Was the 'Credit Crunch' a Myth Used to Sell a Trillion-Dollar Scam?

By Joshua Holland, AlterNet. Posted December 29, 2008.

Economists at the Federal Reserve Bank of Minnesota's research department -- V.V. Chari and Patrick Kehoe of the University of Minnesota, and Northwestern University's Lawrence Christiano -- crunched the Fed's numbers in an examination of these bits of conventional wisdom (PDF), and concluded that all three claims are myths.

The researchers found that "interbank lending is healthy" and "bank credit has not declined during the financial crisis"; that they've seen "no evidence that the financial crisis has affected lending to non-financial businesses" and that "while commercial paper issued by financial institutions has declined, commercial paper issued by non-financial institutions is essentially unchanged during the financial crisis." The researchers called on lawmakers to "articulate the precise nature of the market failure they see, [and] to present hard evidence that differentiates their view of the data from other views."

That finding was backed up by a study issued by Celent Financial Services, a consulting firm, again using the Treasury Department's own data. According to a story on the report by Reuters, Celent's researchers concluded that the "data actually suggest world credit markets are functioning remarkably well." Rather than a widespread banking problem, Celent found that the rot was limited to "a few big, vocal banks and industries such as car manufacturing, which would be in difficulty anyway."

There are also some important caveats. Economists at the Boston Federal Reserve responded to the Minnesota Fed's research (PDF), arguing that the use of aggregate data doesn't fully reflect the dysfunction in specific subsectors of the economy, nor does it adequately reflect the decline in new loans.

It's also the case that single-cause explanations for complex crises usually fail to hit the mark. Banks, having fueled the housing bubble (and similar bubbles before that) with the creation of ever-shadier "exotic" securities, are probably erring on the side of caution in writing new loans. They're looking at their balance sheets as quarterly reports approach, and the number of foreign investment dollars coming into the U.S. has declined, meaning that some qualified firms may, indeed, have trouble raising cash in the near future.

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.

But one thing is clear: the economic crisis may have woken up Washington's political class when it hit the banks, but it remains a product of long-term imbalances in the economy, and the idea that it's primarily a pathology of the banking system in isolation is a misdiagnosis that, if uncorrected, can only result in a longer, deeper and more painful recession than might otherwise be the case.

See more stories tagged with: economic crisis, financial crisis, paulson plan, tarp, big lie

Joshua Holland is an AlterNet staff writer.

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