accounts rather than spending it for this reason).

But you and Paulson both may be neglecting a large potential cost to the taxpayer. If current mortage paper prices are, to use Bernanke's terms, accurate as "long-term hold" values as well as "fire sale" values, real estate still has a very long way to go down. The money to pay off an entire recently originated mortgage may not be recouped even if the government got 100% of the equity, much less if it only gets 50%. With the feds buying mortgage paper in reverse auctions, there is also a big risk from underestimating the real estate downside (severely depressing the foreclosed collateral behind the mortgage paper), but only if the banks themselves make this overestimate (wishful thinking) or if corruption occurs and government overpays rather than engaging in honestly competitive reverse auctions. (Neither too unlikely, alas).

My hunch is that, contrary to the wishful thinking (or at least public statements) of those holding mortgage paper, the mortgage paper market actually reflects real estate values better than current real estate prices, which are quite sticky, do. In other words, much U.S. real estate is worth only a fraction of its current selling prices. We'll get to see if this hunch is correct.

Comrade Alex's idea doesn't work for reasons that would be obvious had we not contracted the Panic: governments have no expertise figuring out who the good and bad commercial credit risks are. Comrade Nick signing off for now...

Very interesting analysis. I wrote a blog post looking at different places $700 billion could be spent, starting with ideas of propping up the intermediaries, and ending up in a very similar place.

Now if we were leverage that $700 billion at, say 20-1, that gives us $14 trillion dollars to play with, er, invest (and if we were a hedge fund, we could leverage probably leverage this at 50-1)! I'm pretty sure we could then buy a huge chunk of the world, and maybe save Social Security and Medicare... (I expect we'd also need some currency hedges).

All kidding aside, yours seems like a reasonable paradigm to evaluate this morass we've found ourself in, and perhaps begin to find some smart answers...

I just heard that yesterday Caterpillar got a loan at 7% interest where last week they would have paid half that.

This analysis overlooks the very decline in commercial paper outstanding. For large corporate borrowers that is the preferred borrowing method. General buyer is the money fund. What has happened is that the slightly lesser quality issuers are not able to roll it over as easily. The alternative for them is the bank loan or drawing on that bank LOC. Bank lending is going up to replace some of the decline in CP outstanding.

If you take a look at the price of GE stock you will see that the market has really hammered them lately. GE Credit is one of the largest issuers of CP. The question hs been broached that they may not be able to roll it. That is the cause of the big spike down a few days ago.

Where can I find the details of the bailout plans?

There aren't any details. Paulson's official plan was (I hope this form of it at least is dead) to give the Secretary of the Treasury (that would be Paulson, for now) unlimited and unreviewable authority to spend from a floating amount (not to exceed $700 billion at any one time, but that could certainly far exceed $700 billion in total) in any way he likes, and to deprive all courts of any jurisdiction over any resulting disputes or violations of the law, including violations of the law by the Secretary or his executive branch agents.

Unofficially, there are all sorts of clever untried ideas for how to spend the money being floated about by Paulson and Bernanke, not unlike the many clever and untried ideas being floated about on MR.

The data Alex links to are all for commercial banks, which are some of the most regulated lenders and have been weathering the crisis pretty well. When you look at the data for the overall economy, borrowing has collapsed. Even in the second quarter of this year, borrowing by the nonfinancial sector was less than half what it had been in the last quarter of 2007. One shudders to think what's happening in the current quarter. So, I'd say the credit crunch is very real.

"next, Jar Jar Binks will be tricked into testifying before Congress in favor of the plan."

He already has:
http://finance.yahoo.com/banking-budgeting/article/105840/Bush-Lays-Burden-on-Congress

"I will let Alex or another person with a degree in, you know, economics"

I bet degrees in economics is positively correlated with dumb decisions that caused this crisis and the inability to have predicted it, and dumb ways to fix it.

That's kind of funny

http://federalreserve.gov/releases/z1/Current/z1r-3.pdf

Lending/Borrowing so far this year is almost exactly what it was at in 2003. Now, who on earth would have thunk that? Again, 3 guesses and the first 2 that aren't Austrian don't count.

It seems to me that the problem is in public capital markets generally. I can't find exact figures, but last week was the slowest for issuance of new securities in almost 20 years. And even now, the only deals getting done are ones where the issuer is very well known and can get a deal done overnight. Smaller issuers have very little ability to get funds in public markets.

No credit crunch? Are you all serious?

I guess the last comment on this thread is "Largest Bank Failure in US History"

WaMu just failed....

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