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October 1, 2008

The people speak

The article in yesterday's NY Times, Lesson From a Crisis: When Trust Vanishes, Worry explains why so many Americans turned on the bailout bill.

It’s not enough to say that markets could freeze up, loans could become impossible to get and the economy could slide into its worst downturn since the Great Depression. For now, the crisis has had little effect on most Americans, beyond their 401(k) statements. So to them, the specter of a depression can sound alarmist, and the $700 billion bill that Congress voted down this week can seem like a bailout for rich scoundrels.

I have to say that I've spoken to a lot of economists who think the current bill is bad for the same reason.

Mr. Bernanke and his fellow worriers need to connect the dots. They need to use their bully pulpits to teach a little lesson on the economics of a credit crisis — how A can lead to B, B to C and C to Depression. ... Why are we talking about the Depression, anyway? Almost no economist thinks that even a terrible downturn would look like the Depression. The government has already responded more aggressively than it did in Herbert Hoover’s day. So a Depression-like contraction — a 30 percent drop in economic activity — is highly unlikely. The country is also far richer today, which means that a much smaller portion of the population is living on the edge of despair. No matter what happens, you’re not likely to see shantytowns.

It is exactly a failure to make this case that leads many professionals and much of the public to be against this bailout. Instead, Paulson decided to appeal to fear and panic, depriving us of well designed policy and the opportunity to see how matters progressed more calmly.

In late 1930, however, a rolling series of bank panics began. Investments made by the banks were going bad — or, in some cases, were rumored to be going bad — and nervous customers besieged bank branches to demand their money back. Hundreds of banks eventually closed. Once a bank in a given town shut its doors, all the knowledge accumulated by the bank officers there effectively disappeared. Other banks weren’t nearly as willing to lend money to local businesses and residents because the loan officers at those banks didn’t know which borrowers were less reliable than they looked. Credit dried up.

Against this is significant evidence that credit has dried up on a local level. Credit card limits remain unchanged and many small business owners report no problem making loans. The credit markets are very different now, and you don't need as much expertise as you once did to make a $250,000 loan because of greater geographic and portfolio diversification and more sophisticated lending protocols. This could still matter, but it is hard to see it as important a factor as in the 1930's. Yet that same data showing that standards are tighening are showing that total lending is at an all time high (New Banking Data: Where's The Credit Crisis? Total Bank Loans and Leases Exceed $7T For First Time). That is, total lending and leasing from commercial banks is at an all time high. Though only up a tiny amount in the last couple of months, it hasn't declined in a way consistent with a credit contraction. Which I see as more important than the price of credit. There isn't nearly as large a problem with credit getting more expensive as there is with there not being some at any price.

Alternatively, CNBC speaks to the National Small Business Association lobby and they say they are hurting. I liked this article for the surveys it provided and a few anecdotes. Most of the article suggests credit is more difficult to get rather than impossible, which would be consistent with a credit tightening than a credit freeze. Obviously, up until the last year or so standards have been pretty lax, so some tightening is to be expected.

That said, while I still would be for doing nothing and getting this over with quickly and painfully, I would be more comfortable with a bailout if there were a genuine credit crunch.

Posted by OneEyedMan at October 1, 2008 7:09 AM

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