When the current recession started back in late 2008 many economists, bankers and politicians described the situation in very vivid language. “The economy is going over a cliff” many of them said, yet no visual image accompanied those words. In a world where newsrooms are comfortable with infographics quotes from experts like “The economy is going over a cliff” would be followed up with questions asking to see the data supporting that phrase. Those questions may even be asked with an eye toward creating an infographic that would evoke that phrase in the minds of the readers. However, we’re not there yet; reporters, numbers and graphics aren’t mixing as well as I’d like but that shouldn’t stop us from trying to visualize what that graphic could look like.
Another phrase that accompanied these early stories of the recession was “the credit markets are seizing up”. These two phrases may be related. Normally lending occurs between banks and also from banks to businesses. Some of these loans are short term loans, sometimes paid back in a matter of days, sometimes within a few months. Companies that rely on these short term loans could be forced out of business if they can’t get them. Think of a small retail clothing store. If they don’t have the money on hand to buy their Spring inventory they’ll need to borrow it from a bank. This would normally be a safe bet for the bank if the store had several years worth of sales history from previous Spring sales. The fact that the retail price of the inventory is about double the wholesale doesn’t hurt either. After all, the store wouldn’t need to sell all of their inventory to pay back the loan. So the store buys the clothes on credit and pays the bank off during the sales season as customers buy the clothes. But if the bank is suddenly unwilling to lend the money the store can’t buy as much inventory. Their sales season may end early for lack of inventory and the store may need to lay off staff or even temporarily close after their inventory runs out. Sales at this store would have dramatically dropped from the same period last year. Multiply this across many other businesses in the region and suddenly it’s not just the credit markets that are seizing up, it’s the whole local economy. Or in other words, the economy is going over a cliff.
The question is, is there a way to visualize this? Adding up sales volume of every business in a region (or the nation) is a difficult task. Yet the example above relied on only one business, the banks. If the credit markets did seize up one way to track that would be to track the growth (or shrinkage) of business loans, which is just what the Economist did in a recent graphic. This graph shows business loans for the US, parts of Europe and the UK. The US portion of the curve almost looks like the phrase “going over a cliff”, with the only caveat being the rapid rise just before the rapid plunge. If you ignore that rise, US bank loans dropped by 40%* between mid-2008 and early 2009. However, even if you were to discount the rise before the fall, the fall would still be a 20% fall and furthermore, the fall would end below the no growth line, end in a 10% reduction in loans.
The phrase “falling over a cliff” evokes an image of a long plateau suddenly falling away and so the above graph, with that peak before the fall, fails in conveying that sense. But that peak may be a distraction. The far left side of the graph appears to have a relatively stable 20% growth in business loans before falling away in early 2008. This story reminds us that Bear Stearns collapsed around this time and that undoubtedly put a chill in banks’ willingness to lend money. However within a few months Bear Stearns was forgotten and lending resumed, perhaps even making up for lost ground, hence the spike**.
Banks like to have a certain amount of assets on hand before they lend. If their assets fall below their threshold, they stop lending until those assets rise above above that threshold. With the decline in asset values of the sub-prime mortgages the banks suddenly found themselves with much fewer assets than they thought they had. To remedy this situation the US government came in and provided nearly $1.5 trillion dollars through TARP and reduced Federal interest rates. These funds went to the banks to increase their asset level so they’d start lending again. Where did all that money go? It’s still in the banks. This chart shows the total money available for use in the US monetary system.
As planned, this money did go to increase the banks’ assets so they’d feel more comfortable lending. This graph (also from the Economist) shows us that their asset ratio is crazy high, yet apparently many banks are still not lending.
We still haven’t found (or even simulated) a graphic that would qualify as a smoking gun for the phrase “economy is going over a cliff” yet we’ve come close. The reduction in business loans starting in the latter part of 2009 and continuing through today certainly is unprecedented during the 2 year range of that graph and may be unprecedented for an even longer period of time. Indeed Bernake and Paulson may have had a mental image of a similar graph extending further back in time when they were urging congressional action on the TARP program. A slightly different perspective, perhaps dollar flows, interbank lending volumes or total loans (and not loan growth) may yield a more evocative picture. But our hats are off to the Economist for creating these graphs even if they were done 18 months after the start of the recession.
**Astute readers may note that the loan growth chart is a derivative chart (in the calculus sense). “Loan growth” being flat at 20% means that total loans are growing at 20%. Loan growth of 0% means you’ve reached a plateau. It takes a negative loan growth before the total quantity of loans drops or falls over a cliff.