Where’s That Credit Crunch?

I’m still skeptical we face a credit crunch requiring unprecedented government intrusion into the financial services industry. Today the Fed released the latest data. The weekly updates are current as of September 17 and they are instructive.

Total Loans and Leases of Commercial Banks reached $7.026 trillion, the highest amount in history.

It turns out that rather than a credit crunch, credit is simply growing more slowly than in the past year. As a commenter put it the other day, rather than “the sky is falling!” the truth is that “the sky isn’t rising fast enough!” Just how much has credit slowed down? We’re about where we were in the dark days of 2004.

Instead of the astronomical 10-13 percent year-over-year growth in credit of the past few years, we’re down to a mere 6-7 percent. You’ll note that as far as a yearly comparison goes, we briefly had a credit contraction (that is, we ended the year with slightly less credit than we began it)…in 2002. If you like, click through and examine the data in finer detail. There’s nothing unprecedented in our current situation. Growth remains generally positive and is well within the usual range of values for the past twenty years.

As I posted late last week, the monthly numbers are equally reassuring, though I admit it will be nice to see what’s happened since the last update. Consumer credit reached an all-time high ($845 billion) as of August 1st. Real estate loans are near their all-time high achieved in May.

Some commentators have insisted that the real crunch is in commercial paper, but that’s not reflected in the Fed data either (current to August 1). That’s at $1,513.9 billion, just shy of its July all-time high of $1514 billion:

But of course we’ve all heard from the neighbor who knows a guy who knows an industry banker who says that commercial credit in the past week has completely dried up. That may be true; we’ll have to wait for the Fed to release the data. But it’s entirely possible that Paulson and Congress precipitated or worsened the crunch by creating a panic last week. Consider: if you thought that Congress might intervene in the next few days and give you better terms than you’d otherwise get, you might be less willing to lend too, at least until you figured out what Congress is going to do. By announcing that it will intervene, Congress may have caused lenders to hold their credit more dearly, and thus precipitated the very crisis it is claiming to prevent.

As for today’s market event, I tend to agree with Ilya Somin:

What is good for stockholders isn’t necessarily good for the economy as a whole. Normally, I’m not much moved by populist rhetoric about how the interests of “Main Street” are at odds with those of “Wall Street.” This, however, is one of the rare cases where such cliches have a measure of truth. If Congress were planning to pass a bill providing, say, a $100 per share subsidy to stockholders at the expense of taxpayers, no doubt stock values would rise in anticipation and then fall precipitously if the plan were unexpectedly voted down. That is essentially what happened here.

Many stockholders owned shares in firms that expected to be bailed out. In addition to the financial firms that would have been the immediate beneficiaries of the bailout, shareholders in many other industries could foresee a “slippery slope” under which their firms could expect an increased chance of a bailout for themselves. At least for the moment, this slippery slope has been forestalled. Naturally, shareholders are disappointed, and their stocks are falling in value. But the outcome is good for the larger economy because we will not have a massive orgy of wealth transfers from successful industries to failing ones, nor will we create a serious moral hazard by signalling that firms that make overly risky investments that fail can expect to be bailed out in the future.

Past history shows that stock market drops, even big ones, don’t necessarily cause longterm damage to the economy. Today’s drop in stock values, while the largest in absolute terms, is not even in the top 10 relative to total shareholder value. The 1987 stock market crash was much more severe – a 22.6% loss in share value on the Dow Jones in one day – three times today’s 7% drop. Yet the economy recovered swiftly, in part because policymakers were wise enough to let failing firms go bankrupt and free up their resources for use by more efficient industries.

Congress and the President have yet to explain why our current situation is so dangerously unlike other years (e.g. 2001-2004) when commercial credit was contracting. And a fundamental question remains: if mortgage-backed securities were such an unsound investment, why the insistence that if we let the government own them, for however brief a time, they can be safely auctioned back into the market? The truth is, the point of the bailout is to give endangered financial institutions breathing room to get their balance sheets in order. Staving off a credit crisis is only a secondary goal, one which could be accomplished by other means.


~ by Gabriel Malor on September 29, 2008.

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