Three Myths of the Financial Crisis

V. V. Chari, Patrick Kehoe, and with Lawrence Christiano1 have a working paper arguing that three popular statements regarding the financial crisis are largely a myth.

  1. Bank lending to nonfinancial corporations and individuals has declined sharply.
  2. Interbank lending is essentially nonexistent.
  3. Commerical paper issuances by nonfinancial corporations has declined sharply, and rates have risen to unprecendented levels.

They point to data showing that none of these statements are true. They also point to three unappreciated facts,

  1. In the aggregate nonfnancial corporations can pay their capital expenditures entirely from their retained earnings and dividends without borrowing from banks or households.
  2. In the aggregate, increases in nonfnancial corporate debt are roughly matched by increases in their share repurchases.
  3. Only about 20% of nonfnancial corporate debt is held by banks.

Chari, Chirstiano and Kehoe argue that these three facts suggest that the crisis in the financial markets isn’t quite the problem many are making it out to be for non-financial firms. They argue that firms can finance investment via retained earnings and that if firms can lend directly to each other or pursue joint ventures. Thus the claims that disruptions in the banking/finance system pose a problem for non-financial firms is likely over-stated.

Finally they look at the spreads between various interest rates and Treasury Securities. They argue that during times of a financial crisis looking at these spreads can lead one to conclude, erroneously, that the cost of borrowing has gone up. They argue that during times of crisis there is often a flight to quality–i.e. investors move to Treasury securities which leads to a reduction in the real return on Securities and thus an increase in the spreads.

In conclusion the authors do not claim that there is no recession or that it isn’t possibly going to be a deep recession. They merely point out that many of the claims have yet to be seen in the aggregate data. They also argue that without these claims being true the case for massive government intervention has not been made.
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1Research economists with the Minneapolis Federal Reserve Bank and professors at the University of Minnesota (Chari and Kehoe) and Northwestern.

FILED UNDER: Economics and Business, Government, ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Drew says:

    Here we go again. If anyone should be bleating and moaning about the current environment out of raw self interest it should be me, a player in private equity. But I’m not. I find myself once again in agreement with what has been posted here.

    The interbank lending problem was actually very short lived. Look at the LIBOR history. And the commercial paper market is functional right now.

    “In the aggregate nonfinancial corporations can pay their capital expenditures entirely from their retained earnings and dividends without borrowing from banks or households.”

    Except for leveraged companies with debt service issues, this is most assuredly true.

    “In the aggregate, increases in nonfinancial corporate debt are roughly matched by increases in their share repurchases.”

    “Only about 20% of nonfnancial corporate debt is held by banks.”

    I have to take the economists at their word. But it seams entirely plausible.

    So where does this leave us? It really is small business and the LBO business that have real issues. They are the ones who need the banks. Acquisition financing. Working capital loans and such.

    I know for a fact that the LBO business has been rocked due to the credit crunch. Small, business somewhat. So yes, let’s not deny the issue, things are depressed and affected.

    But the “worst crisis since the world started” mantra just simply needs to be deep sixed. Its clearly a smokescreen to some other motive.

    Heed my words, people. Focus on the (commercial) banks. The banks, the banks, the banks. If they in fact remain “solvent” and functioning reasonably well all else will be fine in time. Any bailout dollars, if warranted, should be focused there, and simply as equity infusions. Period.

  2. DL says:

    This cynic views this financial crisis “almost” the same way as global “climate change.” It’s an opportunity to create an environment of fear and panic, allowing the control freaks a free shot at pretending to be saviours while they grab control and steal freedoms without much criticism. I just have learned to not trust them but to beegin any evaluation assuming they’re up to no good all the time.

  3. Dave Schuler says:

    This is closely allied to a point I’ve made over at my place: it’s darned hard to deal with the problems that you do have when you’re completely occupied in dealing with problems that you don’t have.

  4. SavageView says:

    I read this when it came out… in early November. Their data run through mid-October. Let’s see an update with full Q4 data, in particular Figures 4B and 6A.

    Yes, we should focus on the commercial banks, as BoA and Citi are essentially insolvent now.

  5. Steve Verdon says:

    Yeah, I’d like an update too. Hmmm…maybe an e-mail….

  6. tom p says:

    OK… here is where the rubber hits the road.

    I don’t pretend to be smart enough to figure out this sh*t… but I do know when the rest of you are full of it, after all

    So where does this leave us? It really is small business and the LBO business that have real issues. They are the ones who need the banks. Acquisition financing. Working capital loans and such.

    I know for a fact that the LBO business has been rocked due to the credit crunch. Small, business somewhat. So yes, let’s not deny the issue, things are depressed and affected.

    I am unemployed.

    If anyone should be bleating and moaning about the current environment out of raw self interest it should be me, a player in private equity.

    Drew, I am sorry, but are you trying to figure out how to put a roof over your food next week? I am.
    And I am just a little bit tired of people who are worried about how they are going to make next months payments (while they still have a job) when I am worried whether last years garden will feed me thru the spring…

    And yes, this is pure self interest. So what?

  7. Drew says:

    C’mon tom p –

    If you have read and really comprehended anything I have ever written here you know that my philosophy and policy prescriptions are oriented toward free enterprise and a growing economy, because that is what I truly believe is what will really help “the Average Joe,” a title I apply to myself. But dislocations and disappointments will inevitably occur.

    Did you note something I wrote (ripped off, really, from another source) that 8 million jobs are destroyed each quarter in the US, offset by the jobs created? That is a stunning stat. But it demonstrates the dynamic economy we live in. So wailing and moaning about job loss just goes nowhere. It is reality. We have to deal with it, and capitalize on the inverse stat.

    The very fact that you are here on this website tells me you are someone who is capable of adapting and succeeding in our economy. Why else would you participate and hold your own here? Obviously, my condolences on any current problems, but nobody on this site is incapable of finding their way.

    I could regale you with stories of my near death experiences in risk taking and job hopping to get ahead. Engineer today, banker tomorrow, small business manager then……small business owner now. But that would bore you. However, such change and adaptability is the way of our economy and how it is done.

    Please, I do not in any way mean to be condescending…….but promise me wrt your fortunes you will absolutely forget this Obama guy is President, and all his fancy talk. Just focus on your talents, skills and desires and make it happen yourself. Forget, Obama, he won’t be there for you. He will be no help. Only tom p can make it happen. And I bet he will.

  8. tom p says:

    Drew, thanx for the thoughtful response.

    If you have read and really comprehended anything I have ever written here you know that my philosophy and policy prescriptions are

    I have and I do…

    But dislocations and disappointments will inevitably occur.

    And when they do, they can be very painful. I have been a carpenter (and a damned good one) for almost 30 yrs, and have weathered many storms. But this one is different. The construction industry is going thru a contraction the likes of which I have never seen. As I pointed out recently I am incapable of seeing what is on the other side for me. I’ll figure it out… but I can not tell how.

    But it demonstrates the dynamic economy we live in. So wailing and moaning about job loss just goes nowhere. It is reality. We have to deal with it,

    Yes we do, as I am now.

    The very fact that you are here on this website tells me you are someone who is capable of adapting and succeeding in our economy.

    How well I will adapt and succeed this time, only time itself will tell (I will, I always have before), but I am here because I like to have my preconceptions challenged… It makes me think about what I beleive the truth to be.

    I could regale you with stories of my near death experiences in risk taking and job hopping to get ahead…But that would bore you.

    Truth be told, I would find it very interesting. I have a good buddy who has reinvented himself several times… A fascinating life he has led.

    but promise me you will absolutely forget this Obama guy is President, and all his fancy talk.

    This I can not do. Not because I think he is going to “rescue” me, because I don’t. My problems are my problems and I have to solve them on my own, as I always have. I won’t forget he is President because everything he does will affect me (and you) either directly or indirectly.

    As to his “fancy talk”… It is rather refreshing after the past 8 years.

  9. Drew says:

    “Drew, thanx for the thoughtful response.”

    So am I really that full of shixt?

    “I have been a carpenter (and a damned good one) for almost 30 yrs, and have weathered many storms. But this one is different.”

    It certainly is a precipitous fall, because the zenith was a bubble. In any bubble the key is not to beleive that the good times were “normal” or that they would last forever. I trust you socked some dough away during the bubble.

    “How well I will adapt and succeed this time, only time itself will tell (I will, I always have before)”

    It would be presumptuous for me to make suggestions (but I will relay a recent anecdote). Straight off of -17 degrees here in Chicago, we had a busted water pipe. To make a long story short, the plumber shows up, and 2 hours and $500 later the problem was fixed….and I paid all the materials. To be sure, he was a pro, but I know fancy deal lawyers who charge $500 an hour. $250 seems pretty good to me. Plumbing must be good.

    – I could regale you with stories – “Truth be told, I would find it very interesting.”

    That might lead us too far astray for the proprietor of this site. Let me just say that prudent risk taking and hard work always have and always will pay off. Further, anytime I think I’ve had some great sacrifice, I think about the guys in the military. WWII, Iraq, etc. Now THAT’s sacrifice. And when I hear the whining – “who’s going to pay for my gas; I ran my credit card bills up, poor me, boo-hoo” I think shut the fk up and get to work fixing it. Think about those guys over in Afghanistan.

    “This I can not do. Not because I think he is going to “rescue” me, because I don’t. My problems are my problems and I have to solve them on my own, as I always have. I won’t forget he is President because everything he does will affect me (and you) either directly or indirectly.”

    Suit yourself. But I view government as primarily a series of roadblocks and messes to be overcome. Yes, they keep us safe. Yes, they should provide support for the most unfortunate. But govt is big beyond any reasonable necessary level, and I don’t think Obama is going to be in any way constructive in correcting that.