The U.S. is "indisputably" undergoing a financial crisis, but it’s a myth that banks have cut back sharply on lending to businesses and individuals, or that lending between banks has dried up, according to a new paper by economists with the Federal Reserve Bank of Minneapolis.

The paper, which analyzes data through Oct. 8, also disputes claims that the cost of corporate borrowing through the issuance of commercial paper has risen sharply, or that banks play a crucial role in channeling funds from savers to borrowers.

The four "myths" identified in "Facts and Myths about the Financial Crisis of 2008" have been cited as reasons for drastic action in recent weeks by the Federal Reserve, Treasury Department and central banks around the world, which have included taking ownership in banks to "recapitalize" them, and guaranteeing bank deposits and money market accounts.

The paper’s authors — V.V. Chari, Lawrence Christiano and Patrick J. Kehoe — say that while spreads between securities considered safe by investors, such as Treasury bills and corporate bonds, have widened, they remain "well below levels in non-crisis years." Much of the increase in spreads is because Treasury yields have been pushed down by a "flight to quality" by investors, the paper asserts.

"The increase in the spread is due to the drop in the real return to Treasury securities as a result of the flight to quality, and does not constitute an increase in the real cost of borrowing," the paper argues.

Financial institutions have cut back on commercial paper issues, but nonfinancial institutions have not, the paper said. Even though interest rates for commercial paper issued by financial institutions have risen, they are "still well below the levels that prevailed from the beginning of 2006 to the middle of 2007."

The analysis raises questions about claims that have been made about how the financial crisis is affecting the economy as a whole, and policymakers’ response.

Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke warned Congress of dire consequences for businesses and average Americans if lawmakers did not authorize $700 billion in government borrowing to fund purchases of troubled assets from banks and financial institutions (see story).

"We emphasize that we do not dispute that the United States is undergoing a financial crisis and that the United States economy may be in a recession or may experience one in the near future," the paper said.

But while decision makers may believe bold action is necessary based on other data not considered in the paper, "responsible policymaking requires that they share both the data and the analysis that underlies the need for bold policy with the public," the authors conclude.


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