Crunching the Recovery: Bank Capital and the Role of Bank Credit

Other papers presented at this conference have documented the substantial recent decline in real estate prices and the impact of this decline on financial institutions. This paper will take the decline in bank capital as a result of exposure to real estate as given, and address how banks have responded to their deteriorated financial condition. The paper will show that real estate losses, combined with increased regulatory scrutiny of bank capital, have resulted in substantial shrinkage of bank assets. Thus, the conclusion will be that New England is suffering from a regulatory-induced capital crunch. Complaints of reduced credit availability have been widespread during both the recession and the anemic recovery. As early as July 1990, Federal Reserve Chairman Greenspan attributed weak economic growth to problems with credit availability. Despite the statements by major policymakers and the public outcry concerning the credit crunch, its importance, both in macroeconomic fluctuations and in the transmission of monetary policy, continues to be hotly contested. Questions about the importance of credit crunches remain unresolved for two reasons. First, the term is not well defined and thus is applied to a wide range of circumstances. Second, while much theoretical work has been done on credit rationing, definitive empirical tests for a credit crunch are lacking.