THE CREDIT CRUNCH….For several months we’ve been reading about how the credit bubble has burst and capital markets are all battening their hatches and refusing to underwrite new business. At the same time, the actual dollar volume of bank loans has gone up. So what’s the real story here? Paul Krugman offers an explanation:
Here’s what I’m told by people who know these markets better than I do: the increase in bank lending is basically a statistical illusion — in fact, it’s in large part a consequence of the credit crunch.
One example of how this might be happening is the now-famous “liquidity put”. Suppose that a bank has created a SIV (special investment vehicle) with an agreement to provide a credit line to pay off investors if they want out and new investors can’t be found. That obligation doesn’t show on the bank’s balance sheet — but when investors cut and run, and the line of credit is called on, the bank is obliged to pony up — and hey presto, it looks as if bank credit has expanded.
A subtler example would involve a firm that has good credit, but finds that security markets have dried up — so it goes back to old-fashioned borrowing from banks, instead. Again, it looks like a credit expansion, but it’s really a sign of tight credit.
Bottom line: yes, there is a credit crunch, and it’s not contained.
Just thought I’d pass this along in case you, like me, have been puzzled by this conundrum. The answer may be bad news, but at least there’s an answer.