Credit Relief May Not Last Long

Floyd Norris|The New York Times

The experience of being choked to death can concentrate a person’s attention. When the chokehold is removed, a feeling of relief, perhaps even of exhilaration, is to be expected.

But allowing a person to breathe may not be enough to restore him to health.

In that regard, 2009 is starting to feel a little like 1980.

Then, as in recent months, a sudden credit contraction choked off economic activity. When the credit squeeze eased, a sense of relief spread. Within a few months, consumer confidence leaped amid expectations that both employment and business conditions would soon improve.

The improvement came, but it did not last long.

When the current credit crisis was at its worst, even financially solid companies could not get short-term financing. Banks did not trust one another, and trade financing dried up. One result was a collapse in inventories, as imports sagged even more than final demand.

Now, thanks to government financing of debts as diverse as mortgages and commercial paper, credit is more readily available. That should provide a lift to orders and at least a temporary boost for countries, including China and Germany, that rely on export markets.

“The free fall in global trade seems to have halted,” said Josh Green, the chief executive of Panjiva, a company that monitors customs declarations.

Credit markets have opened at least a bit. Corporate bond offerings are up, and many big banks have been able to raise billions in dollars by selling stock, something that would have been unthinkable a few months ago.

But enthusiasm may still be getting ahead of reality. Government-financed credit has its own problems, which will grow. The banks still have toxic assets on their books, and the number of bad loans is rising.

Moreover, the world economy, which was so dependent on America’s borrow-and-spend behavior, has not found a replacement. “Have we put into place a new engine for global spending, or even repaired the old?” asked Robert Barbera, the chief economist of ITG.

The enthusiasm of markets is even creating its own problems, pushing up long-term interest rates and thus the cost of mortgages.

The 1980 credit squeeze came because the government, seeking to combat inflation, slapped on credit controls in March. President Jimmy Carter urged Americans to put away their credit cards. The economy promptly tanked.

With borrowing difficult, private investment declined at an annual rate of 30 percent in the second quarter of 1980. No subsequent quarter was half that bad — until the 22 percent drop in the fourth quarter of 2008.

The problems in 1980 were in some ways very different from the current ones. Interest rates were high and inflation seemed to be out of control. Ending the government-induced credit contraction did not solve those problems. It took a sharp and prolonged recession, which soon arrived.

This crisis was made in America, but it has had the largest impact on countries that sold a lot of goods to the United States. “Thus the crisis punishes the frugal more than the profligate,” Martin Wolf wrote this week in The Financial Times. “It seems so unfair. It is not. The frugal depend on the profligate.”

Restocking of inventories may help exporters to show economic growth in the current quarter, but that effect will fade. The profligate seem unlikely to resume their bad old ways, if only because they cannot borrow as they used to — despite the recent relaxation in credit markets — when they had billions of dollars in home equity they could withdraw and spend.

In 1980, recalled Henry Kaufman, who then was Wall Street’s most influential economist as the bond market guru at Salomon Brothers, “the financial malaise was in the big institutions, because they had been lenders to Latin America, but it was not as widespread as it is today.”

In the end, many of the big American banks of that era were replaced by a crop of growing regional banks that had not made the same mistakes. The old Bank of America was folded into NCNB, which took the old name but not most of the old management. Wachovia, another North Carolina bank, grew to be a major player. Citicorp was absorbed into Travelers, becoming Citigroup . Now Wachovia is gone, absorbed into Wells Fargo after it faltered, and Citigroup survives as a government ward.

In baseball terms, the financial system had a good crop of minor leaguers available when the big league stars went onto the disabled list in the 1980s. Now the minor leaguers are also battered and bruised.

Bailouts and government spending do appear to have warded off Great Depression II, but the current government-supported financial system may not be enough to do much more than keep the economy breathing. In the words of Mr. Kaufman, whose prescient warnings of credit market excesses in recent years were largely ignored by Wall Street, “we do not have the financial firing power to lift this economy in any meaningful way.”

If he is right, the end of the current recession is unlikely to produce much of a recovery.

Floyd Norris comments on finance and economics in his blog at