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What Credit Crisis?   May 5th, 2009
Where exactly is the problem?       


More observations...

News today that the LIBOR rate dropped to its lowest rate on record would seem to suggest that banks are quite ready to trust each other with each others' money. I'm starting to wonder where the credit crisis is?

A key interbank lending rate fell to its lowest point on record Tuesday as credit market conditions continue to ease.

The 3-month Libor fell to 0.99%, dropping below 1% for the first time since 1986, when the British Bankers Association started keeping records...

"This is good news," said Gus Faucher, director of macroeconomics, at Moody's Economy.com. "It means that banks are trusting one another again and that we're getting to the bottom of the problems in the financial system."...

The 3-month Libor soared to 4.8% in October after the collapse of brokerage Lehman Brothers, and the resulting market volatility caused banks and investors to hoard capital.

Since interest rates factor in the risk of not getting the money back at all, wouldn't a LIBOR rate that is the lowest in history suggest that banks aren't particularly afraid of loaning money to other banks?

Anecdotal evidence from my personal life would suggest that there's no shortage of credit available to qualified (and maybe even unqualified) borrowers: I've refinanced my home, others I know have refinanced their home, several acquaintances have purchased a home, my credit card's credit line was increased even though I didn't ask for the increase, and someone I believe to have marginal credit (at best) was able to obtain a car loan.

So if qualified borrowers are able to obtain credit and the LIBOR rate indicates that banks are willing to loan money to each other, where exactly is the credit crisis? Is the crisis that unqualified borrowers can't get credit? If so, is that really a bad thing?

A working paper from the Minneapolis Federal Reserve written in October 2008, at the height of the crisis, suggested that even then there wasn't any noticeable credit crisis. That analysis was criticized by other economists but the data in that report really does seem to speak for itself. There was no apparent contraction in credit available to non-financial industries. So even in October while everyone was claiming there was a credit crisis, the data offered by the Minneapolis Federal Reserve suggested that that wasn't accurate.

As time passes I'm becoming more convinced that my analysis of the financial crisis was correct. This really isn't a subprime crisis, a housing crisis, or even a credit crisis (though the first two did contribute). Rather it seems more and more likely that the bank bailout was and is an effort to avoid triggering trillions of dollars in credit default swaps.

I also think that's the reasoning behind the bank stress tests. It's not that hard to just say "What would happen to the bank if 20% of its mortgages failed?" Nor would it necessarily sink a bank to have higher-than-normal losses on mortgages for which there is a fixed asset as collateral (the house itself). What makes the stress tests potentially more complicated is the fact that the failure of mortgages owned by other banks and investors may impact the credit default swaps the bank has extended and require massive payouts that are many times larger than the underlying value of the mortgages, and for which there is no underlying fixed asset.

Perhaps I'm wrong. Perhaps I'm missing something. But I'm running out of alternative explanations that make any logical sense. As I wrote in my original analysis, it's about bailing out the credit default swaps. I understood that to be the root cause of the crisis but I admit I've bought into the hype that that caused a credit crisis. But at this point I'm no longer convinced that a credit crisis actually exists.

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