The Region

Whither the Credit Crunch?

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Gary H. Stern - President, 1985-2009

Published September 1, 1991  |  September 1991 issue

For at least a year-and-a-half, there has been considerable discussion and concern about a credit crunch in the U.S. economy. According to much of the commentary, lack of credit has particularly plagued the real estate industry, especially commercial real estate, and small business has reportedly been affected as well. I will not go into all dimensions of the issue here, but it does seem worthwhile to add perspective to the credit and real estate situation.

While concern about credit availability is no doubt real, evidence of the credit crunch phenomenon is not easy to come by. And there are those, both in banking and in business, who feel that the problem has been exaggerated if, indeed, a crunch exists at all.

A cursory look at some evidence for banks intimates that the credit crunch is an illusion. For example, commercial bank asset portfolios have continued to expand in recent years at rates comparable to relevant historical experience. This performance does not suggest that there were unusual credit restrictions in place immediately preceding or during the recent recession, at least in relation to previous economic contractions. Rhetoric about the credit crunch notwithstanding, it is hard to detect in the commercial banking data.

A very different conclusion is reached, however, upon examination of data for the savings and loan industry. There, it is clear that S&Ls curtailed their lending significantly, and atypically, beginning in 1989 and continuing through mid-1991. It is evident that the contraction is much sharper and more prolonged than during the serious 1981-82 recession. This recent pattern is hardly surprising, given the severity of the problems in the savings industry and the demise of so many institutions. While not surprising, it nevertheless may constitute a reasonable, and rather obvious, description of the credit crunch.

Is this all there is to the credit crunch then? Problems with savings and loans have forced them to curtail their activities, and the affected customers, principally real estate developers, have been unable to secure alternate financing in a timely way? While this chain of events has undoubtedly played out, I do not find it an adequate explanation of recent experience. Something more fundamental is going on, and the credit crunch is a symptom, not the cause, of what we observe.

Essentially, we confront a serious inventory problem in real estate in many parts of the country. Evidence of the inventory overhang abounds. Nationwide, office vacancy rates are about 20 percent on average in major metropolitan areas. Moreover, it is widely recognized that there is a glut of retail, hotel and other space in many locations. And the number of vacant residential units in the country is presently the highest in at least 30 years. Is it any wonder that it is difficult to obtain financing for real estate projects? Indeed, isn't it appropriate that lending to real estate is constrained?

This argument says that it is excess space, and the attendant decline in values, that fundamentally has hampered real estate development and lending. Put another way, terms and conditions may well have tightened in real estate finance, and more deals may be being rejected than formerly, but this would seem appropriate in many circumstances given current conditions as well as near-term prospects. In many locations, there is simply no demand for additional commercial real estate.

Another dimension of the environment, namely the state of capacity and competition in the financial services industry, also suggests that the heart of the real estate problem is oversupply rather than lack of credit. We know that competition is keen among financial firms—domestic and foreign banks, and non-bank providers as well—and capacity is plentiful. Given this situation, it is hard to believe that most viable projects will not find financing. The fundamental problem is conditions in the real estate market itself—conditions that render many projects uneconomic—rather than a generalized lack of financing.

Of course transitions can be costly and time consuming, and many developers who formerly relied on savings and loans for financing may have had difficulty obtaining replacements. But it is likely that this difficulty stems from the real estate market and the prospects for future projects rather than from excessive stringency on the part of the lenders.

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