The Credit Crisis: Over at Last?

Signs are adding up that the long, painful credit crunch is over and banks are bouncing back. But recovery for the real economy is still a ways off

It is time to declare it: the credit crisis is over. The U.S. banking system, epicentre of the chaos, is returning to health; the outlook for the global economy, once seemingly completely black, is brightened by a dawn light.

It is, of course, hardly a consensus yet, but it is the best conclusion to draw from this number: $36bn (£22bn). That is the amount that investors have poured into the weakest of the American banks in the past month, helping to fill the holes which opened up in their balance sheets and crippled their lending activities. Stronger banks such as Goldman Sachs (GS) have raised billions more, giving them greater resources to lend into the U.S. economy and abroad.

None of this is to say that recessions on either side of the Atlantic are about to end, that job insecurity and business caution are about to be replaced by a new bullishness, or that banks will suddenly be turning on the credit taps for sub-prime mortgage applicants or consumers who are already up to their card limits. But the first phase of crisis has given way to something more normal.

The necessary deleveraging of the consumer—their gradual repayment of credit card and burdensome mortgage debt—will continue to be a drag on the economy, but fewer people and businesses that can and should get credit will find their banks turning them away.

And at the root of the problem, credit conditions have improved, too, for the banks and other players in the financial markets. Banks began charging each other sky-high interest rates in 2007 as they feared a coming crisis could sink many of their counterparts, a phenomenon that reached its apogee in the panic of last September, when Lehman Brothers did collapse and the resulting chaos threatened to bring down the entire financial system.

Key to the change has been the "stress tests" conducted last month by the U.S. Treasury on the nation's 19 biggest banks, and which told 10 of them to raise a total of $75bn in new equity capital to weather a deeper than expected recession, according to Matt Warren, an associate director of equity research at Morningstar. "The stress tests forced all banks to raise their level of capital and to even out their abilities to absorb losses. That reduced the serious counter-party concerns and put banks on a steady footing. It was collaborative action that couldn't be done one bank at a time."

The nation's biggest banks, Citigroup (C) and Bank of America (BAC), after absorbing eleven-figure losses on their credit investments, quarter after quarter last year, had seen their shareholders' equity capital reduced to a tiny proportion of the banks' assets. Executives, with their fiduciary duty to shareholders, were forced to defend that last sliver, putting the brakes on lending and dramatically shrinking their activities, with disastrous knock-on consequences for the economy. Thanks to the conversion of government loans into equity, in Citi's case, and a combination of asset sales, private equity conversions and a $13.5bn share sale, in Bank of America's case, that process of shrinkage seems likely to abate in the coming months.

In China this week, Tim Geithner, U.S. Treasury Secretary, expressed doubt that his much-vaunted "public private partnerships" would ever be used in great numbers to buy toxic loans from ailing banks, precisely because so many banks now have enough capital to avoid having to sell them at firesale prices. And next week, the healthiest banks—ones which have proved that they can raise new equity and debt without the benefit of a government guarantee—will be told they can pay back the bailout money which they received last October. It will mark a new beginning.

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