Robert Hall of Stanford presented an assessment of why the housing crash and financial crisis caused such sharp and prolonged economic pain this morning at the Kansas City Fed's annual economic symposium in Jackson Hole, Wyo. It is worth reading, but in commenting on the paper, Hyun Song Shin of Princeton offered an interesting analysis that goes a long way toward explaining why growth has been so disappointing over the past four years.
While the biggest companies rely on stock and bond markets to finance themselves, and those markets have improved a lot after years of interventionism from the world's central banks, small and mid-sized companies rely more heavily on the banking system, Shin argues. If you only have a couple hundred employees, you probably go to your local bank rather than to Wall Street to obtain financing.
So what's happening with the price and availability of bank lending?
The chart on the left, from Shin, shows that the interest rate on bank loans to businesses (the dark blue line) is usually a bit higher than whatever the Federal Reserve's target interest rate is at any given time, but by a pretty consistent amount. The chart on the right shows just the spread between those two rates; it bounces around in the 2 to 3 percentage point rate most of the time.
But when the crisis began and the Fed cut its interest rate to zero, actual bank lending rates remained stubbornly high. Thus the spread, shown on the right, skyrocketed and has remained high. That means that despite the Fed's best efforts, interest rates for actual businesses trying to take out a loan to build a new factory or open a new office are still awfully high.
These charts show the contrast between the amount of credit extended to the corporate business sector, which relies heavily on corporate bonds, and the non-corporate business sector, which relies overwhelmingly on mortgages and bank loans.
As it shows, credit to corporate businesses has been rising since 2010, from around $7 trillion to $8 trillion, and has easily surpassed pre-crisis highs. Meanwhile, for non-corporate businesses, lending is still below its pre-crisis level.
In other words, the types of businesses that are crucial to job creation have less total credit, and when they get a loan it is at much higher interest rates than historical trends would suggest makes sense.