Sunday, October 12, 2008

Economic crisis?

"There have been headlines that this is the worst economic crisis since the Great Depression. No. It is a financial crisis."

Our productive capacity is intact. Poorly functioning finance institutions are being culled. Misdirected capital is being shifted out of an artificially bloated housing sector. Risk levels on subprime and Alt A loans are being adjusted to more rational and realistic levels. There are important lessons to be learned about the functioning of the market, appropriate lending standards, investment risks, and the detrimental effects of government manipulation of the market for social and political purposes. The sooner those lessons are learned the better.

For some, the lessons will be painful. Homes, savings and investments will be lost, but only those financial decisions based on reality are sustainable anyway. Meanwhile, it is important to keep a proper perspective and not allow panic to make matters worse. Our leaders are failing us, adding to the panic, rushing to action without understanding the underlying causes or even basic economic concepts. The politically-motivated solutions will only delay the necessary corrections and increase losses in the long-run. Their spastic responses decrease predictability, without which there is no way to for investors and businesses to assess the situation, regroup and start rebuilding.

As the dust settles, here is a great tool to help keep our current challenges in perspective: the St. Louis Fed’s website, brougth to my attention in an article by Robert Higgs.

In spite of all the cries of "credit crunch" and "economic crisis," take a look at this data.

This chart shows the bank credit (in billions of dollars) of all coomercial banks from 1970 to date. Gray bars are recessions. Overall, the trend is pretty encouraging.

The website lets you choose what period of time over which to display the data. This is important as data can be misleading just by the scale in which it is presented. Below is Bank Credit All Commercial Banks from 1990 to the present. The recent downturn is now evident. What also is striking is that we are not nearly as low as 2000-2001. That wasn't fun, but we certainly survived and came out stronger.

Here is a look at Commercial and Industrial Loans since 1940.

The site lets you look at the data as total dollar amount or as "Change from Year Ago." Here is the data on Commercial and Industrial Loans 1940 to present as change from year ago:

And from 1980. Ups and downs are more evident but again, what strikes me is how we are doing significantly better than the circa-2000 recession.

Just two more and then I encourage you to play around with the charts yourself. Here are Consumer Loans All Commercial Banks since 1940.

Here is a zoomed in look at Consumer Loans for the past 10 years. Again, it's not so frightening.

The website data is updated weekly. We haven’t seen the last of the fallout from years of mis-investment. What happens from here on out will also depend on whether the true mistakes are recognized and corrected. But the first rule in a panic is "Don't panic." I hope this information provides the kind of information that makes it easier to follow that rule.


Anonymous said...


I'm not sure how to interpret these graphs. But my initial take on them is that they do represent cause for concern. Specifically, most of them seem to reflect the rapid increase of credit, the post-2001 credit bubble, that is now deflating rapidly.

If you were to draw trend lines through them, they would be fairly level until you got to post-2001, then they seem to take off a sharply upward angle. If that reflects the credit bubble, it suggests a lot of mal-investment that needs to be wrung out of the system.

And the early trend indicates that the "credit crunch" is a reality, with the trend lines on those graphs headed almost straight down. When banks won't lend credit to other banks, the system is frozen.

What is true, is that there is not a liquidity problem. All sorts of institutions are sitting on tons of cash because they fear a run by their investors. And for the same reason, they are afraid to loan money to other institutions: if those other institutions suffer a run, they may not be able to pay it back.

John Steele Gordon is correct that this is financial crisis, not an economic crisis. But the two are not unrelated. When companies can't borrow money, they reduce their economic output.

I also think it's hard not to panic when you are telling people that in some cases their homes and life savings will be wiped out.

- cfc

Beth said...

There are ups and downs...but we aren't down as far as the 1980's and we certainly aren't as far as the 1930's.
There is cause for concern...but not for panic. The push for government to "do something now" is leading to actions in the wrong direction. Or maybe I should say wrong "directions" because of the inconsistency of the actions, in particular those of the Fed and the Treasury.
This could be a great opportunity if we had a leader versed enough in economics and US economic history in particular. It is not reassuring to have both Republican and Democratic candidates bad-mouthing business and calling for government "solutions."