Is the credit crunch really as bad as bankers make out? The data for the US doesn't indicate that the credit contraction so far has been that serious.
Take, for example, bank lending to businesses. The chart above illustrates US lending developments going back to World War II. The chart makes two points. First, that credit crunches happen all the time. I have highlighted at least five. Second, by historical standards, this crisis doesn't look particularly serious. There have been bigger nastier credit contractions in the past.
Does this mean that the recession lurks only in the diseased imaginations of a few Keynesian Neanderthals? I'm afraid not. Recent labour market data indicates that something really nasty is unfolding. US employment is likely to be above 10 percent by the end of the year. Unemployment duration is at an all time high.
However, it wasn't a sudden contraction of credit that sent the economy into a nosedive. Credit growth, while not being spectacular has continued until recently. This begs the question why did firms begin to shed labour so violently, despite the challenging but less-than-disastrous credit situation?
Three things did the damage. First, as soon as gullible investors woke up and stopped buying mortgage backed securities, bankers started to panic. They began making wild and exaggerated comparisons with the 1929 crash. It was always a bit of stretch to argue that a collapse in subprime securitization would bring down the world, but somehow bankers sold this story to the rest of us. This spooked the real economy, forcing companies to reconsider their future employment and investment plans.
Second, central bankers overreacted, cutting policy interest rates to zero. Rather than helping the real economy, low interest rates provided a powerful signal that medium term economic environment had worsened. It was confirmation that the panic stricken bankers had something to worry about. Then add in the Lehman debacle, where central bankers were again at the centre of some terrible decision making, and the story of a rerun of 1929 starts to look vaguely credible.
Finally, there was the reckless deficit created by US government. Firms understood that fiscal policy was unsustainable and that over the medium term, taxes were going to rise horribly, creating the basis for a terrible recession in the future. Big deficits are bad for economic growth and firms are now responding accordingly.
Ultimately, this is a policy driven recession. It started out as a policy generated housing bubble. When that burst, bankers started to scream, and rather than ignoring these self interested cries for help, the central bank and federal government accommodated every foolish wish that bankers laid before them.
Of course, the banks were in trouble. However, the government should have just nationalized them, fired the managers, and wiped out the shareholders. Instead, they protected the bankers and got a massive recession in return for their kindness.
Does any of this have any relevance for the UK? Of course, every mistake made in the US was repeated and amplified in Whitehall and Threadneedle Street,
(Note: The data has been converted into logs, which allows a more accurate comparison of peaks and troughs over time. This allows us to look at any two points on the chart and roughly eyeball the percent change.)