Four Myths of the Credit Crisis, Again

Contra Tyler (see below) neither the post from Free Exchange nor Mark Thoma’s comments "rebutting" the Minn. Fed study, Four Myths About the Financial Crisis of 2008, are compelling or well thought out.  The Minn. Fed. presented data demonstrating that four widely reported claims about the credit crisis panic are myths – do either of the cited links claim that any of these myths are in fact true?  No.  Do either of the cited links present any data at all on the quantity of credit?  No.  Many people cite prices/rates/spreads as evidence for the crisis but what we ultimately care about is quantity not price.  The Fed. piece had lots of data on the quantity of credit.  Where is the rebuttal?  Does Tyler cite any data at all or lay out his counter-claims?  No.

Consider the major item that these links suggest as evidence of the crisis.  Amazingly, it’s "an unusual spike in bank lending during the
crisis period."  That’s right, an increase in bank lending is evidence of the crisis.  The argument is that lack of credit elsewhere means that firms are drawing on their line of credit at banks.  One problem with this is that Paul Krugman made this argument way back in February when I said that the lack of credit was being overblown.  Thus the "crisis period" keeps changing.  In February, the crisis was in February, now Thoma is saying it’s just the last few weeks.  More fundamentally, the whole point of a line of credit is to keep credit flowing when one source dries up.  A commentator at Thoma’s site nails this one:

Saying that credit availability is so ‘severely’ endangered that
borrowers are forced to utilize credit from banks isn’t the most
persuasive argument. What next?

"Gasoline supplies had withered to the point that I was forced to fill up at Texaco instead of Chevron!" 

Finally, Tyler and both of the cited pieces attack a stupid claim that obviously neither I nor the Minn. Fed. piece made, namely that the interventions by the Fed. have had no effect.  Obviously, they have.  But the story the media and the commentariat are reporting is that there is a credit crunch, credit is frozen, firms are starved for credit, we are on the verge of a Great Depression etc. The story has not been, ‘despite some problems in the banking sector quick action by the Federal Reserve and plenty of alternative non-bank credit has insured that credit continues to flow to nonfinancial firms.’


there is plenty of data here (and links):
from the BIS:
"In the second quarter of 2008, the consolidated international claims of BIS reporting banks on an immediate borrower basis declined by $781 billion (3%). This decline mirrored developments in claims on a locational basis."

the story the media and the commentariat are reporting
Why stop there?

At the highest levels of government, we were dished up the urban legend that small companies were on the verge of not making payroll, because of the dry-up in the *Commercial Paper* market.

More fundamentally, the whole point of a line of credit is to keep credit flowing when one source dries up.

Well sure. But this doesn't mean it can operate indefinitely. To follow to follow the gasoline analogy, suppose there's a hurricane and most shipments of gasoline are cut off to an area. in the short run, at a higher price, I can get gas by drawing on different stocks. If Texaco runs out, I can siphon off the gas from the twenty pickup trucks I have at my company to run the two trucks I actually need. But in the longer run, the solution is to recreate the supply chain that links the area hit by the hurricane to everywhere else.


I am with you 99%. However, I have to admit that at that site Tyler linked to, the second graph they analyzed did look pretty compelling. I.e. it did look like the volume of lending tapered off due to the crisis, and then only resumed after all the government shenanigans.

Was that a fair point on their part, or are they distorting what Kehoe et al. are saying?

Of course lending goes up during a credit crisis. Companies tap revolvers when they can't hit the credit markets. Why is this even being discussed? That report doesn't prove or disprove anything.

"One thing I didn't like about the Minn Fed piece is that they talked about these myths, but did not attribute them to anyone specifically. I think they are setting up straw men."

You're saying you have _not_ seen these same claims propagated endlessly throughout domestic and international media? The sources and propagators are vastly too numerous to specifically address. If they're knocking down straw men, they're not of the Fed's making. The fact is these are claims that, true or not, have driven discourse globally, and I'd rather see them addressed in some way than not at all.

From yesterday's Seattle PI

Citing petrified bond markets, the Port of Seattle Commission voted 4-1 Tuesday to use up to $20 million from Sea-Tac Airport's cash reserves to ensure that construction of a $382 million rental car facility continues despite the lack of acceptable customers for the bonds needed to pay for it.

Now I have no idea if this single data point can really be attributed to a credit crunch (are the markets "petrified" as in frozen or "petrified" as in scared due to reasonable fears of receission).

I wonder if some kind of "citizen journalism" might give us insight into this. Do people know of projects cancelled due to a credit crunch specifically? Or does this look like a normal recessionary pullback from where you sit?

I found the "This American Life" piece interviewing the Treasurer of ServiceMaster (Terminix etc) convincing that commercial paper dried up in the wake of the Lehman failure. But again, only one data point.


(Sorry I'm repeating what I just posted on Tyler's post, but I want to make sure you see it.) I finally went and read the Fed study; since I had been following your posts all along, I just assumed it was more of the (good) points you had been making.

But even though I was the "credulous blogger" whom the Economist blogger ridiculed, even I thought that Fed paper was useless. Those charts all show lending volume rising like gangbusters for years, and then it completely levels off starting in 2008, and doesn't pick back up until the government's interventions.

So it seems like what happened is that you (quite correctly and fairly) were saying in February, "Hey, lending volume is at all-time highs!" but that what really happened is that growth completely stopped.

At the very least, the Fed authors should have dealt with this subtlety. But after having read the Fed paper, I can totally see why Tyler, Thoma, et al. think it is useless.


I was curious about this line of your post

Do either of the cited links present any data at all on the quantity of credit? No. Many people cite prices/rates/spreads as evidence for the crisis but what we ultimately care about is quantity not price.

It's been a long time since I took my undergraduate economics courses, but I'm curious as to what happened in terms of simple supply & demand curves. Is the change in price (but not quantity) due to a simultaneous shift in the curves? Or something else. A price-insensitive demand curve?

Certainly I would think that almost any "crunch" can be resolved by a sufficient increase in price. But I wouldn't expect quantity to stay the same for long.

Ha, now Greenspan's in the House blathering about the credit crisis.

"Alan Greenspan, the former Federal Reserve chairman told a House panel that the “once-in-a-century credit tsunami† will have a severe impact on the economy."

From what I've read, he's up there pointing fingers at all and sundry while accepting no responsibility whatsoever.

Some of my favorite arguments in favor of the notion that there is a credit crisis are:

1) There is a credit crisis because the volume of credit and loans available has increased.

This argument is almost too stupid for words. The whole idea of a credit crisis is that banks are UNWILLING to lend to businesses and individuals. To say that the evidence of a credit freeze is the fact that banks are lending more than ever is only valid evidence on bizarro world.

2) An increase in loans doesn’t disprove that there is a credit crisis.

This argument is also valid only on bizarro world. An increase in loans does disprove that banks are not loaning money and hence a credit crisis.

3) The data shows an increase in bank credit, but I believe thing got worse.

Who are you going to believe: your lyin’ eyes that show an increase in bank credit or my gut feeling that things got worse?

4) The volume of lending leveled off and then increased again after the government intervened.

Year-on-year growth in bank credit never got below 5% in 2008 and the year-on-year growth of bank credit started increasing (to its current level of 9.5%) before the government bailout plan was proposed.

I'm not so sure that there is a great difference here. If I read this graph correctly:

the trend remained level or slightly increased, which everyone agrees happened because of intervention from the Fed.

As to going forward, everyone seems to believe that lending could decrease because of:

1) Lack of funds: Because of credit crisis
2) Lack of demand: Because of the recession
3) Lenders being shell-shocked: Because they're human

There might well not be a great decrease, or other reasons for a decrease, but sorting them out would seem to be complicated.

Anyway, you, Thoma, Kling, Mulligan, Salmon, and Cowen are all favorites of mine, and know a hell of a lot more than me, so I'll wait to read more from all of you.

a few potential reasons for bank lending (quantity) to be higher in a credit crunch:

1. as already stated, customers draw down on lines of credit to insure they have access to cash
2. commercial paper doesn't roll over, causing cp back up lines to be drawn (typically provided by banks)
3. larger banks running big off-balance sheet books (SIVs, etc.) continue to bring these assets on balance sheet as abcp matures with no prospect of selling new abcp
4. credit card securitizations are not economical (major source of funding credit card portfolios), therefore only alternative is bank funding (bringing the assets back on bal sheet)

as a banker, I can tell you firsthand that credit crunch depends on your point of view - from banker's point of view "What, you don't like the terms we've proposed on your loan - 50% LTV (as opposed to 75% LTV last year), 300 over LIBOR (as opposed to 100 over LIBOR last year)" From borrower's point of view - easy to see that they would yell "credit crunch!"

Francois is right. Bank credit is up in many cases because banks have been forced to involuntarily honor existing contracts (Lines of credit, letters of credit, term funding agreements) by being pushed by stretched borrowers- in at least two cases I know under threat of lender liability law suits. They have also been stuck on balance sheet with frozen deals they used to securitize - Wachovia in particular had billions of stuck CMBS, and the problems in the leveraged loan business tied to buyouts are well known. Finally, the SIV reconsolidation and the forced repurchase of ARP type instruments have swollen their asset bases.

New credit in many cases has become unattainble on economic terms. Banks pretend to make an offer, but at terms they know their customer can't or won't accept. They can pretend to be in business "for their good customers" that way. And where possible banks have shrunken or pulled lines

BTW I'm not an armchair economist theorizing about these things. I actually have to borrow money to keep a business going


1) I think you have set out an excellent summary of how corporate and small businesses alike have been turning to commercial banks for necessary short-term loans, once their standard commercial paper (CP) --- or even asset-backed commercial paper (ABCP)--- can't secure the necessary financial support.

It's important for the posters here to grasp that CP and ABCP lines of credit are cheaper than direct bank loans. That's why they use them. Commercial paper in the US is issued by the business firms or their financial arms to get money for either a few days up to 9 months. And the credit for these purposes has dried up.

Which is why the Treasury has said that it will, if need be, buy commercial paper to keep the credit-crunch from undermining worthy business firms.


2) Additionally, commercial banks have been making big purchases --- over $250 billion since this summer --- of business assets, as the Federal Reserve has noted.


3) The outcome?

When there is a financial crisis that threatens traditional lines of credit for business firms --- never mind households --- you'd expect that there would be an increase of short-term loans from the commercial banks that are solvent. As for banks that are solvent buying stocks and other assets, what else would they be putting their money into if they don't want their reserves to pile up more and more . . . as in the Great Depression between 1929 and 1933?

Sooner or later, though, even these sources of credit for business firms will dry up if a credit-crunch spreads widely. Which is the reason, as a couple of canny posters here have noted, Alex's analogy about going from Texaco to Chevron is simply and unequivocally misleading.


4) All this, please note, is additional to what the role of the rescue plans and bailout money started doing between early and mid-September until October 8th or so --- the date, if I remember from reading the Minneapolis Fed Reserve paper --- tracked by the three economists.


Remember here. It takes time for bankers and other financial institutions to adjust to a totally new financial environment, especially of the radically innovative sort that the Bush-W administration, Congress, and the Federal Reserve have created in the last month or so. It will take time for banks to alter their guideliness under the new legislation; take time to process new loan applications; take time for the bankers to decide which applications are credit-worthy, and whether for the very short-term, the short-term, or the long-term.

And similar points probably apply --- I'm just guessing --- to what Visa and other institutions do for credit-card allowances for households and small businesses.


And so?

If so, then maybe the three economists who wrote the Minneapolis Fed-study haven't given enough time to see what's what in the credit system.


5) Oh, just dawned on me. If interbank lending wasn't constrained badly during the crunch-period of the late summer and into September and early October, why was the LIBOR spread so huge in that period . . . only to come down in the last few days?


Michael Gordon, AKA, the buggy professor

a few more points about the credit crunch and the rescue/bailout:

1. recipe for credit crunch is equal parts banks becoming more conservative with their credit terms just as borrowers' financial conditions are deteriorating. Also, the good, strong borrowers (best clients) don't want to borrow because terms are too onerous or they are intent on deleveraging like the rest of the world. The weak borrowers are desperate to borrow and their plight is way too obvious, even to dumb bankers. You may ask, what then are banks doing with their money? We're investing it in Treasuries, GSE debt and securities, relatively safe stuff.

2. i am puzzled why more is not being written about US Treasury's strategy to restore the health of banking system. their goals seem crystal clear to me and yet few seem to care.

3. I applaud US Treasury for Goal #1: get deposits back into the banking system where regulation and oversight can occur. Shrink the shadow banking system - money market funds, asset backed commercial paper, CMBS, MBS, Wall Street IBanks. Great progress has already been made here.

4. Goal #2: create a steep yield curve to help the banks restore their health. Short-term liabilities (deposits) cost banks fed funds or less, assets earn much higher spreads (even when you're investing in GSE debt or GSE MBS.) A steep yield curve is absolutely essential to the health of banking system for at least the next 2 years.

5. Goal #3: (the most controversial, by far) US Treasury is going to force the consolidation of the US banking industry and it's going to happen very quickly. They are distributing capital to the good banks (those with CAMEL ratings of 1 or 2). They started with the largest banks and are moving down to the next tier (regionals). This capital is not for lending, it is for acquisition. In late 1980s, we entered S&L/RTC crisis with 16,000 banks and came out with 8,000. We're about to do the same. Half of our banks will disappear. They are insolvent. Most of them (by number) are less than $200MM in assets and they have loaded up on ADC loans to resdiential and commercial real estate developers. Their loan portfolios are totally upside down. US Treasury knows this (their counterparts at OCC, FDIC and OTS examine these banks and know the problems). Here's what I find controversial - US Treasury is not publicly acknowledging their game plan - consolidation of the banking industry. In addition, US Treas will be deciding who winners and losers are, by virtue of to whom they give capital. They will not give capital to banks with CAMEL ratings of 4 or 5. That's a given. What is not known is whether they give give capital to those rated 3.
BTW, CAMEL ratings refers to a non-public rating assigned by regulators (Capital, Asset Quality, Management, Earnings, Liquidity) - 1 is best, 5 is worst.

Nuff said, back later.

So if we decide to suck all the oxygen out of the air and, instead of giving it away for free, sell it at the reasonable rate of one dollar per cubic foot. Should we expect a decrease in demand for oxygen as the result of this price increase? What does it tell us if demand increases in the short term? Does this mean we will not incur that many casualties because after all, oxygen trading is up, no matter at what price?

The following is some data you can get at that I think refutes Francois suggestions above. This data isn't as up-to-date as one would wish for, but it's what's available.

Francois suggests "credit card securitizations are not economical therefore only alternative is bank funding (bringing the assets back on bal sheet)". The Fed bank data shows that, on the one hand, there has been some recent decrease in the flow of banks' consumer credit assets into off-balance sheet securitized pools. On the other hand, this has been more than offset by real increases in consumer credit outstanding, and most of those increases have been in consumer loans of the non-revolving type. This is true as of the end of August. See page 2 at

Francois suggests "commercial paper doesn't roll over, causing cp back up lines to be drawn (typically provided by banks)". But Figure 6A in the Minneapolis Fed document is showing that the value of nonfinancial commercial paper outstanding is -- as of October 8 -- higher than at almost any time over the past six years, and twice as high as it was in January 2004, and essentially the same as it was six months ago.

Fed data also shows that the current competitive terms of lending are attractive to the borrower, or at least that's true up until the end of the period for which data is available today. In particular, as of August 8, for business loans of less than one million dollars the average bank's interest rate spread over the "intended federal funds rate" is lower than at any time during the years 1990 through 2006. In August 2008 it was a little higher than it was in January 2008 but nothing to whine about. And of course the full interest rate is attractively low today because of the low federal funds rate. See

Francois suggests "customers draw down on lines of credit to insure they have access to cash". Again, Francois doesn't deliver data to support this hypothesis. Alex Tabarrok has already mentioned above that people "made this argument way back in February" and I've already mentioned that it ain't true for consumer revolving lines as of the end of August.

Remember, for a full year now, the banks have been well aware of the need to shore up their reserves against the deteriorating picture in their mortgage loans delinquencies. So I don't fully agree with the buggy professor is that we "haven't given enough time to see what's what in the credit system". It's true we don't have good current data for Sept and Oct, yet. This being so, we should wait and jump to conclusions about what's what in the Sept and Oct data. Remember we're not seeing a basis for panic in what data we have available right now (excluding the securities market trading data, where we've seen panic alright, but market trading data is not the fundamental data).

Another data set at the FederalReserve.Gov website is loan delinquencies and loan charge-offs, up as far as Q2 2008. This data provides no basis for panicing either. The delinquency rate on residential mortgages in Q2 2008 is only slightly higher than what it was in the early 1990s. There was a real estate setback in the early 1990s but the good folks back then didn't panic.

The following is some data you can get at that I think refutes Francois suggestions above.

I would prefer it if you would refute Francois' suggestions by finding a bank that will extend a term sheet on a couple of deals I have working...

Seriously, message from the real world here, banks aren't very keen on initiating new business loans right now.

I encourge joof and diz and other business borrowers to take 10 seconds to look at the graphs at the bottom of page one at bearing in mind that banks for at least the past 15 months have been conscious of the desirability of strengthening their reserves.

Look at volume data for commercial paper:

There is absolutely no calamitous dropoff in A2/P2 on a weekly basis. So what if the rate is +6% - this is still low by historical standards.

The data on bank lending volumes given in the Minn Fed paper show no dropoff. Based on available data, their case that "banks have stopped lending to each other" and "CP credit is frozen" are myths is open-and-shut.

Proponents of the idea that there is a freeze in commercial lending are saying "prove to me that there is no freeze". Aside from the fact that the data so far prove just that, this is the wrong approach. Support for the idea of a credit freeze is almost entirely indirect or anecdotal - that's what makes a myth.

Of course there are big problems in credit markets and it is likely that this will spread from Wall Street to Main street. If fact, since a recession is imminent and credit has obviously been overextended, there is no risk in the prediction that credit will contract. But the situation will not be improved by chicken-little squawks of a "freeze" if it doesn't exist. We see again the herd stampeding off on the basis of unsubstantiated rumor, and in this case the herd includes Nobel-prize-winning economists.

[mixed-metaphor disclaimer: there are herds (flocks) of chickens]

TED measures the difference between the interest rates paid by 20 large money center banks and the T-Bill rate.

While it measures the preceived risk difference between the U.S. Federal government and these 20 banks, it isn't a useful measure of a credit crunch.

Only if we assue that these 20 money center banks are the second best credit risks in the world, then an increase in what they pay measures (at least) the increase in risk differential for everyone.

But that isn't true. Nonfinancial AA borrowers are paying much less than money center banks.

Looking at what the top money center banks pay just tell us about those banks.

The issue remains can the sound portions of the banking system expand fast enough to provide adequate credit? And there will be an increase in the diference between what savers earn and borrowers pay on credit markets. If the result of this is inadequate spending in the aggretate, then interest rates on both ends need to fall.

Which suggests that a lower T-Bill rate is exactly in order.

Bill Woolsey asks How is it possible that large money center banks report that they cannot borrow from other banks, while the statistics show expansions in interbank lending?. I'm told the interbank lending statistics have 3-month interbank lending and overnight interbank lending rolled into one. There's a big difference between 3-month and overnight. The banks are not engaging in 3-month interbank lending because (a) there's loads of money available for 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 (c) 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 30-day interbank lending", which today acts as a replacement for the money-center banks 30-day interbank lending (a few weeks ago the Fed expanded the Term Auction Facility further).

With apologies to all you borrowers that have been contributing

I am not asking you for anything. I am not a big fan of the bailout personally. I think it may actually slow the recovery of the credit markets down.

I am just relating my own experience to the board, so that intelligent people may understand that historical charts may not be telling the story. From where I sit, actually talking to banks trying to get credit, the idea there is not a credit crunch is an absurdity. You could talk to pretty much anyone in my sector of the market and get the same response.

So, all I am saying is that if you are looking at data that does not show this, I'd be inclined to understand exactly what the data is measuring and what the limitations of the data are. I recognize as well that my sector of the market (mid market business and project loans - companies too big for mom and pop local banks and too small for investment grade credit ratings) may be one of the harder hit.

Comments for this post are closed