I see Paul Krugman has taken me to task for questioning the importance of the credit crunch. Just to be clear, I wouldn't say that there is no issue of credit availability, but I just don't think that it is hugely different than what we typically see in a downturn and that we would be seeing pretty much the same awful economic picture even if our banks were fully solvent. You don't lose $6 trillion in housing wealth and $8 trillion of stock wealth and not expect to see a real impact on the economy. Krugman's main argument is based on the spread between corporate bond yields and treasury yields. But, these always rise during a downturn. In fact, the current spread between Aaa bonds and treasuries of 2.0 percentage points, is the same or lower than year round average for 2001. The 5 percentage point spread on Baa bonds is higher than the 3.8 percentage point peak spread reached in October of 2002, but given the relative severity of the two downturns, the gap doesn't seem hugely out of line with the relative risk associated with this debt. It would be nice to see lower yields on corporate debt, and cleaning up the financial system should help to bring this about (Krugman's is absolutely right in his column this morning calling for takeovers of the banks whose bad assets we buy), but fiscal policy will have to do the heavy lifting to get us out of this downturn. [Addendum: As a sidebar on media reporting on the credit crunch, there has been no article that I've seen that has noted the decision of Federal Reserve Board chairman Ben Bernanke to directly lend money to non-financial institutions by buying commercial paper after Congress approved the bailout. The Fed always had this ability. The best argument for the urgency of the TARP was that the economy was shutting down because companies could not get the credit needed to meet their payrolls and meet other bills. Mr. Bernanke had the authority to ensure that such a shutdown did not happen by buying commercial paper. He is hard to understand his decision to wait until after the Congressional vote except as part of an effort to promote an atmosphere of crisis. Manipulating Congressional votes is not part of the Fed chair's job description.]
--Dean Baker