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FED FOCUS-Regional Feds battle over bank crisis 'myths'

Wed, Nov 12 2008, 22:33 GMT
http://www.afxnews.com

By Alister Bull

WASHINGTON, Nov 12 (Reuters) - Two regional Federal Reserve banks are taking rare public pot-shots at each over how to interpret data that one says debunks the "myth" of declining U.S. bank lending during a global credit crunch.

U.S. authorities have pumped $1 trillion into the financial system to prevent a credit crisis, sparked by the collapse of the country's housing market, from causing a severe recession.

A team at the Federal Reserve Bank of Minneapolis argues that four common claims about the sharp drop in bank lending to nonfinancial borrowers during the crisis are false, and they provide extensive data to back up this argument.

The study does not deny that the United States is suffering a financial crisis. Instead, it uses the evidence to dispute how this is spilling over the rest of the economy.

But researchers from the Boston Fed say the Minneapolis Fed's work ignores underlying loan market dynamics indicating a credit crunch, although they agree the numbers can be hard to untangle.

"Such a difference of opinion and open debate between researchers at Federal Reserve banks is both unusual and interesting, and is testimony to the difficult times in which we find ourselves," said former Atlanta Fed research head Bob Eisenbeis.

Minneapolis Fed researchers say their data contradicts claims that bank lending to non-bank borrowers has collapsed; that interbank lending has dried up; and that commercial paper issued by non-bank borrowers has fallen off sharply.

"Bank credit has not declined during the financial crisis. Indeed, bank credit appears to have risen relative to trend in the month of September," they wrote in a paper called "Facts and Myths about the Financial Crisis of 2008".

They also disputed whether banks played such a large role in channeling funds from savers to borrowers.

"The claim that disruptions to the banking system necessarily destroy the ability of nonfinancial businesses to borrow from households is highly questionable," they said.

These assertions were backed up by numerous charts of rising bank lending, commercial and industrial lending, and commercial paper issuance through September, when the crisis came to a head with the bankruptcy of Lehman Brothers.

They also challenged the argument that an abrupt widening in credit spreads was evidence of a credit crunch.

"The increase in spread is due to the drop in the real return to Treasury securities as a result of the flight to quality and does nor constitute an increase in the real cost of borrowing," the study said.

Boston Fed researchers said the growth in bank lending disguised what was really going on.

"During crisis, bank balance sheets expand for a number of reasons," they wrote, noting that loans that formerly had been securitized -- packaged up as bonds and sold to investors -- were now being retained on bank balance sheets.

"Second, during this and other times of financial weakening, companies increasingly rely on their existing loan commitments and lines of credit."

The Boston Fed also picked holes in the other study's examination of commercial paper issuances to AA-rated nonfinancial borrowers. This held steady through September even as issuance by financial firms nosedived, prompting a massive multibillion dollar support package by the Federal Reserve.

"While one might take comfort in the fact that AA borrowers can obtain CP funding, it does not necessarily reflect the absence of problems in the CP market over. In fact, we interpret this as evidence of a flight to quality," they said.

"The claims regarding the financial markets and the mechanism through which they may affect the real economy are largely supported by looking behind the aggregates of publicly available data," the study concluded, but conceded there were a lot of "confounding factors" which demand more research.

(Reporting by Alister Bull; Editing by Chizu Nomiyama)

(+1-202-354-5820; e-mail: alister.bull@reuters.com)

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