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The credit crisis that wasn’t?

October 26th, 2008 · No Comments

According to some (rather serious) researchers, the credit crunch is a myth. This really is an interesting article, we have to say..

Credit Crunch? What Credit Crunch?
By: Michael Kling

  • The much-discussed credit freeze that is reportedly grinding business to a halt is a myth.
  • The belief that consumers and nonfinancial companies can’t get loans, that interbank lending has disappeared, and that commercial paper has dried — all myths, according to a study by three economists at the Federal Reserve Bank in Minneapolis.
  • Fed economists V.V. Chari, Lawrence Christiano, and Patrick Kehoe admit there’s a financial crisis, but they say its impact on the general economy so far has been greatly exaggerated.
  • Using data from the Federal Reserve Board, they argue that the overall volume of commercial bank loans and leases, commercial and industrial loans, consumer loans and bank credit, or the aggregate amount of assets held by banks not counting vault cash, has not fallen.
  • At least that the case of Oct. 8 when the information was gathered, they say.
  • While commercial paper from financial companies has fallen, commercial paper from nonfinancial institutions remains essentially unchanged.
  • Interest rates for nonfinancial companies have barely budged, and rates for financial companies, while higher, remain within historical levels.
  • Differences between Treasury securities yields and interest rates on loans with corresponding maturities, or spreads, have skyrocketed. Many believe that means borrowing costs have increase.
  • Wrong, the economists say. Spreads are wider because investor flight to quality has driven down Treasury yields. Loan interest rates are actually historically low.
  • Commercial and industrial loans have jumped. Some say businesses are drawing on their credit lines while they still can, while loans to business without such commitments has dropped, signaling a sharp drop in future bank lending.
  • There’s no evidence to support that theory, the economists assert.
  • The study “confirms what a lot of healthy banks have been saying — that they have the capital and resources to continue making loans,” James Chessen, the chief economist at the American Bankers Association, told the American Banker

And one might argue that things have gotten worse after Oct. 8, but on the other hand, we have the bail-out plan yet to be implemented, infusing banks with new capital. So perhaps things were never that bad.

We are pleasantly surprised by the conclusions of this study, we have to admit.

However, there are those that have a similar opinion but rather more dire conclusions:

  • The common denominator of everything that has gone wrong so far has been reckless amounts of leverage. The system both nationally and globally is still trying to de-lever as fast as possible, the problem is that everyone is being forced to do it at the same time. 3-month LIBOR is off the charts – not as many believe, because banks don’t trust each other – but because THERE IS NO MONEY LEFT FOR THEM TO LEND TO EACH OTHER. We have argued for years now that there is not enough money at the bottom of the levered pyramid scheme the world has put together. In the U.S. alone, with Lehman, AIG, Bear Stearns, Fannie, Freddie, WaMu, IndyMac, Countrywide, and the rest of the companies that have failed to date (any many more “on deck”), there are $8 TRILLLION of assets already in receivership, conservatorship, liquidation, or “parked” with a big brother. [Hayman Advisors letter to clients October 14, 2008]

And Hyman goes on:

  • Do you think the Government will be successful in purchasing illiquid assets off of the balance sheets of troubled companies? The odds (and the assets) are against them. Even if the Government invests equity to fill the “hole” that is created upon the sale of these assets, it leaves the same nefarious management teams in place to continue the problem by taking the money and levering it up again. The only way to solve this problem is to go THROUGH IT. We know it isn’t politically popular or even popular on Wall St, but the fact is that the U.S. and the world need a Darwinian flush to rebuild our foundations and become even stronger on the backside of this mess.

Well, that’s why we have long argued that buying these assets was an inexplicably stupid idea in the first place, infusing banks with new capital is MUCH more effective (as we argued here). We agree with the comment about the management teams, but the solution is not to replace them, the solution is to change the incentives they’re facing and making it more difficult to leverage to the hilt through new and better regulation.

Even Greenspan agrees, a bit late, we would say..

And Levitt, former head of the SEC also:

  • The U.S. financial regulatory system “failed to adapt to important, dynamic, and potentially lethal new financial instruments as the storm clouds gathered,” Arthur Levitt wrote in a Wall Street Journal op-ed. Levitt, SEC chairman from 1993 to 2001, now calls for the establishment of a new, self-financing government agency to supervise over-the-counter trading, exchanges, boards-of-trade, and municipal debt. [moneynews]

Tags: Credit Crisis