Last Monday, the National Bureau of Economic Research decided
that it is still not sure when the recession ended -- or if it has ended.
Although real economic growth (GDP) has grown continuously since the fourth
quarter of last year, it remains concerned about a "double-dip" recession.
"The NBER's Business Cycle Dating Committee will determine the
date of a trough in (economic) activity when it concludes that a
hypothetical subsequent downturn would be a separate recession, not a
continuation of the past one," it announced.
I remain disinclined toward the "double-dip" scenario. However,
there is no question that the economic recovery has been far less vigorous
than I anticipated. A key reason for this is the apparent reluctance of
banks to lend to businesses. Indeed, it appears that there is a serious
"credit crunch" underway that may be inhibiting the most vital and vigorous
sector of the U.S. economy.
Large businesses do not rely on bank lending for their credit
needs. They sell their debt directly to investors through what is called
commercial paper. However, small- and medium-size businesses do not have
access to this market, because they are not large enough or lack a
sufficiently high credit rating. They must borrow from banks, just as
individuals do, when they need credit to finance expansion or tide them over
a temporary cash-flow problem.
Increasingly, it looks as if small- and medium-size businesses
are being shut out from bank lending. Commercial and industrial loans have
fallen far more sharply over the latest recession than they did over the
last recession in 1990-1991. This is revealing because the principal reason
for the slow recovery from the last recession was a lack of credit to
The last recession, which began in July 1990, according to the
NBER, was in fact caused by a contraction of credit. This resulted from a
government requirement that banks increase their capital relative to loans.
It was thought that this would help prevent another savings and loan crisis,
in which bad loans ended up costing taxpayers about $150 billion.
Unfortunately, many financial institutions increased their capital ratio by
reducing loans, rather than raising capital.
As banks cut back on lending, large numbers of companies went
under. These were businesses that had solid records and good prospects, but
they needed help getting over the decline in cash flow that inevitably
accompanies the fall-off in sales during a recession. Many would still be
operating today if they had gotten a bit of aid when needed. But the credit
crunch forced them out of business.
A similar credit crunch seems to be operating today. According
to the Federal Reserve, total commercial and industrial loans fell by $113
billion between March 2001, when the recession started, and August 2002.
Under normal circumstances, one would have expected such loans to rise by at
least as much, meaning that there is about $225 billion less credit in the
economy than would ordinarily be the case.
To put the loss of credit into perspective, between July 1990
and December 1991, C&I loans fell by 3.5 percent -- a period of an
acknowledged credit crunch. Over a comparable 18-month period between March
2001 and August 2002, such loans have fallen by 10.3 percent. In other
words, credit is three times tighter in the current recession and recovery
than during an equivalent time period during the last economic downturn.
It is not clear what is behind the current credit crunch. There
has been no change in bank capital requirements, as was the case in 1990. A
Sept. 17 Wall Street Journal report says banks are simply becoming more like
investors in commercial paper, weighing long-term business relationships
less than short-term concerns about interest rate volatility.
An Aug. 12 Forbes Magazine article fingers accounting changes
related to securitization. This is a process whereby loans are bundled
together and sold in bond markets. It allows banks to unload their old loans
and get additional funds with which to make new loans. The new rule would
restrict securitization in order to prevent a recurrence of Enron-like
abuses. However, the effect is to cut back on bank lending to businesses.
Economist Victor Canto warns that the credit crunch may be
exacerbating deflationary pressures in the U.S. economy that are eroding
corporate profits, by preventing businesses from raising prices and
undermining the effectiveness of Federal Reserve interest rate cuts.
Small- and medium-size businesses are the most vibrant sector of
the U.S. economy and those most likely to add workers during an economic
upturn. The Bush administration should look carefully at whether government
regulations are restricting lending to such businesses and contributing to a