Robert T. Parry

English

Research Papers in Economics

FRBSF WEEKLY LETTER
Number 92-01, January 3, 1992
The Problem of Weak Credit Markets:
.. .. A .. .... I. I..I.
A Monetary t'OlicymaKer's vlew
9
6
12
Peak
Chart 1
Net Borrowing, Private Nonfinancial Sector Percent
15
The following is adapted from a speech given by
Robert T. Parry, President and Chief Executive
Officer of the Federal Reserve Bank ofSan Fran-
cisco/ on October 11/ 1991,before the University
of California Center for Real Estate and Urban
Economics.
Weak credit markets have been headline news
for some time. Indeed, weak credit markets are
seen as one of the substantial downside risks in
the economy's' recovery from the recession.
3
it is clear that borrowing has been weak, but not
unusually so. Instead, the unusual weakness ap-
pears to be in the business sector, whether flows
are measured by total business debt-the dashed
line-or by debt plus equity-the dotted line. I
think it is appropriate to focus on the latter meas-
ure, since a good portion of debt was used to
retire equity through most of the 1980s.
Note: 4-quarter moving average measured relative to GOP.
Last observation 1991 02.
o
4
2
6
o
1991
1991
Percent
8 Peak
1985
1985
1980
1980
1975
1975
Chart 2
Net Household Borrowing and Net Business
External Financing
See note to Chart 1.
1970
1970
In theory, though, there is not a tight link be-
tween credit developments and the economic
outlook. In fact, our experience in the early
1980s bears this out/ as credit surged far more
than economic growth did. Therefore,we have
to approach the question of today's weakness in
credit markets and its relation to the weakness
in the economy very carefully.
StiII, the unusual weakness in credit markets
does warrant our attention. One reason is that
some special factors appear to be playing a con-
tributing role, and they may have implications for
the economy. Where is the unusual weakness
concentrated? And which lenders are affected?
Exploring these questions can help make sense
of the underlying developments that are now
affecting credit and the economy and what they
might imply for monetary policy.
To give an idea of where the weakness has been
concentrated, Chart 2 plots net household bor-
rowing and two measures of net business exter-
nal financing. Looking at the data on households,
Where's the weakness?
The basic symptom that has raised concern is
unusually weak credit flows. Chart 1 shows the
net flow of debt relative to GOP for the private
nonfinancial sector (households and businesses).
The flows are scaled by GOP to account for the
general increase in nominal values. We do see
evidence of greater weakness compared to pre-
vious recessions.FRBSF
4
2
6
o
-2
-4
Percent
j
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
1991
1991
Peak
1985
1985
1980
1980
See note to Chart 1. Last observation 1991 03.
Chart 4
Commercial and Industrial Loans at Banks
compared with past cycles. But we have to re-
member that some effects are masked by the
inclusion of direct and indirect shifts of assets-
largely mortgages-from thrifts. One area where
banks are not picking up activity from thrifts is
commercial and industrial (C&I) loans, which
are plotted in Chart 4. This chart shows that the
net flows of bank loans to business have been
weak relative to GOP.
Chart 3
Source of Funds: Net Household Borrowing
and Net Business External Financing * Percent
Peak I ., 8
The weakness in bank lending has been attrib-
uted to a number of factors-some related to the
credit crunch, some to the business cycle, and
some to unusual sectoral problems in the econ-
omy. For example, nationwide, the ratio of non-
1974
1970 1975
*Debt and equity.
See note to Chart 1.
In addition to indicating where the weakness is
concentrated, the chart also indicates when the
weakness began. It is worth emphasizing that ex-
ternal financing flows were on the decline well
before the weakening of the economy in 1989
and the downturn in 1990. Thus, some of today's
weakness may be rooted in developments that
were taking hold long before the recent concerns
Over credit market conditions.
In any case, the main lesson from the 1980s is
that debt does not have a close relationship with
economic activity. This point is sometimes forgot-
ten when people talk about a "credit crunch": It
is simply hard to say in general what weak credit
flows might mean for the economy.
A look at lenders
To see where lending patterns have changed,
Chart 3 plots the sources of funds for private sec-
tor financing. The most obvious development in
the chart is the massive contraction in the thrift
industry, as failed institutions were closed and
the survivors grew more cautious in their lending.
We would expect to see the effects of the thrift
contraction most strikingly in home mortgage
lending, the "bread and butter" of the thrift
industry.
One case where weak credit flows do have an ef-
fect on the economy, though, is when the supply
of funds has been artificially restricted. A classic
example from the old days is when interest rates
rose above Regulation Q ceilings. Today, the fo-
cus is again on depository intermediaries as the
channels for the "credit crunch." The commonly
proposed shocks are the turmoil in the bank and
thrift industries and a generally stiffer regulatory
environment.
What about commercial banks-the solid line
on Chart 3? The decline does not look unusual
But as we saw from Chart 2, net household bor-
rowing, most of which is home mortgages, has
not been unusually weak. This is in part because
the mortgage market had the necessary institu-
tions and instruments to make a quick shift in
financing channels. Commercial real estate lend-
ing, of course, is another story altogether. But the
weakness here has more to do with high vacancy
rates than with thrift failures. Overall, I think the
thrift crisis has not created a major disruption in
credit flows.performing loans to total loans has risen above
the level we observed coming out of the last re-
cession. This could be one factor affecting the
credit crunch. And stiffer regulation has played
some role. Research at this Bank shows that bank
lending has become somewhat more sensitive
to weakness in capital positions and loan port-
folio quality on an individual bank basis. At the
same time, Fed surveys on bank lending prac-
tices show that to a large extent banks have
tightened credit conditions because of the weak
economy and problems in particular industries
where banks normally lend.
Looking at lending outside the banking and thrift
industries also suggests more general influences
have led to weak financing flows. The dotted line
on Chart 3 shows that other funding sources
were helping to fill the financing gap until the
onset of the recession. At that point they also re-
duced their lending-more likely in response to
the economic climate than to any regulatory
constraints.
To sum up, regulatory shocks and weakened fi-
nancial condition may have constrained banks'
ability to lend. But regulatory constraints do not
explain it all. Part of the shrinking volume of fi-
nancial activity is simply a predictable response
when the economy is weak and perceived risk
is high.
What role for monetary policy?
How do these restraints relate to policy? The
shocks to banks essentially represent increases
in the cost of intermediation, which in part must
be passed through to borrowers as a rise in the
cost of capital. I think that many of the effects of
these costs on the economy will be temporary,
diminishing as the market shifts the channels of
financing. To the extent that banks are special,
however, we can expect some long-lasting re-
duction in intermediation. A good deal of this is
probably appropriate in view of the need to re-
strain excessive risk-taking by intermediaries.
indeed this is an important element of bank and
deposit insurance reform.
Monetary policy has tried to have a stabilizing
effect on the economy during the transition. Alan
Greenspan has indicated on more than one occa-
sion that credit market conditions were part of
the reason for easing policy over the past year or
so. At the same time, I do not think that consid-
eration of credit market conditions has radically
altered policy.
This is appropriate because monetary policy
actions cannot be expected to neutralize the
real costs of the shifts that are occurring across
the banking and thrift industries, nor can they
solve the problems of individual borrowing
sectors where lenders consider relative risks to
have risen significantly. Given the uncertainty
over the relative importance of factors affecting
credit markets, it is important not to overreact
and thereby destabilize inflation expectations.
Robert T. Parry
President and Chief Executive Officer
Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of
San Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor or to the author.•.. Free copies of Federal Reserve publications can be
obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120.
Phone (415) 974-2246, Fax (415) 974·3341.
Printed on recycled paper Q ~,
with soybean inks. ~ ~OUt6 \'J 'OJSPUl?J::I Ul?S
lOLL xog 'O'd
O)SI)UOJ::f UOS
JO ~U08
aAJaSa~ IOJapa::f
~uaw~Jodaa lpJOaSa~
Index to Recent Issues of fRBSf Weekly Letter
DATE NUMBER TiTlE AUTHOR
6/7
6/14
7/5
7/19
7/26
8/16
8130
9/6
9/13
9/20
9/27
10/4
10111
10118
10/25
1111
11 /8
11 /15
11/22
11/29
12/13
12/20
(91-23)
91-24
91-25
91-26
91-27
91-28
91-29
91-30
91-31
91-32
91-33
91-34
91-35
91-36
91-37
91-38
91-39
91-40
91-41
91-42
91-43
91-44
Using Consumption to Forecast Income
Free Trade with Mexico?
Is the Prime Rate Too High?
Consumer Confidence and the Outlook for Consumer Spending
Real Estate Loan Problems in the West
Aerospace Downturn
Public Preferences and Inflation
Bank Branching and Portfolio Diversification
The Gulf War and the U.S. Economy
The Negative Effects of Lender Liability
M2 and the Business Cycle
International Output Comparisons
Is Banking Really Prone to Panics?
Deposit Insurance: Recapitalize or Reform?
Earnings Plummet at Western Banks
Bank Stock Risk and Return
The False Hope of the Narrow Bank
The Regional Concentration of Recessions
Real Wages in the 1980s
Solving the Mystery of High Credit Card Rates
The Independence of Central Banks
Taxpayer Risk in Mortgage Policy
Trehan
Moreno
Furlong
Throop
Zimmerman
Sherwood-Call
Walsh
Laderman/Schmidtl
Zimmerman
Throop
Hermalin
Furlong/Judd
Glick
Pozdena
Levonian
Zimmerman
Neuberger
Pozdena
Cromwell
Trehan
Pozdena
Kim
Martin/Pozdena
The FRBSF Weekly Letter appears on an abbreviated schedule in June, July, August, and December.

The problem of weak credit markets: a monetary policymaker's view

http://www.frbsf.org/publications/economics/letter/1992/el92-01.pdf

The problem of weak credit markets: a monetary policymaker's view

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics