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Tilting at Windmills

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February 11, 2008
By: Kevin Drum

THE CREDIT CRUNCH....For several months we've been reading about how the credit bubble has burst and capital markets are all battening their hatches and refusing to underwrite new business. At the same time, the actual dollar volume of bank loans has gone up. So what's the real story here? Paul Krugman offers an explanation:

Here's what I'm told by people who know these markets better than I do: the increase in bank lending is basically a statistical illusion — in fact, it's in large part a consequence of the credit crunch.

One example of how this might be happening is the now-famous "liquidity put". Suppose that a bank has created a SIV (special investment vehicle) with an agreement to provide a credit line to pay off investors if they want out and new investors can't be found. That obligation doesn't show on the bank's balance sheet — but when investors cut and run, and the line of credit is called on, the bank is obliged to pony up — and hey presto, it looks as if bank credit has expanded.

A subtler example would involve a firm that has good credit, but finds that security markets have dried up — so it goes back to old-fashioned borrowing from banks, instead. Again, it looks like a credit expansion, but it's really a sign of tight credit.

Bottom line: yes, there is a credit crunch, and it's not contained.

Just thought I'd pass this along in case you, like me, have been puzzled by this conundrum. The answer may be bad news, but at least there's an answer.

Kevin Drum 2:31 PM Permalink | Trackbacks | Comments (29)

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Remember how we all liked Woody Allen's earlier, funnier movies?

Posted by: jerry on February 11, 2008 at 2:35 PM | PERMALINK

With the extremely low interest rates now, it would make sense that loan volumes would increase. The more pertinent question is, what is the nature of these loans? - long or short-term, high quality or low quality, secured or unsecured, consumer or business, etc. Without that information, no meaningful analysis can be done or conclusions reached. If they are simply a bunch of unsecured, consumer loans to aleady-strapped borrowers, that is akin to trying to quench a fire with gasoline...

Posted by: The Conservative Deflator on February 11, 2008 at 3:02 PM | PERMALINK

Well, it's part of the story. Banks are supposed to provide liquidity, that is their function in the economy. The fact that bank loans are expanding shows that banks are providing liquidity. Liquidity means that people and businesses can get loans. Yes, these loans are instead of other credit vehicles, and they are replacing some of the alternative vehicles, but they are proof that the system is working. The Fed's action is minimizing the effects of the crunch.

Another way to look at this is: What would happen if banks refused to honor their agreements to "pony up"� Not that is far beyond a "crunch".

Posted by: Joe Lehman on February 11, 2008 at 3:15 PM | PERMALINK

If you include all of the lending that the banks did, direct or indirect, you will see that there has been a decrease in lending. The reason for that is that banks were getting fees for brokering lending deals without tying up their capital or flipping the loans into the secondary market without having to count them. Even Ben Stein, defender of all that is reactionary, thinks that a lack of decent regulations is a major problem for the financial companies.

The Glass-Steagall Act was repealed so that large commercial banks could get into selling investments, and we got the near ruin of immense banks. And regulation of the mortgage-based securities was confined to a boilerplate that says everything and means nothing. And the cheerleaders in Washington say, “Now we need even less regulation!” And the Supreme Court, that highest judicial body in the land, just spoke through its cloaks most deep and distinguished, and severely limited the ability of shareholders to file federal class-action suits against investment banks that help a company accused of committing fraud.

Is anyone ever going to wake up to the fact that there is a lot of larceny in the human heart and that there are a lot of sheep waiting to be shorn and that regulation is not a bad thing? Or will we just lurch from massive meltdown to massive theft and on and on? Is anyone ever going to get it? Anyone? Anyone?

Posted by: freelunch on February 11, 2008 at 3:26 PM | PERMALINK

nominal C&I loans are hitting new highs, but real C&I loans are still far below their 2000 peak-- reflecting the point that bank lending does not play as big a role in the economy as it use to.

The surge in bank lending stems from the points you are citing and such surges often occurs just before or with the cyclical peak in the economy.

Posted by: spencer on February 11, 2008 at 3:36 PM | PERMALINK

Wow, I wonder if this means Brad DeLong may have to class Ben Stein as shrill!?

Posted by: jerry on February 11, 2008 at 3:38 PM | PERMALINK

One of the better blogs on this kind of thing is Calculated Risk:


The bloggers are smart and experienced, and the comment threads are really interesting, as well as being quite snarky in a financial-snark sort of way. The commenters are often very knowledgeable people and dissect a lot of the stuff that just makes my eyes cross. Highly recommended.

Posted by: Charles on February 11, 2008 at 3:48 PM | PERMALINK

Linked from the NYT article:

"As with mortgages, banks bundle big chunks of so-called credit-card receivables, essentially consumers' outstanding loan balances. Then they issue bonds backed by the bundles, which are sold to big investors such as pensions and mutual funds."

Uh oh, it looks like Buford's Turd Grinders have baked another whole new line of turd cakes we'll be hearing a lot about soon.

Posted by: Doc at the Radar Station on February 11, 2008 at 4:20 PM | PERMALINK

"Then they issue bonds backed by the bundles, which are sold to big investors such as pensions and mutual funds."

Among the advantages (to the bank) this procedure confers is the ability to turn future revenue streams into low-cost borrowings. When the bundles were considered high quality debt, the interest rate for borrowing against them is lower than the company would get on it's own. Plus, by "selling" the credit card receivables (assets) off the balance sheet, a company's ROA (return on assets) improves.

I think the problem is mostly in the ratings.

Posted by: luci on February 11, 2008 at 4:37 PM | PERMALINK

luci, Maybe this is also part of the reason the interest rates on cards are going up-it makes these assets look better on paper than they really are.

Posted by: Doc at the Radar Station on February 11, 2008 at 4:42 PM | PERMALINK

I don't know about you guys, but I want a white pony for Christmas.

Posted by: optical weenie on February 11, 2008 at 4:55 PM | PERMALINK

I want Krugman to go away until Christmas.

Posted by: RollaMO on February 11, 2008 at 5:01 PM | PERMALINK

We've been down this path before... the last time around at the end of the roaring 20's.

The country didn't dig its way out of that mess for 10 years... and arguably without WWII it might have taken a lot longer than that.

It took 50 years for the rich to overturn the exonomic/banking reforms of the FDR 30's (via Reganomics)... and another 25 years for the results of the so-called 'Reagan Revolution' to come to full fruition.

Today we have lots of billionaires with money tucked away offshore, a collapsing middle class and a worldwide financial debacle.

These problems have a long history and won't go away overnight.

Posted by: Buford on February 11, 2008 at 5:06 PM | PERMALINK

But - but - but Krugman is unhinged. Everybody knows that he hates African-Americans who run for president. It will all be better when Barack and Michelle Obama are in charge, I just know it will ...

Posted by: The Obamabimbo on February 11, 2008 at 5:17 PM | PERMALINK

keep clapping.

Posted by: thersites on February 11, 2008 at 5:38 PM | PERMALINK

the increase in bank lending is basically a statistical illusion — in fact, it's in large part a consequence of the credit crunch.

Krugman is being surprising coy here, neglecting to mention that this is all really Obama's fault....

Posted by: Pimping Chelsea on February 11, 2008 at 6:32 PM | PERMALINK

Exactly how much of the financial industry's business is off the books or balance sheet?

Posted by: Mudge on February 11, 2008 at 6:33 PM | PERMALINK

One of the problems with the Internet is that some people think that with a little surfing, they become instant experts on any subject, without the discipline and hard work that goes with really understanding the intricacies and nuances of a particular topic. I see it on this blog all of the time, sometimes by the moderator.

As an example, there are a host of people with no training in civil engineering or architecture have concluded that the World Trade Center towers were brought down by mysterious explosions or mini-nukes, and they haven't even been to New York City.

This seems to be the case with many of our banking "experts". All of this energy that could be used for political activism, is instead diverted into pedantry and quibbling about minutiae, without really understanding the topic. We should be using this time to write our Congresspeople and asking them to put in place some commonsense regulations. Just sayin'.....

Posted by: The Conservative Deflator on February 11, 2008 at 7:25 PM | PERMALINK

i continue to be fascinated as to how it is that no one seems to understand the magnificence of the fraud that is governing this looting of the treasury.

the siv's, the cdo's, et alia[derivatives] are all insider manipulations.

think on them as tantamount to enron's energy trading desk. where one party to a trade was the little finger of one hand, talking to the middle finger of that hand[the counterparty]. as was the case with enron, in the main, the participants in these transactions have been self-dealing. a ponzi scheme beyond sr ponzi's wildest imagining.

as we should have learned from the enron fraud, there were really no legitimate counterparties. there were no honest bankers. there was no honest usg.

this latest looting is just an episode further upstream.

what interests me is the role of the harvard corporation in this more grandiose scheme of rip-offs. some of you may know that it was the harvard corporation[via the kennedy school] that instigated the energy deregulation that implemented the fraudulent transactions that became the heart of enron, et alia.

i would assert that it was the same agents of the harvard corporation, herb winocur, bob rubin, larry summers,[and of course alan greenspan], who created the derivative trading fraud that it virtually identical to the deregulated energy trading fraud.

follow the money.

you won't be solving this legitimated theft until you bring out dr guillotine.

to the barricades, citoyens.

Posted by: albertchampion on February 11, 2008 at 8:24 PM | PERMALINK

This might be kind of unrelated, but I'm gonna miss President Bush.

How about y'all?

I mean, come on, this dude kicks ass. He's a bad ass who does what the hell he wants. He would be cool to have a beer with. He passed tax cuts, let us keep our guns, built up our missile defense all nice, invaded two countries, and did a bunch of spending the Democrats wanted just to be generous.

You all will miss him.

Posted by: mitt romney on February 11, 2008 at 9:00 PM | PERMALINK

Shorter Kevin:

Krugman... stick to economics, because at politics you are a big fat loser.

Posted by: frankly(-1) on February 11, 2008 at 9:11 PM | PERMALINK

Yeah, because when Krugman talks about politics and stuff, he's like, ohmigawd, I'm sure, no way, it's like, Mr. Bufoo -- like, totally! Hello?

Posted by: The Obamabimbo on February 11, 2008 at 9:52 PM | PERMALINK

And Daily Kos predicts that Barack Obama will win Alaska! I mean, dudes, how cool is that?

Posted by: Obamabimbomania! on February 11, 2008 at 10:48 PM | PERMALINK

News Item:

"Tomorrow there are big primaries in Virginia, Washington DC and Maryland. The so-called Potomac Primary. But tonight if you were in New York you could have seen Clinton's message-spin-poll guru Mark Penn giving a reading from his book Microtrends at The Strand." J. Marshall, TPM, tonite

Five Interpretations:

1. Creative new HRC fundraising strategy: have upper-level staff promote their books, contribute proceeds to the campaign.

2. Appearances on tv not going over so well, Penn is being steered into a smaller venue where he will do less harm to the campaign's public image.

3. It's a typo, actually: Mark Strand (the poet) is giving a reading at Penn.

4. Mark was in fact fired from the campaign six weeks ago, but no one bothered to tell him or Hillary until today.

5. Following Patti Solis Doyle, this is the second Clinton aid who's chosen to take time out from work for personal reasons. Do I detect a microtrend?

Posted by: lampwick on February 11, 2008 at 11:43 PM | PERMALINK

I support Obama, or I will be in this weekend's primary (Hawaii), but Paul Krugman has been a rock of common sense and has done an excellent job over the years of exposing what the Republicans have done to our country through bad fiscal and economic policies.

When I see other Obama supporters lashing out at anyone who doesn't tow the party line 100%, no questions asked, I have to wonder how much of his support comes from understanding his policies and how much is simply personality cult.

If Obama heeds Krugman's message, he'll be a stronger candidate.

Posted by: DevilDog on February 12, 2008 at 2:22 AM | PERMALINK

Ben Stein:

Is anyone ever going to wake up to the fact that there is a lot of larceny in the human heart and that there are a lot of sheep waiting to be shorn and that regulation is not a bad thing? Or will we just lurch from massive meltdown to massive theft and on and on? Is anyone ever going to get it? Anyone? Anyone?

Many of us 'get it.' That is not the problem. The problem is that those in power have bought the media, have bought the election process, and through years of propaganda have bought many citizens as well.

Those in power know full well this is not sustainable. They know our entire economy is not sustainable. They are 'getting while the getting is good' so they can build their fortresses for the crash. Since we now have a 'global economy' the crash will be global too. Monocultures are vulnerable to single points of failure.

Posted by: Tripp on February 12, 2008 at 11:29 AM | PERMALINK

Market is up 200 points today b/c one man, Buffet, wants to scavenge from the bones of a few banks. This just seems like total desperation to me - that the investment community is pinning its hopes for rescue on one man to fly in and save the day so to speak.

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