Posted by: Dirk | October 6, 2011

Whatever happened to the credit crunch?

Here is some reporting on the ECB from today’s NYT (my highlighting):

To help avert a credit crunch, the E.C.B. also said it would resume buying so-called covered bonds, which are a form of debt secured by packages of loans and guaranteed by the issuing bank. Covered bonds are one of the main ways that banks raise money. The E.C.B. also bought covered bonds in 2009 to alleviate the bank funding crunch that followed the collapse of Lehman Brothers in 2008.

I find the part about the credit crunch a bit sloppy. A credit crunch is a situation in which potential borrowers approach a bank for a loan and get a nyet. This, however, is not what is happening. What is happening, as the NYT puts it correctly later in the article, is a bank funding crunch. Banks stop lending money to each other, because they know their own balance sheet is probably as bad as that of their competitors. This was what Lehman Brothers’ demise was all about. Looking at the LIBOR gives you some idea then about the situation.

The point that I want to make here, however, is the recent history of the term credit crunch. Macroeconomists associate the term with a decline in the credit supply because of lenders strike. Banks that are running out of liquid funds are unwilling to lend, and this creates the credit crunch. A cure is expansionary monetary policy. The central bank through open market operations increases liquidity in the banking system by buying (covered) bonds with new “money”. This money can be used as reserves at the central bank and therefore loans can be expanded. It seems, however, that this is not the case in this financial crisis.

In lieu of better sources, I have counted the number of times the word(s) credit crunch appear in the NY Times per year. Here is the result:

There seems to have been a lot of media attention in 2007-09, but since then the term has not been used much (I have given you the results for the blue words “credit crunch” as well as the green “credit” and “crunch”, just to be sure). If businesses would have been starved of credit, I am sure we would have heard that phrase more often. Let me quote from the National Federation of Independent Business report “Small Business and Credit Access“:

The number of small employers applying for credit fell 7 percentage points to 48 percent in 2010 compared to 2009 (Table 3). Since the survey measures only the number of owners or businesses attempting to obtain credit rather than the aggregate amount sought, total dollar-volume demand is not known. Still, the year over year decline found here is notable and consistent with the Federal Reserve’s Senior Loan Officer survey, which shows demand decelerating in 2010 though at a much more modest pace than the prior year and then turning up at year’s end.

There is a big difference between diagnosing a credit crunch or a lenders strike. While expansionary monetary policy could help in the former case, it would be less effective in the latter (the famous pushing on a string). The opposite goes for fiscal policy, which would be quite ineffective when denied access to new loans is the problem of business. However, in case of lenders strike more aggregate demand should make businesses expand their production.

Of course, the difference between a credit crunch and a bank funding crunch might seem trivial for non-economists. However, for all others there lies much weight in those terms and they should not be interchanged one for the other.

UPDATE: The guys at FT Alphaville wrote about the same topic at the same time, coming to the same conclusion. However, their data source is slightly, just slightly, better than mine – the ECB’s latest lending survey:

In their survey responses on demand for loans in the third quarter of 2011, euro area banks for the first time in more than one year reported a net decline in the demand for loans to NFCs (-8%, compared with 4% in the second quarter). This decline points to a significant contraction of loan demand from the corporate sector over the summer period, possibly driven by increasing overall uncertainty and a moderation in the pace of economic activity, notably investment. With respect to loans to households, the reported net decline in demand for loans to households marked a substantial deterioration (-24% in the case of loans for house purchase, compared with -3% in the second quarter, and -15% in the case of consumer credit, after -8% in second quarter) that was driven mainly by declining housing market prospects and falling consumer confidence.


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