Thursday, November 6, 2008

Fed Economists Duel Over Crisis 'Myths'

(Felix Salmon) First it was the Minneapolis Fed, where three economists last month tried to debunk four myths about the current crisis and how it's impacting nonfinancial businesses. The big thought was that credit conditions weren't nearly as bad as the media and politicians made them out to be.

The paper got a lot of pushback among econ blogs and now four economists at the Boston Fed have come out on the side of the bloggers with their own paper trying to do some de-debunking (or is it rebunking?).

Here's a quick point/counterpoint.

Myth 1: Bank lending to non-financial corporations and individuals has declined sharply.

The Minneapolis paper shows different aggregate measures of bank lending and how they haven't declined during the crisis. "We see no evidence that the financial crisis has affected lending to nonfinancial businesses."

The Boston paper says that aggregate measures hide the fact that "components of this data show a sharp weakening of credit conditions." Most importantly, the data cited by the Minneapolis paper doesn't tell us much about new lending. The Boston economists say that there's been a big increase in draw-downs from existing lines of credit, a point made by other bloggers. (See this companion paper for all sources.)

Myth 2: Interbank lending is essentially nonexistent.

The Minn. paper shows a chart of interbank lending and that it's stayed flat through the crisis.

Once again, the Bostonians counter that overall numbers hide important nuances. For example, big banks appear to be hoarding cash. Over the past couple of months, cash on hand at these banks has surged from about $125 billion to over $300 billion:

if interbank lending markets were functional and banks were not worried about meeting various liquidity demands (e.g. draw-downs on existing commitments), they would not carry such a high volume of cash given the significant opportunity cost.

Myth 3: Commercial paper issuance by non-financial corporations has declined sharply and rates have risen to unprecedented levels.

To disprove this, the Minn. paper plots commercial paper issuance of nonfinancial businesses with a AA credit rating as well as interest rates on AA-rated paper, revealing that there hasn't been a drop in issuance or a rise in rates.

But the Boston researchers point out that short-term CP issuance as percentage of all CP issuance has jumped from 50 percent to about 80 percent, meaning that there seems to have been a dramatic shift within the CP market as a result of the credit crunch. Another problem could be with how this data is collected. For example, if a company used to be able to issue CP but is no longer able to, this won't get picked up by the data.

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

The Minnesotans argue that 80 percent of business borrowing happens outside of the banking system, and that banks have eschewed the tougher CP market conditions and are tapping into deposits.

The rebuttal: Small businesses and households are probably getting hit hard by reduced bank lending because they don't have the easy access to capital markets that larger nonfinancial businesses have.

What's the upshot here? Frankly, it's hard for me to tell. Both papers are right, depending on which universe of data is your poison. But the most important takeaway would appear to be that it's a mistake to think the Minn. Fed's conclusions mean there's been little or no impact on nonfinancial firms from the credit crunch.

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