One of the most confusing debates through the credit crisis and bailout has been about whether or not bank lending had seriously contracted. Politicians and many pundits argued that banks, even after being bailed out by the federal government, were hoarding cash and refusing to extend credit to companies and individuals. Many bank heads argued that the real credit crunch had nothing to do with bank lending and was really all about the securitization market.
So what’s really going on?
James Kwak at Baseline Scenario points out that charts showing overall outstanding loans are misleading because they don’t tell us what banks are doing now. And the charts, like the one below, that show the flow of funds from banks to borrowers show a sharp contraction from the first quarter of 2008. (Except in the last quarter of 2008, which we’ll get to shortly.)
Astute readers will notice a huge spike in the third quarter of 2008. This might look like banks suddenly started lending out lots of money at the very time the credit crisis was thought to be at its worst. If that sets off your B.S. radar, congratulations. You are still a thinking human being.
What happened in the third quarter of 2008 is that Goldman Sachs and Morgan Stanley converted to bank holding companies, so their loans suddenly started getting counted as bank credit. As Kwak points out, JP Morgan acquired the thrift, Washington Mutual, converting its entire loan portfolio into bank credit. “So $300 billion of the “new” bank credit in Q3 was just the result of WaMu’s collapse. Since the chart above shows annual rates, that accounts for $1.2 trillion, or over two-thirds of the total for Q3,” Kwak writes. Meanwhile, off-balance sheets assets were being brought on balance sheet across the banking sector.
In short, the increase in bank credit in the third quarter was an illusion. It was more a matter of accounting than reality. Or as Kwak puts it, the uptick “was due to exceptional items that were a product of the credit crunch, not any actual increase in bank lending.”
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