No one will lend me $1 billion, that's how bad the credit crunch has gotten. There are probably reporters at major news outlets who would print that.
The news media almost completely missed the housing bubble. They relied almost entirely on sources who either had an interest in not calling or attention to an $8 trillion housing bubble or somehow were unable to see it. As a result they did not warn the public that their house prices were likely to plunge in future years.
Having dismally failed in their jobs to inform the public, reporters are still relying almost exclusively on sources that completely missed the housing bubble. As a result, they are still badly misinforming the public, first and foremost by attributing the economic downturn to a credit crunch.
Ryan Avent does an ample job of demonstrating why this is silly. Yes, people are probably spending less because their house has gone down, reducing their assessment of their position in the lifetime savings cycle. That's a wealth effect, and I don't think any journalists are denying it.
But I do have to pile on a little, because denying that we're having a massive credit crunch is bizarre, like having lunch with someone who thinks the earth is flat, or doesn't believe in marriage. Seriously, I've seen it--hell, my parents were married. It's out there. And frankly, it's scary as hell.
One hopes that one has similarly misunderstood Baker's post. But it does seem, on its face, very certain that the credit crunch is a minor diversion from the real problem of consumers impoverished by falling house prices. But Mr Baker . . . well, seriously--it's out there. I've seen it. A money market fund really did break the buck and spur a massive run in the commercial paper market. Libor spreads really did start acting like your Cousin Becky when she comes for a week at Christmas and forgets to pack the lithium. Several major banks were forced to sell themselves at fire sale prices or liquidate because their credit had dried up. These things really happened. If you think the teevee might have faked them the way they did the Moon Walk and Ronald Reagan's presidency, there are a variety of other sources you could check with. But unfortunately, it wasn't all just a bad dream
The popping of the subprime bubble undoubtedly precipitated the crisis, much as the 1929 stock market crash became the focal point for the financial crisis that followed. But given what's happening to banks abroad, it's getting harder to argue in good conscience that the housing crash caused the financial crisis; the system simply seems to have been in such a state that some adverse market movement was destined to take it down.
I don't know why Dean Baker seems not to have noticed these things. I also don't know why he seems not to have read the financial press, which is talking to plenty of people who predicted the housing bubble. Indeed, it's hard not to, because most people in the finance community thought the more exotic subprime mortgages were pretty creepy, and most economists were pretty sure it was going to crash. Unless I were allowed to rely exclusively on David Lereah (until recently the permabullish economist for the National Association of Realtors) I would be hard put to find one economic expert who had completely missed the housing bubble, much less write an entire article consulting no one else. I wish Dean Baker had provided a link to some of the overwhelming number of journalists who have managed to do so, if only so I can track down their sources for the obligatory idiot quote.
If what Dean Baker means is that we're relying on sources that didn't see the housing bubble causing a liquidity crisis in the banking sector that triggered worldwide chaos, well, no, we're not interviewing any of those, because AFAIK, there aren't any. There are people, like Nouriel Roubini, who called a US financial panic, but saw it coming from the dollar (among other things--the trigger tended to change, though his prediction of panic did not), not the housing market; the dollar is actually strengthening right now. (To the shock of a lot more people than just Nouriel Roubini). There are people like Robert Shiller, who predicted moderate-to-enormous problems when the housing bubble collapsed. But those predictions were along the lines of what Baker bizarrely insists is the actual case: a wealth effect cutting into consumer spending. Even Robert Shiller does not think this is the whole, or even the greater part, of what is happening, which Baker or his readers could discover by listening to the many, many interviews he has given. I particularly recommend his one hour podcast with Russ Roberts. I've interviewed Shiller about the housing markets for stories several times, and Russ Roberts really drew out some interesting observations.
The righ thought experiment is, if you could make housing market start going up again, would you need to do any more financial intervention on behalf of the financial industry?
If the answer is no, why is it helpful to call some subset of the symptoms we currently suffer a credit crisis?
Subject/object confusion here. I assume "it's" refers to the credit crunch, not marriage, although I have seen some marriages that were scary as hell.
The housing bubble, and the credit bubble in general, caused the credit crunch. Credit depends on banks lending money, then people pay it back, then they lend it again. If people don't pay it back it can't be lent again so there is no credit. What's disturbing about this whole thing is the Wall Street suits shrugging and claiming they have been blindsided by some strange and unforeseeable event, and that is why we have to give them all our money. It is plainly obvious to anybody without an MBA that if you lend a bunch of money to people who can't pay it back, they won't pay it back and you will be in big trouble.
This is a massive, massive moral hazard problem. I don't know if it can all be traced back to Long Term Capital Management, (brought to you by John Corzine!) but the preppies with rich parents decided the Fed could always bail them out, and there would never be a real downturn, and they could be as reckless as they wanted to be. The whole hedge fund/money for nothing culture needs to be wiped out.
Ernest question.... I don't fail to see why the housing crash could not be the primary reason (among a group of other reasons) instead of the mere catalyst as you suggest.
US housing debt was massive grew to astronomical proportions thanks to Fannie Mae and Freddie Mac. All the loan buying these two entities were doing encouraged hundreds of other banks to continue to do the same.
And then when the housing prices started to level off and then tip downwards a lot of these loans were completely upside down.
The banks naturally weren't to excited to continue making risks when they were already in the red and here we are.
I'm not saying this with 95% confidence or anything, but I think it's a reasonable picture. Certainly an expert could add to it or tweak it.
But when the average guy on the street (me) knows 4 people who are now faced with paying payments on $300k for a house that is now worth only 180k it's likely the problem is massive, especially when you factor in the amount of debt the US already has. Spending out way out of the situation does not seem like it will work too well.
The whole hedge fund/money for nothing culture needs to be wiped out.
That seems to be happening, albeit at a terrible cost, and if history is any guide there'll just be another bubble before long.
I believe there is a massive credit crunch. I do not believe it is a bad thing (from a long-term perspective), nor do I believe it is something that should make me feel sorry for the large businesses most hurt by it, beyond my worry about the government overreaction.
Keep some perspective, Megan_McArdle. Here's what's happening.
-Creditworthiness standards are reverting to what they were ten years ago because people now know they can't dump their loans on some other sucker. This is bad, why?
-Interbank loads went from ~4% to 6% on an annualized basis. (Go ahead, calculate the the difference in interest payments over a month, the duration of a typical interbank loan.) This is worrisome, why?
-Business models stupidly designed so that they fail catastrophically when interest rates go up a tiny bit, are failing. This is bad, why?
-People are demanding realistic risk premia on stocks and bonds ... kind of. This is bad, why?
You get the point.
I'm not quite sure how you could so completely misunderstand Mr. Baker's exceptionally short and to-the-point post. Nowhere does he claim that there is no credit crunch. The claim is that the consumption collapse induced by the popping of the housing bubble is the cause of the assumed recession. And I have to agree with him, as I have frequently begged you in these comments to explain how, exactly, the financial meltdowns have any consequences at all for the set of people who are not bankers, which you have failed to do.
Megan,
Baker isn't arguing about the existence of the credit crunch but instead its relevance.
Most of his article points to a channel through which the broad drop in housing wealth (that we all see) effects the economy, namely reduced consumption.
The challenge is to show how the credit crunch has or will make the economy worse than it would have been with just this drop in housing wealth.
We've got a rich set of data flowing in every day on the news. Baker's presented some rough estimates on the size of the wealth effect on consumption. All you need to do is show that there is residual economic misfortune after taking into account his estimates (or whatever you think the appropriate estimated effect is).
Bonus points if you can connect this residual convincingly to the credit crunch.
Double gold stars if you can show that the housing wealth effect is caused in part by the credit crunch.
-B
P.S. OneEyedMan's got the right understanding of Baker's point but the wrong counterfactual. We've got to look out for non-linear effects.
There is a credit crunch. It goes much wider than the USA. It is bad. It is a phenomenon that has its roots in the financial markets, not the real economy.
However, we have now administered the necessary medicine to cure the purely financial roots of the crunch. Banks are adequately capitalised (by government fiat in many cases) and liquidity supply is available in whatever quantity is wanted. We are now going through the period when the finacial medicine is digested, and the finacial markets slowly find their way to realistic premia on lots of things.
At the same time we are plunging into a sharp real economy recession. So the process of financial market normalisation - which does not lead us back to bubble conditions - is further drawn out. Look at that squarely. It is not scary, but its effects on a lot of us will be pretty grim for a while.
Megan, I don't know if you take blog requests... and maybe I simply missed the post where you talked about this, but the Minneapolis Federal Reserve Bank did a research paper (http://woodrow.mpls.frb.fed.us/research/WP/WP666.pdf) where they examined many of the "credit crunch" statistics and showed many of them to be historically not very significant.
While certainly there have been bank failings, and even a money market fund which broke the buck, how do you reconcile the two narratives that seem to be at play here? I'd love to see a post regarding this.
"But given what's happening to banks abroad, it's getting harder to argue in good conscience that the housing crash caused the financial crisis; the system simply seems to have been in such a state that some adverse market movement was destined to take it down."
Are we arguing about whether the bad loans caused or merely precipitated the crisis? Or perhaps we're focusing on the housing bubble without exploring the likelihood that the bubble was caused (and later ended) by excessively relaxed lending standards.
To deny that there even is a credit crunch is silly, as Megan said. But it's good to be clear about what led us to this point. It seems to me that what happened was:
1. lending standards were lowered too far, encouraging more and more people to pour more and more borrowed money into housing, thus leading to a bubble
2. the many shaky loans were chopped up and resold, spread throughout the system in such a way that no one knew how exposed anyone else was, and many didn't even know how exposed they themselves were
3. finally the bubble burst, and it became apparent that there were a lot of bad loans out there somewhere
4. the equivalent of a bank run ensued, with everyone trying to be the first to pull their money out and keep it safe; rather than lend short term, people decided to forgo the small amount that they could have earned in interest, in order to keep their money safe, and so there was a massive credit crunch
Just as even a healthy bank can't withstand a full-blown bank run, our credit system can't continue to function if enough people all pull out at once.
Thus, the solutions seem to be:
A. find out why the lending standards were lowered, and see that it doesn't happen again (this is a problem that could be easily solved, except for the fact that people like Barney Frank don't want to face up to what really happened);
B. try to find some way to make the system more transparent and less vulnerable to runs (this is more complicated, since there are a lot of messy trade-offs; simply killing markets for, say, credit default swaps will hurt the system without really addressing the underlying problem, and yet the political temptation to continue to demonize these 'unregulated' securities will be great).
Surprised to find myself agreeing with Person above, but I think he's spot on. I'd add,
-end of never-ending increase in # of 4500 square foot McMansions.
This is a bad thing why?
Also, last month's big drop in retail sales probably was more the product of wealth effect (declining asset prices) than credit crunch: people still had their credit cards but were reluctant to use them.
Lastly, Baker deserves some more serious response to his point that journalists are still relying on sources who were demonstrated to be utterly clueless. Sort of like continuing to recycle the same old thrice fired baseball managers because they have experience.
Person wrote my comment for me.
Bastard!
It's hard to take Ryan seriously after his post on David Brooks push for infrastructure improvements. Investing in infrastructure is about the only thing that actually does stimulate the economy.
Though, I'm also coming around to the idea that CAFE standards are good idea too. They actually increase efficiency (rather than gas taxes and cap and trade which reduce consumption almost entirely by destroying productivity since efficiency has negatively correlated with gas prices this decade).
The last few years Americans were withdrawing around $500B per year in mortgage equity. In a $13T economy $500B is a lot of money not being spent. Combine this with the amount of money that buying and selling homes generates (commissions on sale of home and loan, profits generated, origination fees etc.) and you have a ton of money going into the hands of spenders. I'm not sure how much money was made, but I wouldn't be surprised if this was another $500B a year as well or more. So we've cut $1T or more in spending a year with the housing crash. That's a serious enough cut to send the entire economy into recession all on its own.
The credit crunch as it applies to housing, is just returning loans to the standards of 10 years ago. Considering the high foreclosure rate, there's no way banks could continue the lending standards of the last few years. It's only a crunch compared to the last few years, but compared to the last 50 it's still great lending environment for home buyers.
I have a notion, and I think it's testable:
The mortgage bubble is merely the latest and most traumatic of a series of bubbles brought on by our 30+ years of trade deficits.
1) Everybody and their brothers and sisters built their prosperity around selling to the USA. They didn't want to buy things from us, because that reduced the number of jobs they could create. The people by inclination and their governments by policy sold to us and did not buy from us.
Japan took this to extremes. Even after two crop failures in a row they imported rice from Thailand rather than the USA. American rice farmers have been trying to get into the Japanese market for decades. They plant the Japanese varieties and so on.
2) Nobody wants to convert their US$ holdings into something they can spend elsewhere. If they do that, the US$ exchange rate will go down, and they will lose their export markets in the USA.
3) Nobody wants to just sit on the money, so they try to invest it. The only place you can invest US$ is the USA. I suggest that this led to a succession of bubbles.
In the '80s we had a commercial real estate bubble at least partly because Japanese investors were buying it up. They were sure real estate prices would never go down.
Our financial markets went up because foreign banks were buying. The dotcom bubble came because almost any IPO sold out.
We got this most recent real estate bubble and the commodity bubble that just deflated for the same reason. Dollars looking to come home.
4) All through the '80s the financial news carried stories about how we Americans spent more than we made, and how we shouldn't run up such big trade deficits. Well, you can't push on a rope.
Economics is not a zero sum game. Time wounds all heels.
Is the dollar strengthening or is most other currency just weakening faster than the dollar is?
Or is that just two ways to say the exact same thing?
Wiredog, I'm pretty sure she meant marriage.
BobW
Without commenting on your general point, you might choose a better example than Japan, which actually has a very low level of exports as % of GDP when compared to other industrialized countries.
And you definitely should choose a better example than rice, since US rice production in the past has been subsidized directly via CCC operations, and indirectly via provision of subsidized water to semi-desert climates like Imperial Valley in California. Fact is that US also should be importing rice from Thailand, which last time I checked (a decade ago) was world's low cost rice producer.
BobW - I think you are totally 100% correct.
You might ask why does China buy CDO's and T-Bills when it could be buying MRI machines, and Cat Earth Movers, and 777's, etc. I think the currency manipulations makes financial assests seem like a better investment that capital goods. But in reality, I think it would be more sustainable long term if they let their currencies adjust some thus allowing the import ratio of financial assets, capital goods, and consumer goods to adjust.
By insisting on payment in financial assets rather than capital or consumer goods they are setting themselfes up to get burned.
Megan,
The point in the logical chain of the "housing bubble caused credit crunch" argument (an argument I subscribe to) that I think you are missing is this:
Loans were made, loans on houses. These loans were considered safe. Lots of money went into these loans. These loans turned out to be bad. Millions upon millions of investment dollars are now tied up in these assets. These dollars will probably never be recovered.
The investment dollars put into these assets were considered semi-liquid. Loan packages are/were bought and sold as commodities.
With all that money gone, there is a legitimate liquidity problem, and to a lesser extent a supply problem as well.
Ergo, the housing collapse caused the liquidity crisis.
In simple terms:
Say I loaned my neighbor $100,000. When I got paid back, I was going to help another neighbor finance a bulldozer/tractor/car-dealer. I never got paid back, I might never get paid back - my money is now illiquid and perhaps gone. I can't loan anyone any more money.
When someone asks me to, I answer "Well, I can't get my money out of this guys house". In theory, I have the asset (the loan on his house). In reality, I may, or I may not. Either way, that money is tied up - I can't loan it out. Result: credit crisis.
Normally, I could sell the loan and use the procedes to make the second loan. This won't happen because nobody knows if the loan is any good, and besides that, they are all in the same boat - their liquid cash is ALSO tied up in illiquid and perhaps worthless assets.
ERGO - the housing crisis caused the credit crunch.
You don't have to believe the earth is flat to find this argument compelling. It is actually very simple and even non-economists should be able to follow it easily.
Have a good one.
Semi-topical remarks:
@Gene: I'm guessing you usually disagree with me because you're way to the left of me and so my comments here surprise you. Well, I hope you take this as evidence that when libertarians are against government intervention, *even to help big business*, they mean it. (Well, to the extent I can call myself that anymore.)
@Yancey: Are you on the LibertarianForum mailing list? If so, did you hear aboue me being kicked off it? See the above link.
Here's Alex Tabarrock at Marginal Revolution agreeing with Baker: http://www.marginalrevolution.com/marginalrevolution/2008/11/wealth-shock.html
And here's a graphic from calculatedrisk.com http://4.bp.blogspot.com/_pMscxxELHEg/SOorqFuvg6I/AAAAAAAADho/3m3HtcTpWP4/s1600-h/KennedyMEWQ22008.jpg showing the tremendous drop-off in home equity lending starting in 2d quarter 2006.
Exactly why you are so hard on Baker is a bit difficult to see and a bit difficult to understand. One might be led to think he's Al Gore.
A credit crunch implies that the supply of money being lent has contracted. Has this actually happened? I frankly don't know where to look for the data on this, but I recall that Tabarrok wrote a couple weeks ago about how credit was actually expanding (but more slowly than in previous years). Anyone got the current numbers on this? I feel they would be more useful than just looking at interest rates.
People keep glossing over the major contributors of the crisis. Debt has been increasing, but the return on debt has been decreasing. Combine this with irrational exuberance, increasing interest rates, increasing expenses and risk explodes.
Shoot, even Greenspan, with his loose monetary policy, knew this. He wrote in the Age of Turbulence last year:
I think what Greenspan missed was that irrational exuberance combined with loose money allow demand for oil to rise unrealistically high. This had disastrous effects on risk as incomes fell relative to debt, increasing risk. This caused the market for new debt to evaporate, washing way the value of assets.
The credit crisis will end when bank lend to less risky people at lower rates. They are expecting too much and as a result will get nothing.
Gene:
From
US 2007 Global Trade Deficit by Country
China - US$259.1 billion (up 11.4% from 2006, up 59.9% from 2004)
Japan - $83.1 billion (down 6.1%, up 10.5%)
Mexico - $74 billion (up 15.4%, up 64.4%)
Canada - $65 billion (down 10.7%, down 1%)
Germany - $44.5 billion (down 6.9%, down 2.8%)
Nigeria - $28.9 billion (up 12.5%, up 97.3%)
Venezuela - $28.4 billion (up 0.6%, up 40.4%)
Saudi Arabia - $24.5 billion (up 1.8%, up 57.3%)
Ireland - $21.6 billion (up 7.5%, up 12.5%)
Italy - $20.9 billion (up 3.7%, up 20.4%)
Malaysia - $20.8 billion (down 13.2%, up 20.4%)
France - $14.5 billion (up 12.5%, down 36.9%)
South Korea - $13.6 billion (up 2.5%, down 31.5%)
Taiwan - $12.7 billion (down 16.7%, down 1.9%)
United Kingdom - $6.7 billion (down 16.8%, down 36%).
I wouldn't call the Japanese $83 billion trade surplus almost nothing. As a percent of their GDP it might be less than it was in the '80s. It definitely pales in comparison to China. But they've had that trade surplus with us for decades now. It has already bitten them. Their economy has been largely stagnant since our recession in the '90s.
Now everybody else is in the same boat. It's just dumb luck that this time everybody is exposed. I do mean dumb luck. I'm not happy about any of this.
Did Megan have a posting some time ago about the validity of the saying "When America sneezes, everybody else catches cold"?
Then there's that other saying: When you owe the bank a dollar, the bank owns you. When you owe the bank a million dollars, you own the bank.
Gene:
About the subsidised rice:
If the Thai rice was cheaper than the American equivalent I would understand their preference. The accounts I read back in the day emphasized that U.S. rice didn't suit the Japanese digestion.
There also is no need for subsidised water in the rice growing regions of Arkansas, Mississippi, and Louisiana.
Yeah, the news media is talking to plenty of people who predicted the housing bubble retrospectively, unfortunately none of these people could figure out how to write about the housing bubble in 2002-2006 when it might have made some difference. So of course, they ALL knew about the housing bubble all along, they just didn't think it was worth their time to talk about an $8 trillion bubble.
Unfortunately, economists are not like dishwashers and custodians. They are not held accountable for the quality of their work.
"Facts and Myths about the Financial Crisis 2008" from the Fed Reserve Mpls.
This report contradicts most news reports.
http://woodrow.mpls.frb.fed.us/research/WP/WP666.pdf
So why are the markets tumbling and everyone reporting disaster. I think we are in the middle of an old fashioned Panic set off by a bear raid initiated by the Democrats who wanted to win the election.
Current Democrat political theory holds that the Middle Class votes Republican when times are prosperous because they expect to get rich and they don't want to raise the taxes on the income level they expect to enter.
OTOH, when times are bad the Middle Class votes Democrat because they want to be sure government aid is waiting for them.
If you look at a chart of the Dow (DJIA) since 1955 you will see this theory in practice. The DJIA dips in 6 of 10 election years generally creating a recession.
The Dems try to win elections by creating a Panic, telling everyone the economy is failing because no one is at the helm of the Good Ship Economy steering it. Each election they get better at creating panics. This year they got an A+.
Of course now that they are in total control and the ship is dead in the water and sideways to the wind you can bet they will raise all the sails and capsize the ship.
Integrated Asset Services(IAS, www.iasreo.com), a leader in default management and residential collateral valuation, today released its IAS360™ House Price Index for September 2008. The monthly report, which includes the most current and granular data available in the industry, showed a 2.1% decline in house prices on a national level in September, with an annual decline of 13.3%. However, the data also shows bright spots at the individual county level with 75 of the 360 counties showing month to month improvement in September.
Click to see the index: http://www.iasreo.com/ias360update.html
Dean is NOT saying that the credit crunch does not exist. Rather, he is saying that the loss of home equity is what is driving the slow-down in consumption. I think this article in the Times demonstrates Dean's argument perfectly: http://www.nytimes.com/2008/11/11/business/11home.html?em
Cheers.
Megan, this sounds like a "perversity" argument often foisted upon the public by the right-wing press. Take a sentence out of context of the man's work that criticises over-Financialization in general. And then accuse him of 'being out of touch'. Dean and others left of center have often focused on the downward spiral of incomes for the lot of Americans and how credit is squeezing those incomes. It only follows that there is a 'credit crunch' as simply the income of most Americans has been going down rapidly during the Bush Decade and trying to make money off a dying middle class is not a good business model. Imagine if incomes of most Americans were rising at the same rate as in the Clinton years: there'd be no problem except for a few people. Now, incomes are falling like in the early thirties and you wonder why the credit crunch is happening. (Maybe not so severe yet? Wait..we have another year or so.) The banks et al were lending with a '90's decade model set before them not knowing that flat and falling incomes of most people in the OO decade couldn't sustain the usurous rates of return.
Look at his whole argument and come back to us.