There is something approaching a consensus that the Paulson Plan -- also known as the Troubled Asset Relief Program, or TARP -- was a boondoggle of an intervention that's flailed from one approach to the next, with little oversight and less effect on the financial meltdown.

But perhaps even more troubling than the ad hoc nature of its implementation is the suspicion that has recently emerged that TARP -- hundreds of billions of dollars worth so far -- was sold to Congress and the public based on a Big Lie.

President George W. Bush, fabulist-in-chief, articulated the rationale for the program in that trademark way of his -- as if addressing a nation of slow-witted 12-year-olds -- on Sept. 24: "Major financial institutions have teetered on the edge of collapse ... [and] began holding onto their money, and lending dried up, and the gears of the American financial system began grinding to a halt." Bush said that if Congress didn't give Treasury Secretary Hank Paulson the trillion dollars (give or take) for which he was asking, the results would be disastrous: "Even if you have good credit history, it would be more difficult for you to get the loans you need to buy a car or send your children to college. And ultimately, our country could experience a long and painful recession."

For the most part, the press has continued to echo Bush's central assertion that there's a "credit crunch" preventing even qualified borrowers -- that's the key point -- from getting loans, and it's now part of the conventional wisdom.

But a number of economists are questionioning the factual basis of the credit crunch narrative. Columnist David Sirota recently looked at those claims and concluded that Americans "had been punk'd" -- that "the major claims about a credit crisis that justified Congress cutting a trillion-dollar blank check to Wall Street were demonstrably false," and the threat of a systemic banking crash was used by the Bush administration to overcome popular resistance to the "bailout."

It's a reasonable conclusion; this is an administration that used the threat of thousands of al-Qaida sleeper cells in the United States to sell Congress on the Patriot Act, the specter of mushroom clouds rising over American cities to push through the Iraq war resolution and the supposedly imminent crash of the Social Security system to push for privatizing Americans' retirement savings.

But the question comes down to what they knew and when they knew it. The analyses that suggest the whole credit crunch narrative is false are based on data that lagged behind the numbers that policymakers had available, in real time, back in September. So the question -- probably unanswerable at this point -- comes down to whether or not they looked at the situation and in good faith believed that pumping hundreds of billions of dollars into the banking system would contain the damage and save an economy teetering on the brink of collapse.

What Else Could Be Happening?

Of course, no one disputes the fact that as the economy has tanked, the number of new loans being issued to American families and businesses has plummeted. But is because credit has dried up for qualified borrowers?

Economist Dean Baker doesn't think so. He explains the situation in simple terms: The media, he argues, "are blaming the economic collapse on a 'credit crunch' instead of the more obvious problem that consumers just lost $6 trillion of housing wealth and another $8 trillion of stock wealth." It's a commonsense argument: much of the economic growth of the Bush era existed on paper only, built on the rise of a massive bubble in real estate values rather than growth in productive industries. When all that ephemeral wealth vaporized -- and with the economy shedding jobs like a dog with dermatitis -- consumers stopped buying, and businesses, anticipating a long slowdown, stopped seeking the loans that they might have otherwise tapped to expand their operations.

Whether good borrowers can't get credit from banks because the latter are hoarding cash or lending has stopped because of a drop-off in demand for new loans is not some wonky academic debate; it's of crucial significance. Because if lending to qualified parties has truly frozen, then even if the specific implementation of the Paulson Plan was deeply flawed, its broad approach -- "recapitalizing" banks in various ways, buying up some of their crappy paper and guaranteeing some of their transactions -- is fundamentally sound.

If, on the other hand, the primary problem is that people are broke and maxed out on debt, and firms aren't looking for money to expand, then the kind of massive stimulus package being considered by the Obama transition team and congressional Dems -- largely designed to stimulate demand from the bottom up, with public works projects, tax cuts for working families, aid to tapped-out state and municipal governments and new money for unemployment and food stamps -- is obviously the best approach to take.

Broadly speaking, these are the parameters of the debate in Washington, and that means that properly diagnosing the underlying problem is crucially important.

Is the Credit Crunch a Big Lie?

There's plenty of evidence that Baker's right. He points out that even though mortgage rates have plummeted, the number of applications for new loans has dropped to very low levels and argues it's "the most glaring refutation of the claim that people are unable to get credit." If creditworthy applicants were being denied loans by banks unable or unwilling to lend, Baker explains, "then the ratio of mortgage applications to home sales should be soaring" as qualified homebuyers apply to multiple banks for a loan. "Since there is no notable increase in this ratio, access to credit is obviously not an issue."

Again, this is common sense. Consumer spending drives about 70 percent of the U.S. economy, and in recent years, much of that spending was financed by people taking chunks of home equity out of their properties -- people might have been eating in fancy restaurants, but they were essentially eating their living rooms to do so.

That the American people don't have the appetite to go deeper into debt than they already are in order to make new purchases is hard to dispute. In November, consumer prices across the board fell at a record rate for the second month in a row. And even with mortgage rates plummeting, so many homeowners are "underwater" -- owing more on their homes than they're worth -- that they're unable to refinance because the equity isn't there. Paul Schuster, a vice president at Marketplace Home Mortgage, told the St. Paul Pioneer Press, "What I'm really concerned about is the job picture ... If (people) don't feel good about their jobs, rates aren't going to matter."

The National Federal of Independent Business' November survey of small-business owners found no evidence of a credit crunch to date, concluding that if "credit is going untapped, it's largely because company operators are not choosing to pursue the credit. It's not that companies can't get the extra money, it's that they don't want or need it because of the broader slowdown in economic activity."

The credit crunch narrative -- and the justification for creating Paulson's $700 billion TARP honeypot -- is built on three related assertions: 1) banks, fearing that they'll be unable to meet their own financial obligations, aren't lending money to one another; 2) they're also not lending to the public at large -- neither to firms nor individuals; and 3) businesses are further unable to raise money through ordinary channels because investors aren't eager to buy up corporate debt, including commercial paper issued by companies with decent balance sheets.

Economists at the Federal Reserve Bank of Minnesota's research department -- V.V. Chari and Patrick Kehoe of the University of Minnesota, and Northwestern University's Lawrence Christiano -- crunched the Fed's numbers in an examination of these bits of conventional wisdom (PDF), and concluded that all three claims are myths.

The researchers found that "interbank lending is healthy" and "bank credit has not declined during the financial crisis"; that they've seen "no evidence that the financial crisis has affected lending to non-financial businesses" and that "while commercial paper issued by financial institutions has declined, commercial paper issued by non-financial institutions is essentially unchanged during the financial crisis." The researchers called on lawmakers to "articulate the precise nature of the market failure they see, [and] to present hard evidence that differentiates their view of the data from other views."

That finding was backed up by a study issued by Celent Financial Services, a consulting firm, again using the Treasury Department's own data. According to a story on the report by Reuters, Celent's researchers concluded that the "data actually suggest world credit markets are functioning remarkably well." Rather than a widespread banking problem, Celent found that the rot was limited to "a few big, vocal banks and industries such as car manufacturing, which would be in difficulty anyway."

There are also some important caveats. Economists at the Boston Federal Reserve responded to the Minnesota Fed's research (PDF), arguing that the use of aggregate data doesn't fully reflect the dysfunction in specific subsectors of the economy, nor does it adequately reflect the decline in new loans.

It's also the case that single-cause explanations for complex crises usually fail to hit the mark. Banks, having fueled the housing bubble (and similar bubbles before that) with the creation of ever-shadier "exotic" securities, are probably erring on the side of caution in writing new loans. They're looking at their balance sheets as quarterly reports approach, and the number of foreign investment dollars coming into the U.S. has declined, meaning that some qualified firms may, indeed, have trouble raising cash in the near future.

Dean Baker, while arguing that "the main story is that people don't have money and therefore want to spend," acknowledged that "some banks are undoubtedly anticipating more write-offs from other loans going bad, so they will hang on to their capital now rather than make new loans." And, as Sirota notes, some of the institutions that are relatively healthy are reportedly holding cash in anticipation of picking up weaker banks on the cheap.

But one thing is clear: the economic crisis may have woken up Washington's political class when it hit the banks, but it remains a product of long-term imbalances in the economy, and the idea that it's primarily a pathology of the banking system in isolation is a misdiagnosis that, if uncorrected, can only result in a longer, deeper and more painful recession than might otherwise be the case.

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