From the February 2009 issue of Treasury & Risk magazine

Follow the Money

Key members of Congress were stunned to hear Federal Reserve Board Chairman Ben Bernanke and Treasury Secretary Hank Paulson say on Sept. 18 in a closed-door meeting on Capitol Hill that the country was "days away" from a complete financial meltdown--one that could lead to Depression-like runs on banks, widespread violence and ultimately even to a possible declaration of martial law. It was a vision of Armageddon, but, of course, 10 days later, the House rejected a Wall Street bailout package sent over by Paulson, only to pass one in a more limited form--the Emergency Economic Stabilization Act--a week later that gave Paulson less power and only half the money he wanted.

Meanwhile, the financial system did not collapse and while a few banks were failing, there were no runs on them, and martial law wasn't invoked. One reason things didn't fall apart when Congress didn't immediately act as Paulson and Bernanke demanded, may be that there wasn't any danger of a meltdown in the first place. So say three senior economists working at the Federal Reserve Bank of Minneapolis, who in October examined the Fed's own data, and concluded in an article titled Facts and Myths About the Financial Crisis of 2008 that the claims that interbank lending and commercial lending had seized up were simply not true. "Bank lending to consumers and to non-financial companies had not ceased, and banks were lending to each other at record levels," says V.V. Charri, an economist at the Minneapolis Fed. "Maybe Bernanke and Paulson had information that they were not making public, but the available data simply did not support what they were saying." Charri and his colleagues and co-authors Lawrence Christiano and Patrick Kehoe agree that with companies like Lehman Brothers, AIG and Citigroup foundering because of toxic debt instruments, there was a sense of a financial crisis brewing, but they say it wasn't a credit freeze. "This was a lot like the run-up to the Iraq invasion in 2003," says Charri. "You had people in government saying: `We're smart guys, trust us.' But they were either wrong or they were lying."

Adds Kehoe: "Normally, when you're going to spend a lot of money, you present the data and the economic theory to support it, yet here's the biggest non-military government intervention in history since the Great Depression, and there was no evidence presented to support it, and no detailed economic argument made about what market failures this $700 billion was going to fix."

Supporting that view, Octavio Marenzi, founder of financial technology research and consulting firm Celent, says more bluntly: "There was no credit crisis. What was happening was much more arcane: A few big institutions that had made bad bets were at risk of going bust, and that's it. And if they had gone bankrupt, it wouldn't have been the end of the world. In fact, there is huge excess capacity in financial services and there's a need to focus on the healthy ones and let others fail. Meanwhile, business lending and consumer lending were still strong in September and October, and it's still okay."

Even in the corporate realm, there are some indications that all may not be as it appeared as the $700 billion Wall Street bailout was hammered out, followed by trillions of dollars more in government backing pledged for everything from corporate paper to money market funds to the Big Three auto companies. Bill Dunkleberg, chief economist with the National Federation of Independent Businesses (NFIB), says that over the years of routine business condition surveys conducted among members by his organization, which primarily consists of companies with sales of under $1 billion, only about 3% of financial officers have cited access to credit as their biggest problem. This November, the latest survey, which covered the period of the credit crunch and bailout, the figure was still 3%. Dunkleberg adds: "We also asked people who borrow every quarter if things had gotten harder for them or not; 11% said it had, but then that's about what happened in 1991, when the percentage saying that loans had gotten harder to obtain in that recession was 12%. So the situation is really pretty typical for a period when an expansion runs out and P&Ls get worse."

No doubt things have gotten tougher for businesses, and obtaining credit has become more challenging. The question is whether it was necessary or even a good idea for the government to put taxpayers on the hook for hundreds of billions of dollars for a crisis that may have been overblown or mischaracterized, or whether all that money has been spent in the best way so as to address the crisis at hand.

"We haven't seen a freeze," says the treasurer of a leading A-rated global international consumer goods company, who asked to remain unidentified. "Credit has consistently been available, but at a price. And I do imagine if you were a new credit customer going to a bank, or if you didn't have a good credit rating, you might have problems."

Another treasurer at a global management consulting company based in New York City, who also asked to not be named, says his firm raised $500 million in debt last year. "But now things are tight. The kind of funds we could raise last year, we cannot raise now," he says. "Even if funds were available, the credit spreads have widened significantly and the 'covenant-lite' era is a thing of the past."

But that, argues Robert Higgs, an economist and senior fellow at the Independent Institute, a libertarian think tank, is just the point. In recessionary times, companies should be improving their balance sheets, not adding debt. "For the last five or six years, financial institutions have been lending irresponsibly, and companies and individuals have been making borrowing decisions based upon easy credit," he says. "In a recessionary period, companies should not be trying to borrow; they should be de-leveraging."

Higgs worries that by injecting staggering and unprecedented amounts of capital into the nation's banks, the government is encouraging a continuation of irresponsible lending practices, and is deferring an overdue correction that would adjust corporate balance sheets. "The Fed can print money and it can throw trillions of dollars around, but it just puts off the day of reckoning, and makes the inevitable adjustment in the future that much worse," he says. Higgs was one of a group of 200 prominent economists who wrote Congress to oppose the Wall Street bailout.

Critics of the bailout are not just on the right. Liberal economist James Galbraith, a professor at the University of Texas, calls the credit crisis "more hype than real math." He adds: "Calling the problems on Wall Street a credit freeze was a mischaracterization." In Galbraith's view, Secretary Paulson's original proposal to have the Treasury Department buy up the banks' toxic securities, which was not implemented, was a bad plan. "Like trying to fill the Pacific Ocean with basketballs," he says. And the actual action--the government's injecting capital into troubled banks by buying preferred shares--was only marginally better. He thinks backing the commercial paper market and extending deposit insurance to cover $250,000 per depositor made more sense, which the government also eventually did, though not with the bailout money. "I think belatedly they did some things right," he argues.

So did the government bailout work? If keeping companies from going belly up, or preventing massive layoffs, or rescuing the mortgage markets, was the goal, as the Treasury Department, the Fed and backers of a bailout in Congress were arguing before passage, the answer is clearly "No." Housing markets have continued to slump, even at an accelerated rate, unemployment has continued to rise, and more to the point, credit is still tight for all but the most credit-worthy borrowers.

Indeed, while corporate treasurers differ on whether they think there was a crisis that required a big bailout of Wall Street, most of those contacted, along with many economists, agree that borrowing money has not gotten appreciably easier for them following the injection of all that cash in financial institutions.

"Credit is still tight after the bailout for companies at the low end," says Joanna Oliva, vice president and treasurer of Fluor Corp., an A-rated Dallas-based global construction firm. She says the tight credit situation, which she would not characterize as a freeze, did not really impact Fluor Corp., because her company had decided more than a year ago to reduce leverage. "We felt that the banks had been too loose about credit, and we were saying that a tightening was due, though I must say I never saw tightening accelerate so quickly." While Fluor did not access credit markets this year, Oliva says: "We do have to be bonded on all our projects so we have been speaking with our banks about providing letters of credit and bank guarantees, so we have a sense of what's going on."

That the recession may be more about contracting markets than about frozen credit was underscored by comments from the assistant manager at an auto dealership outside of Philadelphia, part of a regional family-owned multi-dealership chain. He said that the chain would probably be closing a few of its dealerships soon, as many dealerships are doing, but when asked if this was because of the credit crisis and potential car buyers' difficulty in obtaining credit, he laughed. "No. The local banks are happy to lend to customers who want a car loan, and to back our lending program," he said. "But who is going to buy a new car when everyone's worried about whether they?ll have a job six months from now?"

Yves Smith, an economist and management consultant who operates a blogsite called "Naked Capitalism," is skeptical about the Minneapolis Fed trio's thesis on the nature of the credit crunch, noting that the data it reviews is only what is on bank balance sheets. "A lot of lending, including bank lending, is off balance sheet." she says, adding, "commercial lending and corporate paper are just part of the picture." Noting that banks have been canceling unused consumer and small business credit lines and cards for the past year, she says, "It seems clear to me that there was a serious credit crunch."

Charri and Kehoe don't deny that they were only looking at the 20% of lending that is reported to the Fed monthly, but Charri adds, "All we're saying is that based upon the data that is available there was no justification for the actions that were taken, and if there were really a freeze of other credit, the officials who were concerned should have shown the data to justify what was done."

Adds Kehoe, "If what we're experiencing is a generic recession, all that money spent investing in the banks would be wasted, and that may be what this is: a generic recession."

Smith though expresses concern that the bailout of the Wall Street's big financial institutions, using the so-called Troubled Assets Relief Program (TARP), which she argues was a bad strategy, may have "precluded other remedies" that the government needs to take. "With all the money that's already been committed, it is going to be hard to get the stimulus money that is needed now," she says. "Deficits are already so massive that at some point interest rates on long bonds are going to jump from 3% to 5%, and that will be good-bye mortgage markets."

Looking ahead, Smith offers some advice to corporate treasurers and financial officers. "Be very conservative and loss averse," she says. "Financial crises take a long time to resolve, and this is a period when customers will be really slow to pay. Receivables will be bad. In general, even if the risks seem low, the downside these days could be catastrophic."

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