NCPA - National Center for Policy Analysis

The Credit Crunch

September 23, 2002

Small- and medium-size businesses must borrow from banks to finance expansion or tide them over a temporary cash-flow problem. But commercial and industrial (C&I) loans have fallen far more sharply than they did over the last recession in 1990-1991 (see chart) when credit contracted after a government requirement that banks increase their capital relative to loans. Unfortunately, many financial institutions increased their capital ratio by reducing loans, rather than raising capital.

It appears that there is a serious "credit crunch" underway that may be inhibiting the most vital and vigorous sector of the U.S. economy and slowing the recovery from recession.

  • According to the Federal Reserve, total commercial and industrial loans fell by $113 billion between March 2001, when the recession started, and August 2002.
  • Under normal circumstances, one would have expected such loans to rise by at least as much, meaning that there is about $225 billion less credit in the economy than would ordinarily be the case.
  • To put the loss of credit into perspective, between July 1990 and December 1991, C&I loans fell by 3.5 percent -- during an acknowledged credit crunch.
  • Over a comparable 18 month period between March 2001 and August 2002, such loans have fallen by 10.3 percent -- in other words, credit is three times tighter in the current recession and recovery than during an equivalent time period during the last economic downturn.

One possible explanation is accounting changes related to securitization, a process whereby loans are bundled together and sold in bond markets. A new rule would restrict it in order to prevent a recurrence of Enron-like abuses. However, the effect is to cut back on bank lending to businesses.

The Bush Administration should look carefully at whether government regulations are restricting lending to such businesses and contributing to a credit crunch.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, September 23, 2002


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