Wednesday, October 15, 2008

Economic Outlook: Anticipation

Until Lehman failed, I and most of the world had not realized that Fall 2008 would be the time when commercial paper markets would freeze, some major commercial banks would fail (or be gobbled up moments before failing), or that the once-libertarian economist Bernanke would propose spending circa $1 trillion of taxpayer funds helping the banking sector. One story commonly told after the Lehman failure is that banks would cease lending, and this would take a sharp bite out of national investment, which in turn would bring down the economy. Since then, we have been waiting with anticipation to see what would happen to the economy as a whole.

It is quite possible that we do not have to wait. Suppose that, while most of the world did not anticipate these events, the troubled banks themselves understood this much earlier this year. I cannot guarantee you that the troubled banks knew this, but it seems very likely that they did. After all, they were involved in the daily operations in a way that most of the world was not. So let's pursue this possibility to its logical conclusion.

If the soon-to-be-troubled banks understood in 2008 Q1 and 2008 Q2 that they were flirting with bankruptcy, wouldn't they cease lending in 2008 Q1 and 2008 Q2 in order to improve their short term asset positions? Why give a loan to a mediocre customer in Q2 when you recognize that you likely will be cutting off your best customers in Q3 and Q4?! In other words, we should have already seen much of the lending and investment impact of the bank troubles already in Q1 and Q2. [recall my blog entry from yesterday where I explained how the 1930's economy suffered well before the banks actually went broke]

We already have data for Q1 and Q2. Residential investment was down, of course, following the downward trend that began mid-2006 when housing prices peaked. But non-residential investment was UP (a bit), not down. In 2008 Q3, gross nonresidential investment was 4.64% of the capital stock, as compared to 4.55% a year earlier and 4.58% two years earlier.


Tino said...

"Smaller Banks Resist Federal Cash Infusions"

The US has more than 7.500 banks. The small geographically specialized “community banks” have one third of bank offices, and about 20% of all deposits and a slightly smaller part of all assets and loans. These banks are not part of the crisis. The mid-sized regional banks are also generally in a good position (I am sure there are exceptions, but these banks are not interconnected in behavior and asset holdings like the bigger banks are).

Expect this

The 25 largest banks had 58% of assets and 50% of deposits.

NBC: “Small Community Banks Benefit From Money Crisis”

“Conservative community banks that stayed away from the sub-prime market and risky investments are looking better to a skeptical public looking for trust.”

This type of bank will expand and take over some of the work of the bigger banks, even without the need for new entry.

(For years people have been asking why the bifurcated banking structure in the US survives. Here is one reasons. Not only did these banks differentiate themselves by focusing on local knowledge, they followed a different investment strategy than the big banks. The inherent diversity of the free market is going to soften the blow, even to the financial system).

Donald Pretari said...

I have a different perspective in that I believe the reaction to the government not helping Lehman showed that the markets were expecting a bailout, which is what I thought would happen. So, in the sense that some banks were prepared for this crisis and bailout, I believe that some were.As we have here:

Who Was Counting On A Bailout?
Via Chump Changer, the following:

"Read the story carefully and note which bankers seem to love the plan most: JP Morgan's Jamie Dimon and Bank of America's Ken Lewis. The guy who seem to have been counting on a bailout since long before the government suspected it would be giving it to them. "

It's good to put names to the list of people who were counting on a bailout. I, of course, belief that this belief was widespread, and that the government knew that it was implicitly committed to a bailout.

Still, I take the post as a little positive proof of this.

So, I tend to agree with you, but not for the same reasons.

By the way, I believe that the system of implicit government guarantees to aid in a crisis like this abetted it happening.

Don the libertarian Democrat