Flawed Assumptions about the Credit Crisis - A Critical Examination of US Policymakers
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
Octavio Marenzi Flawed Assumptions about the Credit Crisis A Critical Examination of US Policymakers December 2008
Content 3 Executive Summary 5 Introduction 7 US Policymakers’ Explanations versus the Data 7 US Bond Market 9 Bank Lending 10 Interbank Lending 12 Commercial Lending 13 Commercial Paper 16 Real Estate Lending 18 Consumer Credit 20 Municipal Bonds 21 Cost of Credit 23 Lending Activity in Europe and Japan 23 Eurozone—France, Germany, and Italy 25 Japan 25 United Kingdom 26 Conclusions 28 A Brief Look at the Money Supply
Executive Summary
This report compares leading US policymakers’ assumptions with
available data regarding the credit and lending markets. We find irrec-
oncilable differences between the public pronouncements of leading
US policymakers and information published by the very institutions
they lead. We consider the two policymakers most involved in the
financial crisis: the chairman of the Federal Reserve Bank, Ben Ber-
nanke, and the secretary of the United States Department of the
Treasury, Henry Paulson.
While there is no denying that we are mired in a very serious financial
crisis, this does not yet appear to have transformed into a general
credit crisis. In aggregate, credit and lending markets appear to be
functioning well, and in many cases are actually operating at histori-
cally high levels.
In repeated areas, the key assumptions about US credit markets being
made by these policymakers are not supported, or are flatly contra-
dicted, by the available data. In most cases, we have relied on data
from the Federal Reserve Bank for our analysis. In particular, the fol-
lowing assumptions regarding the credit crisis are at odds with the
information available to us:
Table 1: Flawed Assumptions about the Credit Crisis
Assumption Available Data
Businesses are unable to Overall US bank lending is at its highest level ever and has
obtain credit, and lending grown during the crisis.
has been severely curtailed.
US bank commercial lending is at record highs and is growing
particularly quickly at an annual rate of about 19% since May
2007.
Corporate bond issuance has declined, but increased commer-
cial lending has compensated for this.
The interbank lending mar- Interbank reached its highest level ever in September 2008, and
ket has ground to a halt, and remained high in October 2008. Interbank lending has
funding, when available, has increased about 22% since the beginning of the credit crisis.
become very costly.
The cost of interbank lending, as measured by the interest
banks charge each other for lending overnight Fed funds,
dropped to its lowest level ever in early November, and remains
at very low levels.
Source: Industry Sources, Celent analysis
Copyright 2008 © Oliver Wyman 3Table 1: Flawed Assumptions about the Credit Crisis
Assumption Available Data
Households cannot obtain Consumer credit in September 2008 (the latest date for which
credit. we have figures) stood at a record high.
Household debt burden as a percentage of disposable income
was hovering near record highs of about 19% at the end of Q2
2008.
Commercial paper markets Outstanding volumes in the commercial paper market for non-
have ceased functioning. financials are higher now than at any point since early 2004.
Only very short-term fund-
ing is available, and then at The cost of borrowing in the commercial paper market has
very high costs. dropped to at least 10-year lows for non-financials.
Financials have reduced their issuance of commercial paper, but
any shortfall in funding has been more than compensated by
increased deposits.
Local governments are Issuance in the municipal bond market has continued at levels
having difficulty obtaining similar to those before the credit crisis, which has had no dis-
credit. cernible impact.
Loans for real estate are Bank real estate lending reached a record high in October 2008
severely diminished. and has grown consistently during and before the crisis.
Issuance of mortgage-backed securities has declined, but the
volatility observed in the first half of 2008 is in line with histori-
cal norms.
Source: Industry Sources, Celent analysis
We can offer no firm explanation for the discrepancies between the
public statements and assumptions being made by US policymakers
and the data available. We can only offer two possible hypotheses:
Policymakers have at their disposal far more information and
data than is publicly available. It is possible that these addi-
tional data support the hypothesis that there has been a
general breakdown in credit markets. However, they have not
shared these data with the public, and these data would have
the burden of explaining why the data that are being pub-
lished by the Federal Reserve are, in fact, incorrect. We are
sceptical that such data are in fact available.
Another possible explanation is that policymakers are react-
ing to the situation of a particular set of businesses and
financial institutions, and are incorrectly generalizing this to
the market as a whole. If this is the case, the policy tools
being employed may well be the wrong ones.
We conclude the report by pointing out some of the results of the poli-
cies that have been implemented. In particular, a spectacular rise of in
the M0 money supply, which increased a staggering 74% in only 84
days. Previously, this kind of jump would be seen over the course of a
decade or more.
4 Copyright 2008 © Oliver WymanIntroduction
There is no doubt that we are in the Figure 1: The Worst 10 Years
midst of a deep financial crisis. A number for Equities since 1870
of major financial institutions have
2008, not yet complete,
failed. Indeed, entire countries appear to has the potential to set a
be teetering close to bankruptcy. Com- new record for the worst
parisons to 1929 abound. Looking at the year ever.
performance of the US stock market (see -20% 1893
Figure 1), it is clear that these compari- -21% 2002
sons are not overblown: 2008 has the -24% 1920
potential to become the worst year ever -28% 1930
for equities; 1931 is only ahead by a small 2008 is
through 4 -29% 1974
margin.
Dec -31% 1917
In light of this turmoil, we have seen -33% 1907
unprecedented levels of government -35% 1937
intervention in the markets. The crisis, -43% 2008
while having global ramifications, is -46% 1931
squarely centered on the US, and the
Source: Yale University, Standard & Poors
response of the US government and cen- TMI, Celent analysis
tral bank has been unprecedented in
scope and scale. In this report, we do not examine the policies that
have been put in place to respond to the crisis, but rather the assump-
tions that policymakers appear to be making about the crisis. In order
for policy to be effective, an accurate diagnosis of the specific market
failure at hand is necessary.
Much of the justification for the massive policy response is that lend-
ing and credit markets have frozen, that the financial crisis—which
undeniably is real—has turned into a credit crisis, with banks, house-
holds, businesses, and municipalities seeing their access to credit
severely curtailed. This report examines the claims and public
announcements made by US policymakers and compares them with
publicly available data.
The genesis for this report came from a study published by the Federal
Reserve Bank in October 2008. Three researchers (V. Chari, L. Chris-
tiano, and P. Kehoe) at the Federal Reserve Bank of Minneapolis
published a paper entitled Facts and Myths about the Credit Crisis1. Rather
1. http://www.minneapolisfed.org/research/WP/WP666.pdf
Copyright 2008 © Oliver Wyman 5ominously, this paper is referred to as Working Paper 666. The study
raised interesting points regarding assumptions that policymakers and
the public are making about the nature of the current financial crisis.
These researchers claimed that, contrary to popular belief, bank lend-
ing in the US has not collapsed, but rather has increased during the
credit crisis. Interbank lending, which is widely believed to have com-
pletely frozen, is actually as strong as ever. On a variety of measures,
the Federal Reserve Bank of Minneapolis claims that there appears to
be an abundance of credit flowing in the US market. The researchers
are also unusually strident in their criticism of US policymakers, accus-
ing them of an absence of serious analysis and of substituting hard
data with their own speculation.
Figure 2: A Timeline of the Credit Crisis in the US
The early warnings of a credit crisis had no impact on the US
equities market, which continued to soar until October 2007. By
September 2008, the full extent of the crisis became clear with a
flurry of bailouts and failures.
DJIA reaches Fannie Mae and
record high of Freddie Mac
14,164. nationalized.
AIG bailout.
Two Bear
Stearns
Bear Stearns Lehman Brothers
mortgage-
Largest US fails. fails.
related funds
subprime lender,
fail.
New Century,
Economic
fails. Citigroup bailout.
Stabilization Act
passed.
WaMu fails.
Indy Mac fails.
Mar-07
Apr-07
May-07
Jun-07
Jul-07
Aug-07
Sep-07
Oct-07
Nov-07
Dec-07
Jan-08
Feb-08
Mar-08
Apr-08
May-08
Jun-08
Jul-08
Aug-08
Sep-08
Oct-08
Nov-08
Dec-08
Source: Press, Celent analysis
In this report, we examine the claims made by Chari et al, extend the
analysis to cover additional areas of US policy, and juxtapose these
with policymakers’ public explanations of the nature of the financial
crisis. Furthermore, we add a brief analysis of European and Japanese
lending markets in order to determine what the impact of the credit
crisis has been on lending activity beyond the US.
6 Copyright 2008 © Oliver WymanUS Policymakers’ Explanations versus the Data In this chapter, we examine the explanations and descriptions of the financial crisis that have been offered by policymakers. In particular, we focus our attention upon the Chairman of the Federal Reserve, Ben Bernanke, as well as the Secretary of the Treasury, Henry Paulson, the two individuals who are driving the policy response to the credit crisis in the US. To the extent possible, we compare the comments made and contrast these with publicly available sources of data. In most cases, we rely on data provided by the Federal Reserve Bank. In other instances, we have relied on generally accepted sources of data. It is startling that many of Chairman Bernanke’s and Secretary Paul- son’s remarks are not supported or are flatly contradicted by the data provided by the very organizations they lead. At very least, the data indicate that the credit crisis is not as clear-cut a phenomenon as is being suggested. US Bond Market We begin our analysis by looking at the overall state of the US bond market through end of the second quarter 2008, which is shown in Fig- ure 3. The first half of 2008 did show a decline for bond issuance overall of about 17%. While troubling, this is hardly the stuff that crises are made of. In sub- sequent sections of the report, we examine other parts of the credit markets, for which we have more up-to-date data available. Copyright 2008 © Oliver Wyman 7
Figure 3: US Bond Markets Issuance 1996 to Q2 2008
The first half of 2008 witnessed a 17% reduction in bond issuance
activity in the US.
Note: 2008 annualized based on
Annual Bond Issuance (US$ billions)
8,000
growth seen in Q1 and Q2
7,000 comparied to 2007
6,000
5,000
4,000
3,000
2,000
1,000
0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Municipal Treasury Mortgage-Related
Corporate Bonds Federal Agencies Asset-Backed
Source: US Department of the Treasury, Federal Agencies, Thomson Financial, Inside MBS & ABS,
Bloomberg, SIFMA, Celent analysis
Figure 4: US Bond Issuance H1 2008 vs. H1 2007
In the first half of 2008, asset-back securities saw a sharp decline,
while the issuance of US Treasuries and Agencies increased
significantly.
1,200 Percentage
Bond Issuance (US$ billions)
change H1 2007 -29%
1,000 to H1 2008
64%
800
-16% -80%
600
14%
400
-1%
200
0
Municipal Treasury Mortgage- Corporate Federal Asset-
Related Bonds Agencies Backed
H1 2007 H2 2008
Source: US Department of the Treasury, Federal Agencies, Thomson Financial, Inside MBS & ABS,
Bloomberg, SIFMA, Celent analysis
8 Copyright 2008 © Oliver WymanBank Lending
We begin with an analysis of a claim made by Secretary Paulson, focus-
ing on the credit markets in general and on interbank lending in
particular:
By mid-September, after 13 months of market stress, the financial sys-
tem essentially seized up and we had a system-wide crisis. Credit
markets froze and banks substantially reduced interbank lending.
—Secretary Henry M. Paulson, Jr. at The Ronald Reagan Presiden-
tial Library, 20 November 2008.
Figure 5 shows the overall level of US bank lending over the 30-year
period ending in October 2008. As can be seen, the aggregate level of US
bank lending has been unperturbed by the financial crisis and has
grown steadily and consistently. In aggregate, US banks reached US$10
trillion in terms of outstanding credit in October 2008. The freezing of
the credit markets that Secretary Paulson cites is not visible.
In Figure 6, we zoom in on the 19-month period since the credit crisis
began for commercial banks. Far from falling, bank credit is growing
and has increased by 16.5% since April 2007. The failures of Bear
Stearns, Lehman Brothers, AIG, WaMu, and Indy Mac do not appear to
have had any impact on the aggregate lending activities of US banks.
Certainly, bank lending is an important part of the credit markets, but
it is not the entire market. Other sources of funding are available,
including the issuance of commercial paper and corporate bonds. We
consider these markets in turn later in this report and find limited evi-
dence to support Secretary Paulson’s claims of a seizing up of the credit
markets.
Figure 5: US Bank Credit 1978—October 2008
Overall, US bank credit is at its highest level ever and has grown
steadily for over 30 years…
10
US bank credit (US$ trn)
8
6
4
2
-
1978 1983 1988 1993 1998 2003 2008
Source: Federal Reserve Bank
Copyright 2008 © Oliver Wyman 9Figure 6: US Commercial Bank Credit April 2007 to November 2008
During the credit crisis, lending by US commercial banks has
increased by 16.5%. None of the shocks to the system have
reduced bank lending. Citibank bailout
All-time record high in lending
US Commercial Bank Credit (US$ trillions)
22 October 2008
7.4
Economic Stabilization Act enacted
Largest US sub-prime
7.2
lender, New Century, AIG bailout
7.0 fails
Bear Stearns fails
6.8 WaMu fails
Indy Mac fails
6.6
Fannie Mae and Lehman
6.4 Freddie Mac Brothers
nationalized fails
6.2 Two Bear Stearns
mortgage funds fail
6.0
Apr-07
Jun-07
Aug-07
Oct-07
Dec-07
Feb-08
Apr-08
Jun-08
Aug-08
Oct-08
Dec-08
Source: Federal Reserve Bank, Press, Celent analysis
Interbank Lending
Secretary Paulson goes on to talk about a substantial reduction in
interbank lending in September 2008. Figure 7 shows the level of inter-
bank lending over a 30-year period. This time series shows some
volatility, but the overall trend is upward since 1978. In particular,
interbank lending has increased by almost 60% since mid-2006, when
there was a lull in activity. Far from seeing a substantial reduction in
interbank lending, there has been a substantial increase.
Figure 7: US interbank Lending 1978 to October 2008
US inter-bank lending declined from mid-2004 to mid-2006, but
has grown strongly since, and it at its highest level ever...
US inter-bank lending (US$ trn)
0.50
0.40
0.30
0.20
0.10
-
1978 1983 1988 1993 1998 2003 2008
Source: Federal Reserve Bank
10 Copyright 2008 © Oliver WymanThe assertion made by Secretary Paulson that “banks substantially
reduced interbank lending” in September 2008 is even more puzzling.
Figure 8 shows that interbank lending actually reached a record level in
that month. It is impossible to reconcile Secretary Paulson’s statement
with the numbers provided by the Federal Reserve.
Secretary Paulson is not alone in his assessment of a worsening inter-
bank lending market:
Conditions in the interbank lending market have worsened, with term
funding essentially unavailable.
—Federal Reserve Chairman Ben Bernanke, before the Committee
on the Budget, US House of Representatives, 20 October 2008
Chairman Bernanke’s comment above is more nuanced in that it only
refers to “term funding” becoming unavailable in the interbank mar-
ket. If, in fact, longer-term interbank loans had become unavailable,
then there must have been a corresponding, significant increase in
overnight lending between banks in order for the overall numbers to
demonstrate the growth shown in Figure 8. If this were the case, it
could probably be explained by the fact that short-term interest rates
have fallen to such low levels recently. However, it is hard to construe
this as a crisis in the interbank lending markets.
Figure 8: US Interbank Lending from July 2007 to October 2008
In September, US inter-bank lending reached its highest level
ever, having increased 22% since the beginning of the credit
crisis.
0.47
Record high
US Inter-Bank Lending (US$ trillions)
0.45
0.43
0.41
0.39 By mid-September...banks substantially
reduced interbank lending .
0.37 Secretary Henry Paulson
0.35
Apr-07
May-07
Jun-07
Jul-07
Aug-07
Sep-07
Oct-07
Nov-07
Dec-07
Jan-08
Feb-08
Mar-08
Apr-08
May-08
Jun-08
Jul-08
Aug-08
Sep-08
Oct-08
Source: Federal Reserve Bank, Press, Celent analysis
Copyright 2008 © Oliver Wyman 11Not only has the volume of interbank lending increased during the
credit crisis, the cost of borrowing has decreased markedly. Figure 9
shows that the effective Fed funds rate, the rate at which banks lend
each other reserves held at the central bank, has dropped to almost
zero.
Figure 9: The Effective Federal Funds Rate April 2007 to 26 November 2008
Interest on inter-bank loans, as measured by the Fed funds
rate, has decreased markedly during the credit crisis,
reaching a low point of only 0.24% on 5 November.
6
Effective Federal Funds Rate 5
4
3
2
1
0
Apr-07
Jun-07
Aug-07
Oct-07
Dec-07
Feb-08
Apr-08
Jun-08
Aug-08
Oct-08
Dec-08
Source: Federal Reserve Bank, Celent analysis
Commercial Lending
Businesses, too, are confronting diminished access to credit.
—Federal Reserve Chairman Ben Bernanke, in remarks to the
National Association for Business Economics, 7 October 2008
Chairman Bernanke’s assertion above is widely accepted. However, an
analysis of commercial lending activity by US banks suggests that the
opposite is actually true. Aggregate US commercial and industrial loans
for the 30-year period ending in October 2008 are shown in Figure 10. It
is evident that commercial lending has not declined, but reached its
highest level ever in October. Indeed, the current growth rate of 19%
annually in commercial lending has reached levels that would appear
to be unsustainable. The visible cycles of expansion and contraction in
commercial loans suggests that a sharp contraction in commercial
lending may occur in the near future. However, the “diminished access
to credit” is not visible on this measure.
12 Copyright 2008 © Oliver WymanFigure 10: US Commercial Lending 1978—October 2008
Commercial lending has gone through increasingly rapid
expansions and contractions over the past 30 years. Since May
2007, lending has been increasing at a feverish annualized pace of
US commercial and industrial loans (US$ trn)
1.6
19%... 19.0%
1.4
1.2
12.4%
1.0
8.7%
0.8 -6.4%
0.6 8.9% Annualized
growth rates
0.4 -1.9%
0.2
Recession Recession Recession Recession
-
1978 1983 1988 1993 1998 2003 2008
Source: Federal Reserve Bank, Celent analysis
While corporate bond issuances has declined, commercial lending has
picked up. Overall, there does not appear to be a funding crisis for US
businesses. A shift from the issuance of longer maturity corporate
bonds to shorter maturity bank loans could well be explained by the
shifts in the yield curves that have occurred during the crisis (see Fig-
ure 21 on page 22). Short term borrowing costs are currently
significantly less than longer term borrowing, which naturally drives
businesses to favor shorter term funding sources. Also, the buyers of
corporate bonds are probably viewing assessments from rating agen-
cies with far greater skepticism than in the past, making corporate
bonds harder to place.
Commercial Paper
Clearly, businesses may be having difficulty obtaining credit from other
sources of financing, but an absence of commercial lending by banks is
not the source of any such difficulties. The commercial paper market is
one such additional source of funding that businesses routinely turn
to. In Figure 11, we examine the total amount of commercial paper out-
standing in the US for non-financials. While the outstanding amount
of commercial paper certainly shows some variation, there is little in
the numbers in Figure 11 to support the claim of a crisis. Indeed, since
2004, the outstanding volume of commercial paper has increased.
Copyright 2008 © Oliver Wyman 13Figure 11: Non-Financial Commercial Paper Outstanding 2001–2008
During and after the recession of 2001-2003 , the volume of
commercial paper decilned significantly in the US, reaching a low
point in early 2004. Since then, the market has grown, albeit
unsteadily.
350
Non-Financial Commercial Paper
300
Outstanding (US$ billions)
250
200
150
Recession Recession
100
50
0
Dec-00
Jun-01
Dec-01
Jun-02
Dec-02
Jun-03
Dec-03
Jun-04
Dec-04
Jun-05
Dec-05
Jun-06
Dec-06
Jun-07
Dec-07
Jun-08
Dec-08
Source: Federal Reserve Bank, Celent analysis
The problems extended to blue chip industrial companies who could only
issue commercial paper with very short maturities as the commercial
paper market became severely impaired.
—Secretary Henry M. Paulson, Jr. at The Ronald Reagan
Presidential Library, 20 November 2008
Figure 12 examines commercial paper issuances by AA-rated non-
financials. While not precisely the “blue chip industrial companies”
that Secretary Paulson refers to in the above citation, this should be a
reasonably good proxy. Figure 12 captures daily issuance activity for
commercial paper with a maturity of at least 20 days (most commercial
paper has a maturity of one to four days). In essence, this includes blue
chip industrials and other blue chip non-financial businesses. Shorter
maturities are omitted from this series, in order to focus on Secretary
Paulson’s claim that only very short-term borrowing is available.
Secretary Paulson’s assertion that longer-term commercial paper could
not be issued by blue chips finds no support in these figures. Rather,
Figure 12 shows that issuance of longer-term commercial paper is up,
not down.
It is quite possible that specific businesses are facing difficulty obtain-
ing credit, be it directly from banks or through the commercial paper
market. For example, the US car industry doubtlessly is having severe
14 Copyright 2008 © Oliver Wymanproblems raising funds. However, here the market is working well and
is declining to extend credit to firms that have poor prospects for the
future and represent poor risks. Far from being a market failure, this is
a market success: the market working as it should. In aggregate, the
commercial paper market for highly rated business continues to func-
tion well.
Figure 12: Issuance of Commercial Paper by AA-Rated Non-Financials
During Credit Crisis to 28 November 2008
Longer term commercial paper issuances by blue chip non-financials has
AA-Rated Non-Financials with Maturity of 20 increased significantly since the beginning of the crisis...
Daily Issuance of Commerical Paper by
1,400
Days or More (US$ millions)
1,200
1,000
800
600
400
200
-
Jul-07
Aug-07
Sep-07
Oct-07
Nov-07
Dec-07
Jan-08
Feb-08
Mar-08
Apr-08
May-08
Jun-08
Jul-08
Aug-08
Sep-08
Oct-08
Nov-08
Dec-08
30-day moving average
Source: Federal Reserve Bank, Celent analysis
Figure 13: US Bank Deposits April 2006 There certainly has been a
to October 2008 reduction in the amount of
commercial paper issued by
Since April 2006, almost $1.5
trillion in additional deposits financial institutions. During
have flowed into US banks. 2006, blue chip financial insti-
tutions would issue $30 billion
7.3
7.1 to $40 billion of commercial
US Bank Deposits
6.9 paper on a daily basis. Cur-
(US$ trillions)
6.7 rently, we are closer to $20 to
6.5
$30 billion being issued daily. A
6.3
6.1
decline certainly, but hardly a
5.9 crisis.
5.7
5.5 However, at the same time
bank deposits have grown sub-
06
07
08
6
7
8
-0
-0
-0
r-
r-
r-
ct
ct
ct
Ap
Ap
Ap
stantially, as shown in Figure
O
O
O
Source: Federal Reserve Bank, Celent analysis 13. This increase in deposits
Copyright 2008 © Oliver Wyman 15reduces the need for banks to finance themselves through the com-
mercial paper market. Indeed, in many ways, deposit-based funding is
preferable to funding from the institutional markets. A ready explana-
tion of the decline in financials issuing commercial paper is that they
have found other, more favorable sources of financing. Since the begin-
ning of the credit crisis in April 2007, about US$1 trillion in new
deposits have flowed into US banks.
Real Estate Lending
We continue in our analysis to the mortgage market and real estate
lending:
As we all know, this is a timely issue as the housing correction and capi-
tal markets turmoil has reduced the availability of credit for mortgages
and other lending.
—Secretary Henry M. Paulson, Jr. at the FDIC Forum on Mortgage
Lending, 8 July 2008.
Figure 14 shows the level of real estate lending by US banks. Again,
there is a contradiction between these numbers, which show that real
estate lending by US banks is actually at its highest level ever, and Sec-
retary Paulson’s remarks.
Figure 14: Real Estate Lending by US Banks 1978 to October 2008
Real estate lending by US banks reached its highest level ever in
October 2008...
Real Estate Lending by US
4.0
Banks (US$ trillions)
3.5
3.0
2.5
2.0
1.5
1.0
0.5
-
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
Source: Federal Reserve Bank
Bank real estate loans alone do not tell the entire story. Securitized real
estate loans form an important part of the overall market. Figure 16
shows the issuance activity for mortgage-backed securities for the
leading issuers of mortgage-backed securities, Fannie Mae and Freddie
Mac. So far, 2008 is on track to be in line with the past few years.
Clearly, issuance is down from the halycon days of 2003, but the mar-
ket remains active.
16 Copyright 2008 © Oliver WymanThere has, since July 2008, been a marked slow down in terms of these
two agencies’ issuance activity as shown in Figure 16. However, this
reduction has to be interpreted in a larger context. The overall portfo-
lios of mortgages held by the agencies has continued to grow, as have
bank mortgage portfolios. The continued growth in the portfolios,
despite reductions in issuance, can be attributed to the fact that liqui-
dation rates on mortgages have fallen. Mortgage holders are not pre-
paying their mortgages as quickly as in the past, and are re-financing
at lower rates. This suggests there is a reduction in the demand for
mortgages, not in their availability.
It must be pointed out that non-agency issuance of mortgage-backed
securities has, indeed, almost disappeared completely. However, these
securities consisted largely of sub-prime or Alt-A mortgages, which
were the exactly the types of mortgages to show signs of distress at the
beginning of the crisis. It could be argued that the disappearance of
these types of securities is a welcome return to more stringent risk
management and higher lending standards.
Figure 15: Agency Mortgage-Backed Securities Issuance 1995 to 2008
Agency MBS issuance reached its high point in 2003 and more
than halved in 2004. Since then, issuance activity has remained
stable, with 2008 on track to excede volumes in 2004, 2005, and
2006, but slightly behind 2007. 2008 figures
Agency Mortgage-Backed Securities Issuan
annualized based
2000
on data available
1800 through 30
1600 October 2008
1400
(US$ billions)
1200
1000
800
600
400
200
0
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Fannie Mae Freddie Mac
Source: FNMA, FHLMC, Celent analysis
Copyright 2008 © Oliver Wyman 17Figure 16: Issuance and Portfolios at Fannie Mae and Freddie Mac April
2007 to October 2008
Whiles issuance activity for …the total portfolios of the
agency MBSs decreased agencies have continued to
significantly in July 2008... grow.
Agency Total Mortgage Portfolio (US$ trillions)
Mortgage-Backed Securities (US$ billions)
120 6
Monthly Issuance of Agency
100 5
80 4
60 3
40 2
20 1
0 0
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Fannie Mae Freddie Mac
Source: FNMA, FHLMC, Celent analysis
Consumer Credit
Households and state and local governments have also experienced a
notable reduction in credit availability.
—Federal Reserve Chairman Ben Bernanke, before the Committee
on the Budget, US House of Representatives, 20 October 2008.
Households have not seen a significant reduction in credit. Rather, in
September 2008, the latest month for which figures are available, con-
sumer credit reached record highs (see Figure 22). Certainly, some
segments of households may be experiencing difficulty obtaining
credit. Perhaps subprime households are finding that they cannot
obtain loans any more, but there is no evidence of an aggregate decline
in household credit in the US. Indeed, exactly the opposite appears to
be the case. If subprime credit were down, then prime credit would
have to have increased even more strongly to create the growth for the
overall market seen in Figure 22.
Another way to analyze the level of credit that consumers are carrying
is shown in Figure 18, which shows the percentage of disposable
income that US households spend servicing their debt. At about 19%
currently, this figure is close to record highs, suggesting that rather
18 Copyright 2008 © Oliver Wymanthan facing a “notable reduction in credit availability,” they are facing a
notable reduction in their ability to take on more debt. A fall in the
availability of credit to households is not evident.
Figure 17: US Consumer Credit 1978 to September 2008
US consumer credit reached its highest level in September 2008
ever and has grown steadily for over 30 years, although there
was a flattening during the recession of 1990 to 1991…
3.0
US Consumer Credit (US$ trn)
2.5
2.0
1.5
1.0
0.5
-
1978 1983 1988 1993 1998 2003 2008
Source: Federal Reserve, Celent analysis
Figure 18: US Household Debt Burden 1995 to Q2 2008
At the end of Q2 2008, US households were paying an average of
19% to service debt, a figure that has grown moderately since
1994. This suggests that US households are not facing
significantly diminished access to credit.
20.0
US Household Debt Payments as
Percentage of Disposal Income
19.5
19.0
18.5
18.0
17.5
17.0
16.5
16.0
1994 1996 1998 2000 2002 2004 2006 2008
Source: Federal Reserve Bank, Celent analysis
Copyright 2008 © Oliver Wyman 19Municipal Bonds
In the previous quotation, Chairman Bernanke goes on to lament the
reduction in credit available to “state and local governments.” In Figure
19, we examine the level of issuance for municipal bonds from the
beginning of 2005 to 28 November 2008. Issuance activity fluctuates
from week to week, but the overall trend is flat. There is nothing to
suggest that the credit crisis has had a negative impact on the munici-
pal bond market, which continues with issuance activity in line with
figures for 2005, before the credit crisis began.
Figure 19: Issuance Activity for Municipal Bond January 2005 to 28
November 2008
Issuance of municipal bonds in the US has fluctuated over time,
but is entirely within the bounds of historical volatility. The credit
crisis has not had any visibile impact.
16
12 week moving average
Weekly Issuance of Municipal Bonds (US$ billions)
14
12
10
Mean + 1 sigma
8
Mean = 5.9
6
4
Mean - 1 sigma
2
-
Dec-04
Mar-05
Jun-05
Sep-05
Dec-05
Mar-06
Jun-06
Sep-06
Dec-06
Mar-07
Jun-07
Sep-07
Dec-07
Mar-08
Jun-08
Sep-08
Dec-08
Source: Bloomberg, Celent analysis
20 Copyright 2008 © Oliver WymanCost of Credit
Short-term credit, when available, has become much more costly for vir-
tually all firms.
—Federal Reserve Chairman Ben Bernanke, before the Committee
on the Budget, US House of Representatives, 20 October 2008
The assertion by Chairman Bernanke that the cost of short-term credit
has risen is puzzling. With the dramatic drop in interest rates over the
past year, short-term credit in particular has become significantly
cheaper, not more costly. Figure 20 shows the interest rates on short
term commercial paper for financials and non-financials separately.
For non-financials, the cost of commercial paper is at the lowest point
for at least a decade. Chairman Bernanke’s above statement also sug-
gests that credit for firms is very difficult to come by. As we have seen
previously, there are a variety of indicators that suggest this is not the
case. Figure 11 on page 14 and Figure 12 on page 15 show the overall
size of the commercial paper market remains robust.
Figure 20: Interest Rates on One-Month Commercial Paper December 2006
to 28 November 2008
Since the beginning of the credit crisis, interest rates on short
term commercial paper have fallen dramatically, particularly for
non-financials.
6
Interest Rates on One-Month Commercial Paper
Short-term credit …
has become much
5 more costly for
virtually all firms ”
Chairman Bernanke, 20
4 October
3
91% decline in cost of
short-term credit
2
Non-Financials Financials
1
0
Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08
Source: Federal Reserve Bank, Press, Celent analysis
Copyright 2008 © Oliver Wyman 21Figure 21: Yield Curves for US Treasuries from November 2006 to
December 2008
In late 2006, the yield curve was slightly inverted, and in July 2007
at the beginning of the credit crisis, it was essentially flat. Since
then, short term rates have fallen quickly, leading to a steepening
yield curve.
6
Nov-06
5
Jul-07
Yield on US Treasuries
4
Nov-07
3
2
Feb-08
1
Dec-08
0
0 2 4 6 8 10
Constant Maturities (Years)
Source: US Department of the Treasury, Celent analysis
22 Copyright 2008 © Oliver WymanLending Activity in Europe and
Japan
The core of this study was to analyze the assumptions underpinning
the massive response undertaken by the US government and central
bank, which have consisted of unprecedented injections of liquidity
into the financial system. However, this is a crisis with global implica-
tions. Financial institutions around the world have been shaken. We
provide a brief overview of how lending activity in Europe and Japan
have fared during the credit crisis.
Eurozone—France, Germany, and Italy
For the three major economies in the Eurozone, we consider consumer
lending and commercial lending separately. Figure 22 shows how con-
sumer lending has evolved in France, Germany, and Italy. France and
Italy have shown steady growth since 2002, while Germany witnessed a
decline in consumer credit from 2002 to 2003 and has remained essen-
tially flat since then. The time series shown here are for the period
through the end of October 2008. No evidence of credit crisis is visible.
Figure 22: Consumer Lending in the Eurozone 2002 to October 2008
Consumer lending in France and Italy has continued on the
same trajectory since the beginning of 2003. In Germany,
consumer lending has been flat for some years. The credit
crisis has had no impact.
250
Bank Consumer Lending
200
(€ billions)
150
100
50
0
Oct-02
Apr-03
Oct-03
Apr-04
Oct-04
Apr-05
Oct-05
Apr-06
Oct-06
Apr-07
Oct-07
Apr-08
Oct-08
Germany France Italy
Source: European Central Bank, Celent analysis
Copyright 2008 © Oliver Wyman 23Figure 23: Commercial Lending in France, Germany, and Italy from 2002 to
October 2008
Commercial lending in the three major Eurozone economies was
at its highest ever at the end of October 2008, having shown
steady growth since late 2005...
Lending to Non-Financials (€ trillions)
3.0 Start of
credit crisis:
2.5 April 2007
2.0
1.5
1.0
0.5
-
Oct-02
Apr-03
Oct-03
Apr-04
Oct-04
Apr-05
Oct-05
Apr-06
Oct-06
Apr-07
Oct-07
Apr-08
Oct-08
Germany France Italy
Source: European Central Bank, Celent analysis
Figure 24: Growth Rate in Commercial Lending in Eurozone 2004 to
October 2008
During 2008, commercial lending in the Eurozone 3 has been
growing at an annualized rate between 10% and 12% - a
significant acceleration since before the credit crisis...
Growth in Commercial Lending in France,
12%
Start of credit crisis:
April 2007
10%
Germany, Italy
8%
6%
4%
2%
0%
Oct-04
Jan-05
Apr-05
Jul-05
Oct-05
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Source: European Central Bank, Celent analysis
24 Copyright 2008 © Oliver WymanJapan
As can be seen in Figure 25, Japanese banks started to increase their
lending activity again in late 2005 after a long decline.Through October
2008, there is no indication of a precipitous decline in lending. Indeed,
no decline is visible at all since the credit crisis began.
Figure 25: Bank Lending in Japan 1999 to October 2008
After exhibiting a long term decline, lending by Japanese banks
reached its highest level in October 2008 in over five years
470
460
Lending by Japanese Banks
450
440
(¥ trillions)
430
420
410
400
390
380
370
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Source: Bank of Japan
United Kingdom
During the period from 1999 to October 2008, bank lending in the
United Kingdom has continued to grow, as shown in Figure 26. The
annual growth rate of 12% seen since 1999 has continued uninter-
rupted through the credit crisis.
Figure 26: UK Bank Lending 1999 to October 2008
Lending by UK banks is at its highest level ever,
exhibiting strong growth of about 12% annually since
late 1994.
Net Lending (£ trillions)
2.75
2.25
UK Banks
1.75
1.25
0.75
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Source: Bank of England, Celent analysis
Copyright 2008 © Oliver Wyman 25Conclusions Our analysis of the available data suggest the US credit markets are functioning surprisingly well and have been able to withstand a series of shocks over the past 18 months. The collapse of a number of financial institutions and a severe decline in the stock market have not had negative impacts on bank lending, which is actually currently at or close to record highs. Other sectors of the credit market, such as commercial paper, asset-backed securities, municipal bonds, interbank lending, and consumer credit show sur- prisingly good health. Some sectors of the credit markets certainly have shown strong declines. However, the dire announcements of a freezing up of the credit markets is difficult to support with an analysis of the available data. This assessment is in stark contrast to the posi- tions held by US policymakers, which have in turn become generally accepted by the public. A cursory analysis of lending in Japan, Germany, France, the United Kingdom, and Italy suggests that bank lending in those countries is also functioning well. We have not extended our analysis in these five countries to the level of detail as we have done for the US, and that is a topic for further research. Undeniably, there are some markets that have suffered. Issuance activ- ity for collateralized debt obligations, for example, has collapsed. However, the disappearance of the CDO market will be lamented only by a handful of market participants, and many would consider this to be a positive development. The overall credit markets appear to be continuing to work well. The financial crisis we are living through, which is very real, has not translated into a general credit crisis. The juxtaposition of policymakers’ statements regarding the state of the credit market are both puzzling and troubling. A variety of funda- mental assertions about the state of the credit industry in the US are not supported, and in many cases flatly contradicted, by the available data. In most cases, these very data are being published by the organi- zations led by the policymakers in question. Copyright 2008 © Oliver Wyman 26
A variety of explanations could be offered to explain these contradic- tions, and here we clearly identify the following two explanations as conjecture on our part: Policymakers have at their disposal far more information and data than is publicly available. It is possible that these addi- tional data support the hypothesis that there has been a general breakdown in credit markets. Indeed, this explana- tion was offered by Chari et al at the Federal Reserve Bank of Minneapolis. However, it is hard to see why the Federal Reserve Bank itself would publish and continue to publish information that it knows is misleading at best, and simply wrong at worst. For example, Secretary Paulson may well have additional information that supports his statement that by mid-September ... banks substantially reduced interbank lend- ing. However, this additional information would have the burden of explaining why the Federal Reserve’s data show that interbank lending actually reached its highest level ever in September. We doubt the additional data to which policy- makers have access to could be sufficiently compelling and unequivocal to overcome this burden. It is possible, of course, that such data are available. If so, policymakers have a responsibility to share those data with the public. Another possible explanation is that policymakers are react- ing to the situation of a particular set of businesses and financial institutions and are incorrectly generalizing these to the economy as a whole. Doubtlessly, a number of the leading financial institutions in the US are in serious trouble, as are a number of the leading industrial firms. However, credit difficulties surrounding a specific set of firms is not the same as a problem in the credit markets in aggregate. A choking off of credit to financial and industrial firms with huge losses, questionable prospects for the future, and sig- nificant risk of bankruptcy is not a market failure; it is a market success. Current policy is addressing a significant failure in the credit markets in general, not the failure of a specific set of firms. Our analysis ultimately opens more questions than it answers. It is clear that a number of the key assumptions underpinning the US gov- ernment and Federal Reserve’s recent policies are not supported by a review of the available data. A clear and cogent analysis of the credit crisis has not been presented by policymakers, despite the fact that unprecedented levels of public funds are being deployed. Copyright 2008 © Oliver Wyman 27
Without an accurate explication of the problems facing the US finan-
cial industry, the massive injection of funds could well exacerbate the
problem rather than help. Just like a doctor contemplating an obviously
sick and suffering patient, a massive surgical intervention based on a
misdiagnosis can only worsen the patient’s condition.
A Brief Look at the Money Supply
We finish our report by examining some of the policy impacts that
have become visible over the past few weeks. Figure 27 shows the most
basic measure of money supply in the US, M0, which is also referred to
as the monetary base. This measure of money supply consists of cur-
rency in circulation and bank reserves held at the Federal Reserve. As
can be seen from this chart, there has been an entirely unprecedented
increase in the money supply. By the week of 3 December 2008, the
money supply was a staggering $630 billion, or 74% higher than it was
during the week of 3 September 2008. An increase of this size in the
past took on the order of a decade.
Figure 27: M0 Money Supply in US 1918 to December 2008
The M0 money supply has recently increased at a pace never seen
before in US history.
1.6
1.4
Monetary Base (US$ trillions)
$628 bn increase
1.2
in 90 days
1.0
0.8
0.6
$628 bn increase
0.4
in 83 years
0.2
0.0
1918
1924
1930
1936
1942
1948
1954
1960
1966
1972
1978
1984
1990
1996
2002
2008
Source: Federal Reserve Bank, Celent analysis
Such an increase in the monetary base should be cause for alarm, and
would normally be seen as an indicator of a pending bought of hyper-
inflation. There may, however, be more benign explanations. On 9
October, the Federal Reserve started paying interest on banks’ reserves
held at the central bank. This certainly has made the holding of
reserves more attractive to banks, which shifted more of their funds
into reserves.
28 Copyright 2008 © Oliver WymanIf banks are holding far higher reserves simply in response to the appeal of receiving interest from the Federal Reserve, then there is lit- tle cause for concern. However, this action does merit some further explanation from the Federal Reserve. Normally, when a central bank wishes to stimulate greater lending by banks, it encourages banks to reduce reserves, not increase them, since reserves funds are bank funds that would otherwise be available for lending. A thorough analysis of the recent increase in the monetary base is beyond the scope of this report, and is a topic for further research. However, one might be excused for thinking that the frequent compar- isons with the Great Depression of 1929 are not the most apt. Perhaps the economic crisis in the Weimar Republic some seven years earlier could provide a better comparison. Copyright 2008 © Oliver Wyman 29
For more information please contact info@celent.com or:
T
Octavio Marenzi
99 Park Avenue, 5th Floor
New York, NY 10016
omarenzi@celent.com
Tel.: +1.646.461.6220
North America Europe Asia
USA France Japan
200 Clarendon Street, 12th Floor 16, place Vendôme The Imperial Hotel Tower, 13th Floor
Boston, Massachusetts 02116 75001 Paris 1-1-1 Uchisaiwai-cho
Tel.: +1.617.262.3120 Tel.: +33.1.42.61.06.88 Chiyoda-ku, Tokyo 100-0011
Fax: +1.617.262.3121 Fax: +33.1.42.61.03.12 Tel: +81.3.3596.0020
Fax: +81.3.3596.0021
USA United Kingdom China
99 Park Avenue, 5th Floor 55 Baker Street Beijing Kerry Centre
South Tower, 15th Floor
New York, NY 10016 London W1U 8EW
1 Guanghua Road
Tel.: +1.212.541.8100 Tel.: +44.20.7333.8333
Chaoyang, Beijing 100022
Fax: +1.212.541.8957 Fax: +44.20.7333.8334
Tel: +86.10.8520.0350
Fax: +86.10.8520.0349
USA India
Four Embarcadero Center, Suite 1100 Golden Square Business Center
San Francisco, California 94111 102, Eden Park, Suite 403
20, Vittal Mallya Road
Tel.: +1.415.743.7900
Banglalore - 560 001
Fax: +1.415.743.7950
Tel: +91.80.22996612
Fax: +91.80.22243863You can also read
