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.’
Is there a credit crunch?
Here is a good piece rebutting the Minneapolis Fed study. One point made is this:
…there is the inconvenient matter that the Federal Reserve and
the Treasury went out and did all that stuff they did in order to prevent a
massive breakdown in lending to the real economy. … Now this does
allow sceptics to say, "Well, how do we know things would have collapsed"? We
don’t, of course, but that doesn’t change the fact that current lending takes
into account massive government intervention to make sure that lending
continued. The latter therefore can’t be used to argue that the former wasn’t
necessary.
On these questions I am more of a pessimist than is Alex.
Capitalism with Chinese Characteristics
That’s the title of the new book by Yasheng Huang. This very serious work reexamines the role of the state in the Chinese economy. It suggests that the Chinese private sector has been more productive than claimed, China fits the traditional theory of property rights and incentives more than is often realized, the Chinese economy is not necessarily getting freer, market ideas are strongest in rural China, rural China was reregulated in an undesirable way starting in the early 1990s, the "Shanghai miracle" is overrated, when you calculate the size of the private sector in China it matters a great deal whether you use input or output measures, and China may collapse into crony capitalism rather than following the previous lead of Korea and Japan.
The dissection of Joseph Stiglitz on China, starting on p.68, is remarkable.
I do not have the detailed knowledge to evaluate all of these claims but in each case the author offers serious evidence and arguments. This book does not make for light reading (though it is clearly written), but it is quite possibly the most important economics so far this year. Here is a good review from The Economist.
How to read popular non-fiction better
Trey, a loyal MR reader, asks:
What are good techniques for becoming a better reader of popular non-fiction and history? I analytically approach articles and academic monographs in one way but often find myself having just finished a volume of history or popular non-fiction and am unable to bring my social scientific knowledge to bear on the topic. Rather than asking myself, "What is this a case of?" or "What does social theory have to say about this?" I find myself saying, "That was interesting. What’s for dinner?" Any advice for breaking down this wall is appreciated.
There are (at least) three kinds of useful popular non-fiction works. The first open up a whole new world to you where previously none had existed. Many people felt this way when they read Dawkins’s The Selfish Gene for the first time. For obvious reasons, books like this are increasingly hard to find as you continue your reading career.
The second kind are to be read in batches. No one of them is good enough to thrill you and maybe no one of them is accurate enough to trust. But if you read five to ten of them you get a sense of a field and its critical issues.
The third kind are to be read as marginal additions to a body of knowledge you already have a good grasp of.
The key is to have the kind of book that matches the kind you want.
Low nominal interest rates
Short-term nominal interest rates are rising and that is good:
The nominal short rate is the "shadow real interest rate" (as defined by the investment opportunity set) plus the inflation rate, or zero, whichever is greater.
That’s from Fischer Black and the implication is not a cheery one. It’s either deflation or an unproductive real economy or both. Here is the full abstract:
Since people can hold currency at a zero nominal interest rate, the nominal short rate cannot be negative. The real interest rate can be and has been negative, since low risk real investment opportunities, like filling in the Mississippi delta, do not guarantee positive returns. The inflation rate can be and has been negative, most recently (in the U.S.) during the Great Depression. The nominal short rate is the "shadow real interest rate" (as defined by the investment opportunity set) plus the inflation rate, or zero, whichever is greater. Thus the nominal short rate is an option. Longer term interest rates are always positive, since the future short rate may be positive even when the current short rate is zero. We can easily build this option element into our interest rate trees for backward induction or Monte Carlo simulation: just create a distribution that allows negative nominal rates, and then replace each negative rate with zero.
Will Wilkinson is upset
If a smattering of libertarian ideas can bring it [the system] all down, then the problem isn’t really libertarian ideas, is it? If the integrity of the economy in your preferred model requires a high level of ideological conformity, you might think to reconsider the wisdom of harnessing it so thoroughly to democratic political institutions meant to accomodate pluralism.
That’s not the part where he is really upset. He’s also upset here and here.
Sentence Fragment of the Day
…stochastic calculus porn…
That’s Arnold Kling on the state of modern macroeconomics.
Markets in everything Iceland fact of the day
Frederik writes to me:
In the classifieds on the web of the daily Iceland newspaper Mbl, you find hard currency for sale (US dollar, Danish kroner, and Euro) ranging from USD 300 to USD 12000. With the breakdown of the official exchange rates, the market has emerged.
The article is here, in splendid Icelandic. Just imagine using classified ads to buy foreign currency; I don’t see any market on U.S. eBay but maybe I just don’t have the right keywords.
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.
How are Cayman Island banks faring?
A Friday article says this:
The worldwide financial crisis is proving a lot more damaging than was expected. Not in Cayman, yet, but we had better get ready for it to affect us severely sooner or later.
I’ve googled around and can’t seem to find any reports worse than that one. It’s fair enough to argue those banks are doing OK because bailouts from abroad have limited systematic risk in the world as a whole. But still Cayman Island banks don’t seem to have gotten into trouble on their own, at least not so far.
Cayman banking is not laissez-faire as is sometimes believed, but still it is relatively unregulated and measured in terms of liabilities it is the world’s fifth largest banking center. And it’s doing OK. As Arnold Kling has been pointing out, transparency isn’t everything.
Panama, by the way, also does not seem to be having major banking problems. The country has no central bank or lender of last resort, yet the banking system is highly liquid.
The point is not that the private client-based, tax haven, sometimes drug money, Panama and the Cayman Islands systems are automatic models for the U.S. Rather many of the critics of deregulation are not trying hard to come up with the deepest possible explanation of the crisis. A key principle of science is to consider the outliers or the points which might appear to refute your hypothesis.
It would be useful if someone would do a comparative international study of where the banking crisis has been most severe, least severe and why.
Addendum: Larry Ribstein comments.
The best criticism of me I read today
The fallacies of Cowen and Krugman are of the most basic sort — errors
only made possible by men captured by a deeply false conception of
"science", and hence a pseudo-scientific capital-free, causally impossible, aggregate "modeling" approach to the macroeconomy, rather than a causally real relative price / heterogeneous capital ordering process approach, just as Hayek explained in his Nobel Prize lecture.
Here is the full article. I thank Bryan Caplan for the pointer.
Addendum: Angus comments.
Assorted links
2. Life under extreme scarcity
4. I enjoyed this sentence: "Lady, I know I’m in jeans and you’re all throwing that scarf around over your suit, but two years of blogging has left me pretty confident that my thought is rigorous."
Let me guess, The Heckman Institute?
More trouble at Chicago, this time among the econ faculty, regarding the Milton Friedman Institute. Sad.
Hat tip to Steve Levitt.
Who are the best satirists?
To be one of the great American painters, you must satisfy several criteria:
1. You must have an identifiable style and a consistent body of work.
2. Your pictures must complement each other and look better when shown en masse in the form of an exhibit.
3. Your very best pictures must stand among the very best in the American tradition.
4. You must have had a strong influence on other artists, and must capture some essential element of "the American experience."
Let’s start with the nineteenth century today and move on to the twentieth century soon.
Thanks to Paul Keating for posing the question.
Is the low Fed Funds rate to blame?
Consider that the Greenspan Fed maintained a
1.75% Fed fund for 33 months (December 2001 to September 2004),
a 1.25% for 21 months (November 2002 to August 2004), and
lastly, a 1% Fed funds rate for 12+ months, (June 2003 to June
2004).
Here is the link. But no, I don’t side with Austrian Business Cycle Theory in citing loose monetary policy as the main factor in the artificial boom which preceded the crash. I view the boom as having been fueled by new global wealth, most of all in Asia, and the liquification of that wealth through credit and the desire for additional risk.
Note that if an increase in real wealth fuels the investment boom, consumption can be robust or even go up at the same time as the rise in investment. Now, in the boom preceding the current bust, was American consumption robust? Sure. If the investment boom had been driven mainly by monetary factors, investment would have gone up and consumption would have gone down, as explained here. (Try a rebuttal here.)
Loose monetary policy did contribute to the bubble. In that sense I would defend a modified Austrian theory. But other reasons also suggest that monetary policy was not the main driver. Money has a much bigger effect on short-term rates than long-term rates. Even long-term real rates have only mixed predictive power over real economic activity, including investment. The Austrians have never developed much of a theory of bubbles. Ideally you would have a good bubble theory, with Austrian-like monetary factors stirring up the bubble even more. But you can’t get away with pinning so much of the blame on the government, as modern Austrians are wont to do. "Bubbliness" is a private sector imperfection and relabeling it as "government distorting price signals through monetary policy" doesn’t much change that.