Thursday, September 11, 2008

What credit implosion?

It seems like it's fashionable these days to bemoan the great credit contraction that was triggered by the subprime/real estate collapse. Banks are failing right and left, with the venerable Lehman Brothers hanging by a thread; surely with lending institutions going belly up (not to mention F&F), there must be a shortage of credit big enough to suck the economy into a big recession with deflation to follow? Well, no. In fact it's very difficult to find any evidence of a credit contraction. The chart above shows the most-respected indicator of the amount of money in the economy, M2. It's the sum of currency, bank reserves, checking accounts, non-institutional money market funds, and time deposits. M2 currently stands at $7.7 trillion. M1 (currency plus bank reserves) is only $1.4 trillion, so that means there is about $6.3 trillion out there in checking accounts, money market funds, and time deposits. If banks were contracting their balance sheets, it would surely show up in a decline in M2. Yet there is no evidence of a decline in M2 or in any of its components, or even any unusual slowdown in the growth of M2. True, M2 growth has slowed in recent months, but this could well be due to a decline in mortgage refinancing activity; the two often go hand in hand. In any event, M2 has been growing on average 6% a year for the past several years, and there's absolutely nothing wrong or unusual about that.

The other chart shows the amount of lending by banks to small and medium-sized companies (Commercial and Industrial Loans). These are companies that are too small to easily access the bond market directly, so they get their financing directly from banks (the old-fashioned way). While it may be that loan activity is slowing of late, it has surged over the past year and over the past four years, rising at a 16% annual pace since the summer of 2004.

What about mortgage lending? Surely that must be drying up. Again, the answer is no. Lehman Bros. keeps track of all the liquid, securitized mortgage securities out there. As of the end of August, the total was $4.3 trillion, up over $500 billion (16%) from a year ago.

In short, most traditional measures of money and lending activity show very healthy growth. This economy is not shutting down, and there is no credit implosion in aggregate. That doesn't mean that some companies and individuals aren't hurting, just that the great majority are most likely doing just fine.

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