A paper by three Minneapolis Fed economists is making the rounds – disputing any funding crisis for non-financial corporate firms. IMHO, this is a very disingenuous paper. All of these so-called myths are really non-myths. Basically, the paper’s focus on “bank lending” is mistaken. Focusing on total borrowing by non-financial sectors shows the accurate picture.
Myth 1. Bank lending to nonfinancial corporations and individuals has declined sharply.
The financial market crisis is in the non-bank financial sector, not in the banking sector. And the authors say (correctly) that the majority (80 percent) non-financial sector borrowing is not from banks. So why focus on bank lending to the non-financial firms to see if there’s a credit crunch?
Myth 2. Interbank lending is essentially nonexistent.
If that’s not true, so what? (See response to Myth 1.) Banks are more tightly regulated by the Fed (compared to non-bank financial companies by the SEC). So banks did not hold the riskiest mortgage backed securities (although they originated and sequestered such assets in off-balance sheet entities and “adverse selected” the best ones for their own portfolio, selling the rest to non-bank financial and other firms). So, again, the banking sector is not where the financial market crisis occurred – it happened in the non-bank financial sector.
Myth 3. Commercial paper issuance by nonfinancial corporations has declined sharply and rates have risen to unprecedented levels.
But Federal Reserve Board data on total commercial paper borrowing by non-financial sectors took a huge hit in the 2nd quarter of 2008 (see Flow of Funds, Table F.2 from release Z.1 September 18, 2008, line 3). Thus, it’s not surprising that bank credit to non-financial companies may be increasing: Those companies may be drawing more heavily on their lines of credit with banks because non-bank sources of borrowing are constricted. So, where’s the mystery?
Myth 4. Banks play a large role in channeling funds from savers to borrowers.
Again, non-bank financial (and other) companies supply the overwhelming share of non-financial sector borrowing. And the non-bank financial sector is where the financial market crisis is occurring. So, there IS a funding crisis for non-financial firms. Get with it, Minneapolis Fed!