Sunday, January 11, 2009

Nonexistent WMD III: Small Business Income in October

After Lehman failed and “credit markets froze” in the second half of September 2008, many people proclaimed that a second Great Depression would unfold. A few days ago, I explained how payrolls did not collapse as some had been predicting in late September and early October.

During the first days of October 2008, it was claimed that the frozen credit markets would especially paralyze small businesses. Now that a couple of months have passed, let’s look at proprietor's income (a measure of small business activity) as measured by the Bureau of Economic Analysis. The chart below shows proprietor's income (measured in billions of dollars) for each of the months of second half of 2008 (December data not yet available). Aggregate proprietor's income fell in August. It fell about 0.5 percent in September, and has remained within 0.2 percent of that ever since.

The Lehman Brothers investment bank failed on September 15. The bank was deeply intertwined with other financial institutions – its failure to pay its obligations put its creditors at risk – and brought the credit crisis to its crescendo. By the end of the month, the intense financial chaos motivated Mr. Obama and others to warn that banks needed lots of money from taxpayers, or else small businesses would get hammered. Because the bailout bill took time to pass, and then additional time for the Treasury to design and execute its $700 billion Capital Purchase Program (CPP), no bank received any money from the Treasury pursuant to the CPP until the last couple of days of October. Thus, if the warnings were right, small business should have suffered dramatically in October.

Proprietor's income is a notoriously noisy measure, but we were promised a large collapse -- and thus one that would be obvious even in noisy data.

None of the above denies or confirms that our economy is headed for economic depression, because there are multiple pathways for getting there. Nor does it deny that the Treasury CPP might help in some way. But it does refute one of the scariest pathways to Depression – an immediate collapse of small business – that politicians from both parties alarmingly described to the American public in order to justify spending $700 billion of taxpayer funds on a bailout of United States banks.

1 comment:

Karl Smith said...

So, credit markets were only truly frozen for a few hours on Sep 18th if I remember the date correctly.

The announcement that the government was backing MMMF was enough to get things flowing. The TARP served as insurance against that happening again. And, indeed, knowing that the TARP should be just as strong of an effect as the actual TARP.

My view is that we avoided the worst case scenario by getting Commercial Paper markets flowing again.

I think this was the mainstream argument in favor of the TARP.