More myths about the financial crisis of 2008

Tatom, John (2008): More myths about the financial crisis of 2008. Published in: Research Buzz , Vol. 4, No. 9 (25 November 2008): pp. 1-5.

Abstract

There are numerous myths that surround the financial crisis that began in August 2007. Some of these myths are about the role of bank credit in the crisis, while others concern the weakness of the U.S. banking system and supposed excess leverage—the ratio of assets to equity in banks-- in contributing to the crisis. This paper provides evidence that net new commercial and industrial loans at banks did not slow before the financial crisis began in August 2007, nor was there any slowing in the early months. A subsequent slowing did reach its lowest pace in June-August 2008, but even at its worst, it was not particularly severe. The paper also looks at the safety and soundness of banks as indicated by their equity-assets ratio. The concern is that bank assets are troubled and excessively leveraged, with very low equity-asset ratios so that banks could have to “deleverage” or reduce lending as their equity declines. The shrinkage of bank equity and assets due to deleveraging could deepen the recession. But banks have not suffered significant declines in their equity ratios and they have been holding near record equity ratios. Moreover bank assets are growing rapidly, with equity nearly keeping pace. Ironically the Treasury’s Troubled Asset Relief Program will add $270 beginning in the fourth quarter. The TARP’s injections of bank capital have dried up private sector injections that had appeared on the horizon from sovereign wealth funds and private equity. Equity ratios of banks could become strained in future as total loans and assets continue to expand. The financial crisis has not undermined the safety and soundness of the commercial banking system. It is not likely to do so because most of the expected losses from the foreclosure crisis have already been taken into provisions. Nonetheless, many banks heavily exposed to mortgage losses have failed and more will fail.

• Item Type: MPRA Paper
• Language: English
• Keywords: foreclosure crisis; deleverage; bank credit
• Subjects: G - Financial Economics > G2 - Financial Institutions and Services > G28 - Government Policy and Regulation; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages

References

Board of Governors of the Federal Reserve System, “Assets and Liabilities of Commercial Banks in the U.S.” H.8 Release.

Chari, V.V., Lawrence Christiano, and Patrick J. Kehoe, “Myths About the Financial Crisis of 2008,” Federal Reserve Bank of Minneapolis Working Paper 666, October, 2008.

Ivashina, Victoria and David Scharfstein, “Bank Lending During the Financial Crisis of 2008,” November 5, 2008. http://www.people.hbs.edu/dscharfstein/Lending_During_the_Crisis.pdf

Tatom, John A., “The Fed’s Crisis Continues,” Research Buzz, October 2008.

______, “The U.S. Foreclosure Crisis: A Two-Pronged Assault on the U.S. Economy,” Networks Financial Institute Working Paper 2008-WP-10, July 2008.