The Credit Crunch Isn’t a Myth

Joe Wiesenthal points to a new paper from the Minneapolis Fed which seems to show that bank lending’s quite healthy. A lot of bank lending is going up, say the authors, and therefore the banking system can’t be in as much trouble as people think.

But surely it makes sense that at least at the beginning of a credit crunch, bank lending will go up.

When bond markets shut down, companies are forced to draw down their lines of credit at the bank, since they can’t roll over their bonded debt. And those aren’t the only credit lines which banks have outstanding: there are also Helocs and credit cards, and the balances on all of those credit instruments are surely rising.

What’s more, the authors look at rates rather than spreads, thereby making the credit crunch seem much less bad than it really is. If nominal interest rates stay flat even as the risk-free rate plunges, that’s a significant rise in credit spreads, and rate cuts aren’t having their desired effect.

And in any case, as the amount of loans outstanding increases, and as banks continue their deleveraging process, banks’ capacity to lend is bound to get ever more squeezed. The more they’ve lent in the recent past, the less they’ll be able to lend in the foreseeable future. That’s why Treasury’s recapitalization is so important. It’s not nearly big enough for the banks to start replacing the bond market as a source of funds. But with any luck it will turn out to be big enough to restore some confidence to the bond market, and open that funding window again.

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