Is the "Credit Crunch" Narrative Just a Scam?

Posted by Joshua Holland, AlterNet at 10:38 AM on March 13, 2009.

Two points here.

First, I'll repeat something I've argued several times: the "credit crunch" meme that is so ubiquitous in the news these days obscures the larger story of the economic meltdown we're experiencing, which was precipitated by a massive loss of families' assets as the housing bubble deflated and the stock market tanked.

Second, contrary to what some think, I have no reason to believe, as others have argued, that the whole narrative was an invention the Bush administration pulled out of its collective ass in order to sell the public on throwing $700 billion at the banks under Hank Paulson's TARP boondoggle.

To the first point, here's some new data surveying the wreckage of Americans' financial health, with a hat-tip to Calculated Risk:

Rex Nutting at MarketWatch has more: Household net worth plunges 18% in 2008

Hit by the double whammy of declining home prices and a falling stock market, U.S. households saw their net worth fall by $11.2 trillion, or 18%, to $51.5 trillion at the end of 2008, wiping out five years of gains ...

Household percent equity was at an all time low of 43.0%.

This graph shows homeowner percent equity since 1952.

When prices were increasing dramatically, the percent homeowner equity was declining because homeowners were extracting equity from their homes. Now, with prices falling, the percent homeowner equity is Cliff Diving!

Note: approximately 31% of households do not have a mortgage. So the 50+ million households with mortgages have far less than 43.0% equity.

The third graph shows household real estate assets and mortgage debt as a percent of GDP. Household assets as a percent of GDP is now declining rapidly. Mortgage debt as a percent of GDP was up slightly in Q4, and is only declining slowly.

It's an old lesson: Assets values can fall quickly, but debt lingers!

I feel like a broken record, but this is the big story as I see it. As I wrote a few weeks ago ...

In 1973, the bottom 90 percent of the economic pile -- most of us -- shared two-thirds of the nation’s income; by 2006, we got half. If you take off the top ten percent of the income ladder, the rest of the country in 2006 earned, on average, 2 percent less than they did 30-plus years earlier, despite the fact that the economy as a whole had grown by 160 percent over that time.  

But we continued to buy; it's become almost a cliché to say that American consumerism is the engine of the global economy.

How did we do it with incomes stagnating? First, women entered the workforce in huge numbers, transforming the “typical” single-breadwinner family into a two-earner household. (Between 1955 and 2002, the percentage of working-age women who had jobs outside the home almost doubled.) 

After that, we started financing our lifestyles through debt -- mounds of it. Consumer debt blossomed; trade deficits (which are ultimately financed by debt) exploded and the government started running big budget deficits year in an year out. In the period after World War Two, while wages were rising along with the overall economy, Americans socked away over 10 percent of the nation’s income in savings. But in the 1980s, that began to decline -- the savings rate fell from 11 percent in the 1960s and ‘70s, to 7 percent in the 1980s, and by 2005, it stood at just one percent (household savings that year were actually in negative territory).

So the crisis we face now is first and foremost a deleveraging of over-leveraged consumers in a shopping-for-crap-based economy, rather than primarily a crisis of the banking system.

At some point, some compelling evidence emerged which suggested there was no credit crunch at all. Rather, credit was available to qualified individuals and firms with good business plans and balance sheets. Banks weren't lending because people weren't looking to finance new purchases and firms weren't looking for loans to finance expanded operations. They were busy laying people off and downsizing.

A few people, notably David Sirota, looked at that and concluded that we'd been had -- that the whole credit crunch narrative was a scam. So I looked at all the evidence and wrote one of those weaselly question mark pieces -- "Was the 'Credit Crunch' a Myth Used to Sell a Trillion-Dollar Scam?" In it, I looked at two questions: 1) was the degree to which the flow of credit had seized up  greatly exaggerated in most economic reports?, and 2) was it likely that the Paulson team (whose actions I will never defend in any way) knew it was an exaggeration and used it to sell their bailout(s)?

My view was that the answer to the first question was "yes" (click on the story linked above to see the details). Much to the chagrin of several readers, though, I didn't really answer the second question, except for this graph:

... the question comes down to what they knew and when they knew it. The analyses that suggest the whole credit crunch narrative is false are based on data that lagged behind the numbers that policymakers had available, in real time, back in September. So the question -- probably unanswerable at this point -- comes down to whether or not they looked at the situation and in good faith believed that pumping hundreds of billions of dollars into the banking system would contain the damage and save an economy teetering on the brink of collapse.

In other words, there were indicators -- and they get a bit technical -- that the folks at the Treasury Department were looking at in September which certainly could have led them to believe that the primary problem was in the financial system. That's especially true given their strong -- and, let's face it, ideological --  belief that the American economy was in fundamentally sound shape other than some isolated "excesses" that had become those much-discussed "toxic securities."

It's also the case that while I think the primary story is not of a distressed banking system, I wouldn't overstate the case. There are big financial institutions that are teetering on the brink of insolvency -- if they're not there already, and, as I wrote in that article ...

Dean Baker, while arguing that "the main story is that people don't have money and therefore want to spend," acknowledged that "some banks are undoubtedly anticipating more write-offs from other loans going bad, so they will hang on to their capital now rather than make new loans." And, as Sirota notes, some of the institutions that are relatively healthy are reportedly holding cash in anticipation of picking up weaker banks on the cheap.

Anyway, just wanted to clear that up. Not everyone quite understood what I was trying to say (I blame my damn headline writer, which on that particular piece was, I believe, yours truly).

Tagged as: credit crunch

Joshua Holland is an editor and senior writer at AlterNet.