According to Ambrose Evans-Pritchard, writing last month in the UK Telegraph, U.S. bank credit and M3 (the broadest measure of the money supply) contracted over the summer at rates comparable to the onset of the Great Depression. In the summer quarter, U.S. bank loans fell at an annual pace of almost 14 percent. "There has been nothing like this in the USA since the 1930s," said Professor Tim Congdon of International Monetary Research. "The rapid destruction of money balances is madness."
Chartered banks are allowed to create credit on their books equal to many times their deposit base, but lately they haven't been doing it. In more normal times, one dollar in base money has been fanned by the banks into $8.50 in loans. Today, one dollar in base money is producing only one dollar in loans. Although the Fed has been frantically pushing cash into the banks, it can't make them lendto consumers.
This is not because the banks are trying to be difficult. If they had prudent loans on which to turn a profit and the capital base to do it, they no doubt would. But their books have been choked with toxic assets, destroying their capital positions; and the "shadow lenders" who once took subprime loans off their books have gotten wise to the scam and gone away. Bankers who know the endangered state of their own books don't trust each other, so money is tight all around. And the Fed has already dropped interest rates as low as they can go, so it has no more leverage with which to entice borrowers.
Local Government to the Rescue?