Arnold Kling  

Are Credit Markets Locked Up?

Morning Commentary... The Case Against the Bailout...

Depends who you ask. Robert Higgs says no.

Commercial and industrial loans of all commercial banks, which are reported monthly, have grown rapidly. The most recent report, for August 2008, shows outstanding loans of $1,514 billion, an all-time high. This loan volume is 15.5 percent greater than it was a year earlier, and 30.8 percent greater than it was two years earlier.

Thanks to Don Boudreaux for the pointer.

On the other hand, Megan McArdle is keeping tabs on risk spreads in the bond market. She quotes from a market participant.

In early August Caterpillar brought a 5 year bond to market, the 4.90 of August 2013. That bond priced 175 basis points cheap to the benchmark 5 year Treasury note. With the turmoil in the credit markets the last several weeks, the issue has widened on spread and this morning it was quoted 225/ 210.

The talk on the new issue is T + 325 basis points. That is fully 100 basis points cheap to the outstanding issue and 150 basis points above where the same maturity was priced six weeks ago

If the Treasury rate is 3 percent, and you have to pay 1.75 percent higher (175 basis points), that means you pay 4.75 percent. If you have to pay 3.25 percent higher (325 basis points), that means 6.25 percent. It certainly does seem as though Caterpillar Tractor's funding costs have gone up. However, keep in mind that Treasury rates did not stay constant over this time period. They have fallen sharply. So the nominal interest rate for Cat may not be so high. In fact, if we measure Cat's interest cost relative to expected inflation, they may not be doing badly at all.

To a bond trader, the spread over Treasury is a big deal. You live and die by that. But to a company, it's the interest rate relative to expected inflation that matters.

If the credit markets were really bad for firms, they would be pulling their offerings from the market and running to their banks for loans. If their bank terms were onerous, they would be laying off workers to conserve cash. That's how you know you're in a crunch.

To my eyes, the crisis has not yet arrived. Allan Meltzer feels the same way, and obviously so does Bob Higgs. However, I think most other knowledgeable folks feel differently.

When I played tournament bridge many years ago, it was usually best to "bid with the field" unless your particular bidding system gave you clearly superior knowledge about your your partner's hand. I don't have a reason to believe I have superior knowledge about whether credit markets are locked up, so I think I will bid with the field as opposed to what my own eyes are telling me. That means agreeing that we are in a crisis.

Comments and Sharing

COMMENTS (7 to date)
cent21 writes:

I suspect the issue causing panic is in derrivatives that have no hard collateral, rather than in credit.

There certainly isn't transparency on the core problems, to borrow the buzzword of the day.

rkillings writes:

"you have to pay 1.75 percent higher (175 basis points)"

The whole purpose of using the 'basis point' terminology is to avoid making an incorrect statement like this one. 4.75% is NOT 1.75 percent higher than 3.00%. Percent is a ratio. Percentage *point* is a unit of measure on the ratio scale. 100 basis points = 1 percentage point.

ErikR writes:

Most of the data Higgs referenced is more than a month old. The most recent data he references is Sep 9. That does not include the events of last week.

Alex Martelli writes:

Glad to hear you are/were a fellow bridge enthusiast (I haven't found much time to play in recent decades either;-), but "bid with the field" is rot and always was -- even though card play is/was always my hot spot, I've won more MPs over my lifetime by bidding slams the field just couldn't reach, opening weak NT hands, &c, than by double, triple AND composite squeezes, even though the latter give me a nonpareil thrill... they just don't come up THAT often, while bidding better than the field DOES!-)

TDL writes:

I have a question; why is anyone listening to Megan McCardle?


Jeff writes:
I don't have a reason to believe I have superior knowledge about whether credit markets are locked up, so I think I will bid with the field as opposed to what my own eyes are telling me. That means agreeing that we are in a crisis.

These "experts" are the same people who didn't think there was a housing bubble, and when the subprime problems finally became too great to ignore, they thought the system had them "contained". In other words, they've been consistently wrong so far.

Look at commercial paper yields and volumes, available at

The tables and charts there clearly show that, as of yesterday, nonfinancial firms with good credit quality are not paying much to borrow. Financial firms, especially low-rated ones, and those trying to borrow with asset-backed paper are paying higher rates. Given recent history, that's as you would expect.

Further, the outstandings tables at

show that, while there was a drop in nonfinancial commercial paper for the week ended September 17'th, it recovered a bit in the most recent week ending yesterday.

So why the panic? The financial sector has gotten too big and too leveraged over the past few years, and now it is getting smaller. The process isn't pleasant for people in that industry, but there doesn't seem to be much reason for a bailout.

dlr writes:

Yes, I have become much more cynical over the last few days. We are being told there is "a crisis in 30 day commercial paper", and maybe there is. I have heard scattered reports that investors are still moving out of non-treasury MMF's. I certainly would if I were them. And yet, bafflingly, Paulson isn't lobbying congress to fix that problem. It didn't even manage to make it into his Bailout Plan. It's moved somewhere back onto the back burner somewhere for reasons that are very hard to understand. There have to be MMF's that are getting a real hit from WaMu going bust.

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