Misreading charts...

Its amazing that people who are college economics professors can misread charts so badly. Mark Perry argues there is no credit crunch, which I imagine would be to the amazement of central bankers of the world, and one reason Mr. Perry won't become a Federal Reserve Board member any time soon.

First, lets look at his chart to the left, the original, which shows the total consumer credit outstanding in the US. At first glance, this looks pretty positive, a nice 45 degree slope up. But there are a couple things we are forgetting about this. First, consumer credit only counts credit that is not backed by real-estate, so forget about home loans and home-equity lines (HELOC's). Second, credit increased at an annual rate of 2% in July. That's actually not that good.

The second chart shows the year-to-year percentage change in the same data. You can see its rarely been negative, and generally the 0-2% area borders a recession. Right now, there's nothing really positive happening with consumer credit. Nothing that negative either, but that's not what this credit crunch, or even a credit crunch in general, is all about.

Banks, particularly the now dead institution called the Investment Bank, depend on borrowing money to make investments. Just like when you, a consumer, gets a loan, there is a cost to this borrowing, and that cost is primarily determined by the company's credit rating. So let's dispel one thing first off: talking about consumer credit in relation to the credit crunch makes no sense at all. After all, its not like banks are putting their investments on Discover card...

So lets look at what the total loans and leases of commercial banks are (at left). Notice something striking? Its basically flat over the last year.

Finally, we look at the bank credit of all commercial banks, % year-on-year change. Like chart #2, the striking thing is that it rarely dips below 5%, and when it does, its near a recession. Now look at the recent plunge we have had.. And this data is only updated through July!

So what these banks do is called leveraging, you've probably heard all about it now. The basic idea is that you borrow money at one rate, hopefully cheap because your company has a good credit rating, and then invest that money into something else with a better return. In today's case, that was Mortgage Backed Securities, and a lot of banks were highly leveraged, say 30 times its equity. Now the problem with this is that the debt you are using to finance this activity is often shorter in term, so you have to constantly get new debt to keep the operation going. And that works, except when your company's credit rating get's slashed. Suddenly the cost of your debt, or insuring your debt, goes up and it makes it much harder to do business. Counterparties (your trading partners) may ask you to post up some more capital to prove you are good for your debt, otherwise they'll come knocking for their money. This is the Credit Crunch.

Now some consumers have had their HELOC's reduced or frozen, but again, that's not part of the consumer credit in chart #1. Its all about the banks and their ability to get credit. When they can't get credit, or when their investments blow up on them, they tend to tighten up with any lending operations they did have going. Which is what's happening right now in the housing market; instead of subprime it's become SuperPrime. You have to be Mr.Perfect borrower to get a loan from many institutions; they have tightened standards considerably, and probably unreasonably so. But that's human nature, from one extreme to the other.