Sunday, September 6, 2009

Serious credit crunch remains; and it will until the labor market turns

In July, the Kansas City Fed reported - they measure the Kansas City Financial Stress Index (KCFSI), which is an composite index of 11 financial variables that reflects stress in the financial system - that the financial system is much improved since late last year, however, financial strain remains above the previous peak on October 1998 (Russian default).

What does this imply about credit flow right now? It's anemic; except for revolving home equity lines of credit, credit extended across all loan types is just a few %-points higher than in January 2008 (nearing two years ago), and falling.

Remarkably, the Federal Reserve Bank (see H.8 Tables here) reports that the U.S. commercial banking system is growing credit over the year, 0.5% in July. However, history foretells that credit extension will fall well after the recession has ended, only recovering after job gains have gotten underway.

It's normal for the banking system not to extend credit when the worthiness of borrowers is questionable. The historical relationship does suggest that the credit crunch will remain in place for some time, with annual credit growth easily falling into negative territory soon. However, history also suggests that a 180-degree turn in credit growth is possible.

Rebecca Wilder


  1. Hey Rebecca,

    How great it is to see that you're gettting up to speed -- "It's normal for the banking system not to extend credit when the worthiness of borrowers is questionable...the credit crunch will remain in place for some time, with annual credit growth easily falling ..."

    Since I've long known about money and credit and how money and credit drive economics, I've been writing comments explaining about the effect of the worthiness of borrowers on your blog (and elsewhere) right from the beginning of the recession (August 2008 and not the silliness of the NBER's back-dated December 2008).

    How refreshing it is to see that others are learning finally about central banking and commercial banking.

    It's too bad that foolish Keynesians and Chicago Monetarists don't know a lick about money and credit.

    If not for the boneheaded acts by Bernanke and the U.S. Congress at the behest of both the Bush and Obama presidencies, we'd be long into recovery by now.

  2. Is the causal relationship here what you have described or does it stem from the demand side as business use recessions-early recoveries to reliquify by converting inventories into cash and cutting investments so that business does not need to borrow as much?

    I suspect it is much more a demand side development.

    Also note that quality spreads move with cap use. If quality spreads are falling it should support the argument that weak credit is caused by falling demand, not falling supply.

  3. Hi Spencer,

    Thank you for bringing that up - it is not a one-way causal relationship. I have argued on many occasions that it is not clear that consumer credit is dropping simply due to bank standards (post today).

    On the Fed loan survey, demand for C&I loans and for consumer loans continued to deteriorate in Q2. However, the share of banks reported having seen falling demand dropped slightly for the C&I loans and grew somewhat for the consumer loans. My point is: it is not clear that it is more of a demand story across all loan types. However, demand is just weak.

    Thanks for dropping by! Rebecca

  4. The credit crunch is going to be hard for many people. Along with increasing prices there is also the possibility of losing your job and not being able to pay utility bills or a mortgage. In these times of financial hardship and general monetary belt tightening, many people look around to find sources of extra income. Reduce your costs and raise your income - this is the simple sounding answer to the credit crunch problem.


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