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Recently the Minneapolis Federal Reserve Issued a Paper titled, "Facts and Myths About the Financial Crisis of 2008".  In the introduction the paper states, "Here we examine four claims about the way the financial crisis affected the economy as a whole and argue that all four are myths."  In doing so, they use aggregate data.  In response, the Boston Federal Reserve wrote a paper titled, "Looking Behind the Aggregates: A Reply to Facts and Myths About the Financial Crisis of 2008."  In this paper the authors argue that when an analysis is made of the underlying data for the aggregate data used in the first paper, "Out findings show that most of the commonly argued facts are indeed supported by aggregated data."  So - who is right?  

Information contained within the Minneapolis Fed's report casts doubts on the claims they make.  First, they rely on the fact that there has been no decrease in lending.  They look at total bank credit outstanding, total loans and leases, total commercial and industrial loans, and total consumer loans and conclude "we see no evidence of any decline during the financial crisis."  Before we take their conclusions as golden, let's consider the economic landscape of the last year.  According to the NBER the US was in a recession which started in December 2007 - a year ago.  In other words, it should not be surprising there was not an increase in lending.  In fact, a careful reading of each Beige Book from the last year along with a reading of the Federal Reserve's survey of senior loan officers indicates a drop in loan demand along with a tightening of lending standards throughout the year.

More importantly, let's look at total US credit outstanding going back to the early 1970s.  

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What does this chart tell us?  There are two important facts.

1.) The latest recession is the only recession where total credit outstanding has leveled off.  While it didn't decrease it also didn't increase.  Compare this to the previous 6 recessions when lending increased at least slightly throughout the recession.  In other words, the leveling off of credit creation is a story in and of itself.

2.) In order for the US economy to grow it must have a continual supply of new credit.  A leveling off is just as hazardous as a decline.  

And that is what happened during most of 2008.  The graphs contained within the Minneapolis Federal Reserve report show a clear leveling off of total outstanding credit for most of 2008.  Again - this is the only recession in the last 40 years where this has happened.

Secondly, the Minneapolis Fed relies on the spread of various bonds to the Treasury curve.  This will take several steps to explain.

Step 1: A bond's price and yield are inversely related.  As bond prices go up, the bond's yield goes down.  As a bond's price goes down, its yield goes up.

Step 2: The yield on various bonds and assets are compared to the Treasury curve to measure "risk".  People assume that US Treasury Bonds are the safest investments in the world.  Therefore, comparing the interest rate on various assets to the comparable Treasury (the Treasury with the same maturity) will tell us how risky that asset is.

Step 3: Inflation eats away at fixed income investments.  As a result, when investors think inflation will decrease they are more likely to buy Treasury bonds because there is less chance the income received will fall because of higher inflation.

Here's an example.  Suppose a 10 year Treasury bond was yielding 5% and a 10 year corporate bond was yielding 7%.  The "spread" would be 2% or 200 basis points.  This is the difference between the yield on the Treasury bond and the corporate bond.  Suppose another corporate bond was yielding 8%.  This spread would by 3% or 300 basis points.  These facts tell us the market things the second corporate bond is riskier because it yields more than the comparable Treasury and a corporate bond with the same maturity.

Let's take all of this and apply it to the Minneapolis Fed's report.  They notice that

While the rationale [for using spread analysis] may be compelling in normal times, we think that  a focus on spreads can lead to misleading inferences during financial crises.  Financial crises are often accompanied by a  flight to quality during which the real return to Treasury securities falls dramatically, that is, the nominal return falls dramatically for reasons other than changes in expected inflation.

Over the last few months we've seen a huge rally in Treasuries.  In fact, some people have argued the Treasury market is in a bubble.  As a result, the yield on Treasuries is really low.  But this is not caused by inflation expectations; that is, people are not buying Treasuries because they think inflation is low.  They are buying Treasuries because they are concerned about investment safety.

What the Minneapolis Fed report fails to take into account is inflation in one reason for investors to purchase Treasury bonds.  Another is safety.  Because US Treasury bonds are considered the safest in the world people are buying them at a high rate meaning Treasuries are yielding an incredibly low rate right now.  Some T-Bills have recently been issued at 0% interest!  That in and of itself tells us the level of concern is abnormally high and a credit crunch is indeed going on - people don't' want any return; they simply want their money bank!    

In short, inflation expectations are one reason why people buy Treasury bonds.  But another very important reason is safety.  And investors are clearly concerned mostly with safety right now if they don't even want a return on their investment.  

The Bank of Boston adds other extremely credible explanations for the lack of decline in lending.  They note that in a credit crunch companies rely more on their existing lines of credit as other sources of funds (the stock market, commercial paper and new lines of credit) dry up.  In addition, banks are unable to securitize loans in the current environment and are therefore forced to keep more loans on their books, thereby increasing lending.  The paper also shows that lower grade corporate issuers (single A) have seriously cut back on their commercial paper issuance, indicating that only the very best credit quality issuers are able to obtain short-term funding in the commercial paper market.

The point of all this is simple: the facts within the Minneapolis Fed's paper directly contradict the Fed's conclusions.  In addition, the Boston Fed's paper adds more credible evidence that a credit crunch is indeed ongoing.   I would add that a thorough review of the anecdotal evidence in the Federal Reserve's Beige Book and Senior Loan Survey shows lending standards have been tightening for a year and loan demand has been dropping.

But more to the point: why is this debate occurring?  What are we talking about whether or nor there is a credit crunch?  There are two reasons.

First, the Treasury has mishandled the TARP from the very beginning.  First Paulson wanted unfettered power to do whatever he wanted to with the funds without and Congressional or judicial review.  Then he came up with the $700 billion number out of thin air.  Next he wanted to buy troubled assets only to change his mind to injecting money directly into the banks.  And then the GAO released a report stating there was no oversight of any of this.  Simply put, the program's creation, implementation and supervision are all a disaster.

Secondly, there is a very strong anti-Wall Street mood right now.  Some of this is deserved.  We got into this mess because Wall Street wanted deregulation only to act poorly when there were no rules.  However, not everyone who works on Wall Street is a relative of Satan.  And simply because you are involved with investment banking or investments in general does not mean you are evil.  I know several brokers who have offered their clients excellent advice over the last year - advice which has lead to lower commissions for them.  And they are not alone.  The point is painting any group of people with a broad brush is a bad idea.

 

Originally posted to bonddad on Thu Dec 18, 2008 at 11:56 AM PST.

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Comment Preferences

  •  I Wonder (13+ / 0-)

    How much the lack of lending is also related to the lack of credit-worthy borrowers.  As you said above, banks can no longer securitize their loans the way they used to.  This forces them to actually think about whether or not borrowers will be able to pay back the loan.

    When you are forecasting into a recession, it seems like the answer would often be, "No, this individual or business is not going to be able to repay the loan."  If that is the case, you are not going to want to make the loan, whatever the pressure from the government.

    You can call me "Lord Bink Forester de Rothschild."

    by bink on Thu Dec 18, 2008 at 12:02:31 PM PST

    •  Then you get a feedback loop problem. (7+ / 0-)

      No one wants to lend, so no one can make a move, which makes everyone's business look that much shakier so no one gets approved for a loan.  Once things have frozen up solid, it takes a while to thaw and that's killing the business climate.

      We must allow them to finish their terms. Then they can start their new "terms". -edscan

      by lineatus on Thu Dec 18, 2008 at 12:08:23 PM PST

      [ Parent ]

      •  Problem with Trickle-Down (5+ / 0-)

        Maybe if we bolstered the ability of the consumer and small business to repay credit, we could do a better job of alleviating the problem.  Just guessing.  But I don't see where the incentive to lend is, regardless of how much money we try to give to the banks.

        The consumer, though, has a strong incentive to borrow.

        You can call me "Lord Bink Forester de Rothschild."

        by bink on Thu Dec 18, 2008 at 12:17:13 PM PST

        [ Parent ]

        •  We saw the same 'credit crunch' (4+ / 0-)
          Recommended by:
          bink, DBunn, lineatus, kaolin

          in the 80's when Reagan trickled on us.

          The only people the banks would loan to in our area were the ones who didn't need the money...they were borrowing against their own accounts.

          All of our mortgage loans were private and all of our business improvements had to be made with unsecured credit lines.

          It's very scary for people.  We saw a number of business' in our area go under for lack of credit lines.  They had business, but no room to improve or replace needed items.

        •  incentive to borrow... (2+ / 0-)
          Recommended by:
          Cottagerose, polar bear

          especially if your real wages are stagnant or declining. What else can you do? essentially you have had two things done to the working/middle class - 1. the elimination of manufacturing and other good paying jobs. 2. Credit companies offering easy credit to all comers. Here's a visual for you. hunters drive the cattle into a narrow canyon that ends in a cliff. Guess what! We are the cattle.  

        •  Trickle up should replace it (0+ / 0-)

          We need trickle up economics, not trickle down.  Get working and middle class people wealthy, and this society will hum.

          Trickle up economics

          I am repeating myself, and thats ok.

          by mickslam on Fri Dec 19, 2008 at 12:15:50 PM PST

          [ Parent ]

      •  The LIBOR (5+ / 0-)
        Recommended by:
        mickslam, DBunn, lineatus, forgore, polar bear

        When the LIBOR (interbank lending rate) doubled overnight, that was the sign that things has shut down tight.

        It was like the piano falling out the window. The only thing you were waiting for was the sound when it hit the sidewalk. We are now living that sound.

        •  Ah I don't think it is all that bad (0+ / 0-)

          And let me tell you I am a doom and gloom person over here.

          Libor has corrected itself, it is the flight to quality in treasuries only that is distorting the markets.  After q2 next year, there is going to be plenty of money out there for everything....

          I am repeating myself, and thats ok.

          by mickslam on Fri Dec 19, 2008 at 12:17:21 PM PST

          [ Parent ]

    •  Here's an extension of your question (6+ / 0-)

      As potential employers investigate interviewees' credit reports and as more and more Americans fall behind in their bills...some because they can't get a refi even if their credit was good, some because they owned a small business that failed...will that effect folks' ability to find work?

      •  I Have Wondered That As Well (1+ / 0-)
        Recommended by:
        ksh01

        Will a foreclosure just become one of those things "that happened to everybody" and is just forgiven?

        You can call me "Lord Bink Forester de Rothschild."

        by bink on Thu Dec 18, 2008 at 12:25:46 PM PST

        [ Parent ]

      •  What do you mean "will it"? (7+ / 0-)

        It's already happening.

        And it's really stupid that employers are using credit reports as a way to judge whether someone is going to be a good employee.

        There is no explanation -- it's just a silly number and no one really knows the algorithm that determines it. It could be low because you are a deadbeat or it could be low because you had to file a medical bankruptcy, or because of a divorce or death of the primary wage earner, or because the credit card company didn't credit your payments until they were late so they could hit you with fees and make you universally default so all your cards could raise their rates on you. Credit scores need to be eliminated or at least reset across the board, and they should never, ever be used to determine your employability unless you are applying for a job that deals with money.

        Credit scores should be used to determine one thing: your credit worthiness when you want to borrow money. It shouldn't be used against people who are trying to either rent a place to live or to get a job. In neither of those instances are you asking anyone to loan you any money.

        If you have bad credit because you can't pay your bills but you can't get a job because you have bad credit, how are you EVER supposed to pay your bills?

        "It always seems impossible until it's done." - Nelson Mandela

        by Brooke In Seattle on Thu Dec 18, 2008 at 01:41:42 PM PST

        [ Parent ]

      •  ouch. forgot about that. nt (1+ / 0-)
        Recommended by:
        ksh01
    •  If you don't have a 700+ (2+ / 0-)
      Recommended by:
      ladybug53, polar bear

      If your credit rating is not 700+, you probably will not get a home loan.

      There are ads out there for loans at great rates, but if you read the fine print....you'd better be a superstar credit-wise, and able to present three years of documented steady income to support it. They are looking for a very different kind of debt ratio, too.

      "Credit-worthy" has a whole new definition these days.

  •  It feels like the whole country is on hold - (11+ / 0-)

    everyone just saying "all I gotta do is hang on for 30 more days".  It's as if the great economist in the sky just hit the pause button for half the economy.

    We must allow them to finish their terms. Then they can start their new "terms". -edscan

    by lineatus on Thu Dec 18, 2008 at 12:02:38 PM PST

  •  Thanks for this. (11+ / 0-)

    The media, specifically the financial media, has been slipping the "there has been no reduction in lending" line into multiple discussions for the past few days.  It made little sense to me but I did not know where to research the claims.

    Just another Government Agency promoting their version of reality through bad analysis and ideology.

    <sigh>

    Subtlety is the art of saying what you think and getting out of the way before it is understood.

    by Granny Doc on Thu Dec 18, 2008 at 12:06:56 PM PST

    •  Right...everything is just fine... (3+ / 0-)

      Pay no attention to the man behind the curtain.

      Apparently Bush just used the word depression in one of his photo ops a few moments ago...poor bastard, staying on message really goofs him up.

    •  PR is not reality (1+ / 0-)
      Recommended by:
      Granny Doc

      If a tree falls in the forest, but a talking head on the teevee says it didn't... the tree still fell. In this case, there's too many people out there being crushed by falling trees for the RW propaganda to have a chance.

      Amazing that they keep pushing the spin button even when it's clearly not working. I guess it really is all they know how to do.

  •  thanks. it's good to hear that there are still (3+ / 0-)
    Recommended by:
    oldjohnbrown, Granny Doc, lineatus

    good folks somewhere... sometimes it's as easy to look up and see evil as it is to look down...

    Jesus ain't comin', go ahead and put the Nukes back now.

    by RisingTide on Thu Dec 18, 2008 at 12:07:14 PM PST

  •  Barter, anyone? (4+ / 0-)

    I almost suggested moving to a cash economy, but the $ will probably tank soon, so that might be a bad idea as well.  

    "If only Darwin could have traced man back to the Elephant, Lion or the Antelope, how much ridicule would have been spared to the doctrine of Evolution" H Ellis

    by science nerd on Thu Dec 18, 2008 at 12:07:33 PM PST

    •  Ah, yes! The Republican (3+ / 0-)
      Recommended by:
      oldjohnbrown, TomP, science nerd

      wet dream...no taxes 'cause they'll never find out.

      Subtlety is the art of saying what you think and getting out of the way before it is understood.

      by Granny Doc on Thu Dec 18, 2008 at 12:08:36 PM PST

      [ Parent ]

      •  Republican wet dream or no (2+ / 0-)
        Recommended by:
        Granny Doc, science nerd

        people have to eat, and if they have to do that by bypassing the monetary economy (and, by default, taxes) until the cash economy recovers, well, they have to.

        I don't imagine it scaling up beyond the community level anyway. If it does start scaling up then I'll start looking for Republicans.

        [F]or too many, the cruelty of our system is part of its appeal. - eightlivesleft

        by oldjohnbrown on Thu Dec 18, 2008 at 12:15:40 PM PST

        [ Parent ]

    •  Will the Dollar Tank? (1+ / 0-)
      Recommended by:
      science nerd

      I am beginning to wonder if the problem won't be the "value of the dollar," but the fact that no one has any dollars.  In other words, your dollars will still be worth something ... if you can find 'em. :)

      You can call me "Lord Bink Forester de Rothschild."

      by bink on Thu Dec 18, 2008 at 12:20:04 PM PST

      [ Parent ]

      •  dollar is sinking (1+ / 0-)
        Recommended by:
        science nerd

        The dollar is sinking now.  This should be good for American manufacturing and for us in general.  Our products will sell better and Americans will by American because it's cheaper.  And if wages go up, the pricey houses in the US won't be pricey anymore.

        •  I Thought the Dollar Had Rallied (0+ / 0-)

          Against the Euro?

          http://www.x-rates.com/...

          You can call me "Lord Bink Forester de Rothschild."

          by bink on Thu Dec 18, 2008 at 01:58:21 PM PST

          [ Parent ]

          •  wapo had article saying no (0+ / 0-)

            I think in December it has been going the other way. It had been going down for sometime until the crisis hit with it's flight to quility.  But as the reality sets in, the dollar is more likely to decline.  The reality being that lots of places in the world are as well developed and sometimes more so than the US.  But we also have had a very tight fiscal policy for a very long time that many places don't emulate. And interest rates and growth rates are low here. So, we will see.

  •  In 8 days the Euro has gained back 13 cents (3+ / 0-)
    Recommended by:
    mickslam, forgore, polar bear

    against the dollar that it lost back in October.
    Both were rapid shifts.

    EUR to USD

    (¯`*(¯`*-INAUGURATE-*'¯)*'¯)

    by Lefty Coaster on Thu Dec 18, 2008 at 12:24:43 PM PST

  •  Lender of last resort (1+ / 0-)
    Recommended by:
    polar bear

    I have a hard time seeing what the total value of outstanding loans has to do with it.  If banks won’t lend to each other and are instead going to the Fed for loans, there is a crunch.  That is, if they don’t trust each other, they are hardly going to trust someone who is traditionally riskier.   The only data I need to recognize a crunch is to see the line at the Fed window.

    As for rates, it has been over a year since I have been concerned with rates.  The stock market has been going down.  So why put money in it?  There have been no signs of things turning around.  Sure I have some bonds because they pay better than money market, but now that we are at 0, the capital gains on those are at an end.  It is time to think in terms of foreign bonds and soon the stock market.

    •  That's the conventional wisdom (0+ / 0-)

      We'll soon see.

    •  well, some peeps that have a lot of money (0+ / 0-)

      are investing in companies that they think will stay in business and succeed when we emerge from this, and they don't mind a certain percentage of their money tied up because the stock prices are so very low.

      i heard treasury bonds were actually minus a fraction of a percent for a little bit, there.

      if i had money like that, i'd do it, too.  but i'd do a lot of research, first.

  •  They changed some of the credit card laws (6+ / 0-)

    for the better, but the new rules don't kick in until July 2010, according to this article.

    In the meantime the credit card companies are raising rates, moving payment dates, lowering limits and raising payments.

  •  There ARE "relatives of Satan" on Wall Street. (1+ / 0-)
    Recommended by:
    dennisk

    The people who bundled up scam mortgages and flipped them off to investors, along with the people who grossly mis-rated those instruments, should be in jail right now praying to Satan for help.  

    Why aren't they?

    •  They're not relatives of Satan (1+ / 0-)
      Recommended by:
      polar bear

      Just criminals.

      Please Santa, give us a real attorney general, who will be making a list and checking it twice. Or three times.

      •  They are "Just criminals"? (0+ / 0-)

        They are people who caused a massive amount of suffering around the globe.

        I don't think even Satan could have thought up the scams those people did.

        •  We messed up the WOT, too (1+ / 0-)
          Recommended by:
          polar bear

          We messed up the War on Terror by thinking that "terrorists" are some kind of Satanic plague. They're not, they're just criminals.

          Same here. Just criminals.

          They are what the criminal justice system was designed for, designed to protect us from, designed to punish. But it can't do any of that if we don't use it.

          In the WOT, we used the military instead. Bad move. Stupid. Wasteful.

          This time, we need prosecutions and sentences at least as much if not more than we need bailouts.

  •  Let's Take Back Our Money. If we (1+ / 0-)
    Recommended by:
    polar bear

    bank or have accounts at bailout recipients then let's close them and move to a local credit union.

    RebelCapitalist - Financial Information for the Rest of Us.

    by dennisk on Thu Dec 18, 2008 at 12:55:43 PM PST

  •  bonddad, you are so terrific (5+ / 0-)

    bonddad, your excellent diaries have consistently shed light on parts of this crisis that are misunderstood or ignored.

    A good friend of mine is an ex-big-8 refugee now working in the public sector, and she and I always have great discussions about your information and analysis. Like you, we got worried almost two years ago... like you, we have watched the crisis develop, stunned and worried, as they've massively mishandled it.

    The message you have here is a good one. The industry as a whole is made up of a lot of people, most of them just doing their jobs and trying to make a living. The bad apples were allowed and even encouraged to run riot, but that doesn't mean everyone in the business is bad.

    I've been working recently with a very good local loan officer--at a very good local bank that has had no part of the sub-prime mess and still holds its own portfolio of loans. She's been great, nursing us through a refinance in this crisis, with what is definitely a tightened credit market; underwriting takes forever now. Like you, bonddad, she has great insight into what is going on. We had a great discussion yesterday about how the Fed rate cut sent home mortgage rates skyward!

    Some part of investing is more gambling than anything else, and when your home is viewed as more an "investment" than a roof over your head, things happen. Same with 401Ks, etc. Go solely for returns, and you get volatility and risk. People ought to have learned this by now. But apparently not.

    People, anyone reading this, this is a good time to get cozy and stay cozy with a well-funded conservatively run local bank, and your credit union if you have one. If you don't have a credit union, find one and join it. I've had to run from several bank takeovers, and there probably will be more coming, so that's why the credit union is a good resource. Plus credit unions have always had to abide by more restrictive rules than banks, so that is some protection.

    Anyway, bonddad, I always look forward to your diaries. Thanks for the work you put into them.

  •  David Sirota (1+ / 0-)
    Recommended by:
    forgore

    has been pushing the Minneapolis repor, as if it wasn't working paper and the Boston response didn't exist, so I was very glad to see this.  Thanks.

  •  not sure that this goes here, (1+ / 0-)
    Recommended by:
    forgore

    except that if they get a bailout, it will mean more money in the economy, etc.

    credo is sponsoring an e-mail drive to ask Bush to give the Big 3 some money.

    ask bush to save the big 3

    is this ok to post here?

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