Capital Markets

Is it Too Late for a Do-Over?


Three scholars associated with the Federal Reserve Bank of Minneapolis decided to do a little quick fact-checking of "widely held claims about the nature of the [financial] crisis and the associated spillovers to the rest of the economy," and put their findings in a new working paper [PDF]. What'd they learn?

The financial press and policymakers have made the following four claims about the nature of the crisis.

1. Bank lending to nonfinancial corporations and individuals has declined sharply.

2. Interbank lending is essentially nonexistent.

3. Commercial paper issuance by nonfinancial corporations has declined sharply, and rates have risen to unprecedented levels.

4. Banks play a large role in channeling funds from savers to borrowers.

Here we examine these claims using data from the Federal Reserve Board. Our argument that all four claims are false is based on data up until October 8, 2008.

Whole thing, well worth a read (and probably a drink), here.

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  1. Let me know when I can expect fewer credit card offers in my mailbox.

  2. Is it worth noting that it’s labelled “Working Paper 666?

  3. Marginal Revolution has had a pretty good back and forth on ‘is their a credit crunch?’ that includes discussion of this paper and other indicators. To generalize, Tabarrok is a skeptic and Cowen is a believer.

  4. Off-topic, but this has been bothering me for weeks, and I can’t think of anywhere better to ask than HnR. (That was meant to sound desperate, not complementary…)

    The fun kind of got kicked off by Lehman Bros going belly up. But I thought it was weird that they went into Chapter 11. Isn’t that re-organization, not liquidation? You know the old saw about how we’ve all flown on airlines that are bankrupt.

    It just seems weird that, when the sky is allegedly falling, that the first chunk that falls doesn’t even lead to complete annihilation of the company — or, is this just the equivalent of keeping it on life support while the organs are harvested? (But, I thought that’s what chapter 7 — or something — was.)

  5. Chrispy | October 27, 2008, 11:32pm | #
    Is it worth noting that it’s labelled “Working Paper 666?

    Damn, beat me to it.

  6. That the United States is undergoing a financial crisis cannot be disputed.

    I think I’m allowed to dispute this.

    A 2 bedroom bungalow in Los Angeles is not worth $850,000. There is no crisis involved in discovering that it’s only worth $425,000.

  7. We’re getting screwed. Hopefully me less than you.Unless your net worth is in totally liquid US cash with no debts.

  8. The unstated assumption of the nonbelievers is that the type of government intervention we have seen, and will continue to see, is okie fucking dokie provided there is an actual credit crunch. Outside of the far left and the Austrians, I don’t hear many people who think it’s a bad idea regardless. And that’s a shame.

  9. I am of the theory that in real terms this “crises” was not (or perhaps should not have been) worse than the recessions we saw in the 70s and 80s, that the real reason it ended up being worse is that this is the first recession we’ve had since the rise of the new yellow journalism. Whether we like it or not there is a large psychological factor to the economy. Panic is the worst thing that can happen, and the sensationalist “end of the world” coverage this event has been given is like pouring gas on a fire.

  10. Is having a crisis even necessarily a bad thing. Maybe not.

    crisis – “A stage in a sequence of events at which the trend of all future events, esp. FOR BETTER or for worse, is determined; turning point.”

  11. I’d have to go with skeptics-of-skeptics here. While the hysterical tone of our policymakers is unwarranted, that particular paper takes far too shallow a view of the market. It’s really just some stats from the Fed’s H.8.

    For example, take the loans and leases section. Well, a lot of those loans are committed loan facilities, where individuals and companies have been drawing on their lines (often at very favorable spreads) to meet short-term needs. They gloss over this contention in their paper, but if you look at the commercial loan books on several banks, you’ll see they’ve become wildly unprofitable, especially after this quarter’s round of 10-Qs. Or, just intuitively, who’s out there lending so much that new business would be driving loan and lease growth?

    The spread of LIBOR over its respective T-bill should also tell you something. Historically, the spread’s been around 20 bps. It was over 300 bps a few days ago, and a flight to quality won’t explain all of it. I do think a lot of that was strategic behavior — waiting to see what the government will done — but the lending environment has slowed down dramatically.

    As for the increase in deposits, look at how banks have been raising money recently. Almost every major bank advertised a consumer deposit product last quarter because they need the liquidity. It wouldn’t surprise me if people are pulling money out of the equity markets and keeping it liquid in banks. That’s not necessarily negative, but it’s certainly not an indication that our financial problems are overhyped; banks haven’t been able to shrink their balance sheets, so I suspect many are just using deposits to fund existing commitments.

    Eliminate the effects of government liquidity programs, and I wonder how things would look.

  12. I think it’s interesting that they acknowledge that the worst stock market falls happened after the bailout passed.

    Before that things were rocky but not catestrophic. Possibly investors today are either buying into the panic or are worried about excessive government intervention.

  13. There is absolutely no reason to speak to the stock market when analysing the impact of credit policy, the two are not the same challenge, and it is awfully fuzzy thinking. The assertion that there is worry about excessive government intervention seems rather idiotic when one looks at the stream of bad news that is rather objectively more oriented to the bottom line, such as increasing liquidity problems in trade, declining profits reported, and massive falls in leading indicators for economic activity. Only ideologues need look to abstract worries like “government intervention” at this stage.

    Amakudari has it right with respect to the paper and the critique of the sceptics. As is the Economist comment.

  14. “since the rise of the new yellow journalism. Whether we like it or not there is a large psychological factor to the ECOLOGY. Panic is the worst thing that can happen, and the sensationalist “end of the world” coverage this event has been given is like pouring gas on a fire.”

    See also – Global Warming


  15. I teach undergraduate economics and money and banking. As part of my teaching, I use the St. Louis Federal Reserve website to show graphs of various measures of the money supply as well as categories of bank assets and liabilities. Because of a heavy summer school schedule, I have looked at these figures more than usual. And, the statistics I regularly follow told a story inconsistent with what has been told by the media. I have been watching them more than usual for that reason. And continued to watch them closely (and look at more things) during September.

    The Minneapolis Fed working paper just pointed out what those of us who follow these macro statistics could see.

    The Minneapolis Fed paper didn’t say, “the financial crisis is a myth.” It rather used data to debunk 4 myths _about_ the financial crisis.

    Hopefully, those describing the crisis will use these facts to adjust their desciptions. For example, one key element of the crisis was supposedly that banks refused to lend to one another. Looking at data for interbank lending, it is clear that many banks are lending to many other banks. Looking at the effective Federal Funds data, it is also clear that these loans are, on average, at very low interest rates, usually below the Federal Reserve’s target of 1.5%.

    However, that doesn’t mean that some banks cannot borrow from other banks. Maybe the inability of large money center banks to obtain funds from other banks at low interest rates creates a crisis.

    Similarly, the claim that banks aren’t lending is shown false by the data. They are lending. That doesn’t mean that there aren’t some banks that aren’t lending. It doesn’t mean that there aren’t some borrowers who are being cut off. Perhaps those borrowers who usually patronize large money center banks are being cut off, and the banks that are lending are not lending to _them_ either.

    Further, it is very possible that bank lending isn’t increasing enough to make up for decreases in credit outside the banking system. But if that is the nature of the crisis, that is what should be said, not “banks aren’t making any loans.”

    The interest rate on AA commercial paper has remained the same. That does debunk claims that top rated U.S. firms like ATT cannot borrow.

    On the other hand, AA asset backed and AB paper have much higher interest rates. So, less credit worthy borrowers are paying more.

    The Fed’s outstanding volume statistics for commerical paper issued by nonfinancial firms don’t separate the AB and AA. The asset backed are shown separately and shows a large decrease in volume early in September. There is also a huge increase in late September, presumably due to Fed support of this market.

    However, the new issue volumes are shown for the various categories. There was a decresae in new issues of AB paper (and the asset backed commercial paper.) However, they didn’t fall to zero.

    Why say that credit markets are frozen? To me, at least, that suggests that no one can borrow. Not, that some people cannot borrow, or the total amount lent is less.

    The expansion in bank lending has been more than sufficient to offset the decreases in the volume of commercial paper. But perhaps there are other sources of credit that have decreased too. If that is the problem, then that should be the story. Say, “trade credit provided by firms to one another has decreased. As has commercial paper issued by more risky firms. Bank credit has expanded as firms use their back up lines of credit. It hasn’t increased enough.

    The TED (Libor over T-bills) is interesting, but not something to use to cry crisis. The lower T-Bill rate isn’t a bad thing. The entire problem is the higher rates paid by banks. (If you are interested in a measure of perceived risk, TED tells you that, but if you want to assess the “problem” it is the increase in rates that banks are paying.)

    However, the LIBOR just looks at the rates paid by a handful of large money center banks. If you assume that they are the best credit risks, then everyone else would be paying even more. So, an increase in LIBOR would be reflected in higher interest rates elsewhere.

    However, we are in the odd situaiton of the money center bank having sold credit default swaps in large amounts as well as holding mortgage backed securities. They are high risk.

    Again, there are large volumes on the federal funds market at low interest rates. Some banks are paying a lot less than LIBOR. The prime has fallen. The AA commercial paper rate hasn’t changed much and has been lower from time to time.

    As for term to maturity on short term debt–it is interesting that lenders want to keep loans shorter. However, lending for shorter terms to maturity rather than longer isn’t “freezing” of credit markets. It isn’t that no one can borrow. Also, looking at new issues of commercial paper, there volume of new issues of 90 day paper didn’t fall to zero.

    Now, the notion that this has nothing to do with the Fed is of course absurd. With interest rate targeting, the Federal Reserve has automatically acted as lender of last resort to the banking system. The rapid increase in bank lending and checkable deposits happened because the Federal Reserve increased reserves (and the monetary base.) And, of course, the Fed has lowered their target for the Federal Funds rate.

    For most of this crisis (that is, over the last year,) the monetary base, deposits, and bank lending have grown like usual. However, during early September, there are massive spikes. This was the Fed acting as lender of last resort.

    Further, FDIC didn’t close up shop this year. There have been a few “runs” on insured depository institutions (not people lining up at the door, but a loss of deposits.) FDIC has closed and reorganized these instutions like normal.

    The Fed has vastly expanded its direct lending to banks. It is returning to a more traditional role of serving as lender of last resort to particular institutions rather than to just the market as a whole. In a very large way. And, it is lending to a broader selection of institutions than before. Further, it is accepting riskier assets as collateral. (A year ago, lending by the Fed was insignificant–less than one billion. The Fed held government bonds. Now, they are mostly holding loans. The change over the last year has been incredible.)

    Obviously, the “government” has been involved in ways that plausibly mitigate the crisis.

    Again, the issue is “what is the nature of the crisis.” It isn’t that no banks are lending. Or that all banks are lending much less. Or that no bank will lend to any other bank.

    It may be that banks are not lending enough more. It is clear that some banks (famous rich ones that give out millions of campaign contributions) are having difficulty borrowing.

    And, of course, it is clear that most banks were heavily into mortgages, housing prices have fallen, and mortgage default rates are up. Even without seling credit default swaps (promising to cover the losses of others) or holding collateralized debt obligations, banks can face solvency issues. If it is bad enough, FDIC might require a bailout to cover insured deposits.

    In this mornings paper, the reporter said credit markets remain cinched. (tight) Well, perhaps that is better than “frozen.” But I think the best way to correct the public discourse of this matter is to add lots of words like “some, many, or most.” Of course, that leads to the question of “which.” And, that is probably the nature of the problem. Wall Street is in trouble.

  16. If that was an off the cuff answer, you must have some awesome publications.

    Nice analysis BTW. It appears so anyway, and my ability to debunk it is quite limited..

  17. Bill,

    You make great points. Throughout this whole thing I kept reading how the credit markets were freezing up but never saw any concrete examples of it other than some good companies paying higher interest rates on bonds. That is tightening not freezing. At first I bought what the media was selling. But as time went on it seemed to me that we ought to have some real evidence of distress and credit markets truly freezing up before we blow 700 billion dollars. Further, instead of just giving it away to failed banks, why not just loan it out to the remaining solvent banks to get the markets going. The whole thing makes no sense.

  18. Wow! Next there will be reports debunking claims that Saddam Hussein was planning on attacking the U.S. with WMD, that he wasn’t involved up to his neck with Al Qaida and 9-11, and that there is no Iranian nuclear weapon program!
    Ultimate sensational headline: “Archduke Francis Ferdinand found alive – World War fought by mistake.”

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