How Far Will Deleveraging Go?

online.wsj.com...

"The global economy is in recession. Will this lead to depression? And if not, how long and deep will the recession be? The answers to both questions depend on the extent of deleveraging by financial institutions.

The amount of risk-free or "tier-one" capital a bank is holding is a good reverse indicator of how leveraged it is. Globally, financial institutions had about $5 trillion of tier-one capital on the eve of the credit crisis. Those in the United States and European Union had about $3.3 trillion of tier-one capital supporting a loan book of some $43 trillion.

Then came the crisis.

How much did they lose? There are three answers. If mark-to-market rules are applied, global financial sector losses are estimated to amount to 85% of tier-one capital. But mark-to-market rules are extreme and assume the banks are insolvent and that all their assets will have to be fire-sold for whatever they can fetch in today's dysfunctional markets.

If economic value, a concept based on the present value of future cash flows of the assets, is used instead, current losses are about half the amount calculated using mark-to-market rules."

So banks are only 1/2 broke.

JK

reply to post by leo123


Much of the economy is built on credit.

Credit was given out based on cheap ratings. Now that the bubble has popped, we are going to see how exactly what sections of the economy are reliant on the easy credit and what is more solid.

We already seen the housing market drop and we are currently seeing the automotive market collapse. Home and car prices have inflated drastically through the years due to the available credit, how far will the prices shrink due to lack of credit?

Will people have to start paying in cash for everything now? Is the market going to adjust prices for cash only consumers? It seems that the price of fuel is dropping like a rock and many retailers are lowering prices by a huge percentage to attract costumers. Is this deflation in the works?

Are wages going to adjust along with the deflation? If they don't there will be some serious unemployment.

Is the government going to cut spending and its own growth? Is the government going to tax more out of a shrinking economy just to sustain itself? Is the government going to force business to increase wages yet at the same time increase taxes? There is a reason why the Great Depression was called Great in the U.S., it lasted longer and was more severe in the U.S. than in other countries.

Right now, it is sadly up to the government on how long and how severe the recession will be. The government is everywhere, it is the largest employer and it regulates business activity throughout the entire country.


[edit on 8-11-2008 by wutone]

it depends on wether the gov't is on the side of the debtors or creditors as the de-leveraging causes debt deflation and massive defaults

so if the gov't carry thru with some sort of debt forgiveness to debtors then we seemingly could be set up for some sort of recovery, if the gov't sides with creditors (like the roman's did) then we may end up like them IMO. Either way we will likely see the dollar be extinct, or renamed, or revalued (i.e after a bank "holiday" we find out each dollar is now worth 4$) within the next 5 years.

Debt forgiveness will only re-enforce bad behaviour. Namely, if corps or individuals know they can act in an irresponsible manner and the gov will always bail them out they will never act responsibly.

Sadly there is only one responsible solution here. Bankrupt the individuals who acted bad, bankrupt the shareholders of irresponsible cos and fire the managers because they blew it.

JK

Originally posted by leo123
Debt forgiveness will only re-enforce bad behaviour. Namely, if corps or individuals know they can act in an irresponsible manner and the gov will always bail them out they will never act responsibly.

Sadly there is only one responsible solution here. Bankrupt the individuals who acted bad, bankrupt the shareholders of irresponsible cos and fire the managers because they blew it.

JK

this won't work it would lead to a death spiral of unemployment and then consumer spending re-inforcing each other, leading to millions of more foreclosure's and unparralled social unrest.

I understand your sentiment for the re-inforcement of bad behavior. But would this really, the stupid lending practices may be avoided next time, should the creditors (company's /banks lending) realize they may get stiffed next time they get a bit too careless with there lending.

Also debt forgiveness on a personal level only happens once in a VERY LONG TIME, corporate bailouts happen much more regularly, so any consumer that thinks they will get bailed out next time, will have a very rude awakening, since this drastic option is only contemplated when the whole SYSTEM is facing a systematic problem. i.e should joe blow get bailed out and then take on more stupid debt.....his debt will not be forgiven in the next two generations (at least) (leaving him as a debt slave) so that argument (and it is a common one) doesn't really stand up to the severity of the crisis or the practicality of joe blow getting off next time.

Look at it this way, if anything the big banks were reckless because

1. the ceo's knew they would get golden parachutes no matter how bad the company stock tanked

2. also that they would be recipients of giant bailouts from fox in the henhouse secretary of the treasury pauslon.

Maybe next time they wouldn't be so careless.

Also look at it from the perspective of a poor person being told they can live in a house (that they have no business being in) "income wise" or drive a car (that they have no business driving) "income wise". They had an opp. to flip a house and make money, or if they couldn't sell higher, or make payments they go back to being poor and all the while the only person who missed out on the DEBT PARTY was the responsible middle class guy who is paying for it thru taxpayer bailouts.

You are not going to change the "corruption inherent in the banking game /gov't game" and i understand the anger from having to finance stupid lenders and the sheeple who rolled the dice, but don't make the fatal mistake in not realizing that debt forgiveness for the sheeple (alot BTW are in debt due to medical expenses) will be comparatively less out of your pocket than the potential depression that spirals downward from banks unwilling to lend to an indebted public and the re-inforcing cycle of lower consumer spending and unemployment which may cost you more than a few thousand dollars down the road in bailout expenses ( it may in fact cost your company a high % in earnings) or your job.... remember the fractional reserve banking system in which the magick of compound intrerest insures there is more and more debt in the system then that which was created (to pay it back) builds and builds until the point the debt can not be serviced and that is why debt forgiveness is a better solution in a imperfect world......because history shows country's that side with the creditors (not debtors) turn out much much worse!

cpdaman:

I read your post in it's entirety, respect it, but I stand by my opinion.

The lessons learned here must be remembered for generations to come.

JK's 2 bits.

i respect your personal opinion but i think the logic is hogwash!

how would the lessons be learned by those who purpotrated the madness since they already left with golden parachutes! and the company's are getting bailout out?

you think new generations of people won't want to accept loans when the gov't says "we think every american should be able to live the american dream of owning a house" and they see there friends flipping houses during the beginning stages of a credit expansion that precedes a collapse

the lessons learned from your solution...will be that maximum pain was exerted and those who felt the most of it either.....

1. never took out a loan to begin with (responsible middle class borrower.........who eventually lost his job via the depressionary policy)

or

2. were those who tried and may have temporarily lived above there means thru rolling the dice..............and taking out loans they can't pay back

the wealthy ceo's already got bailed out ...........who is this learned lesson of $ value to besides them..........the next generation will have millions more reckless sheeple who will always accept loans that have the blessing of gov't and media......

your solution only makes sense until you weigh the reprecushions of your policy on everyone in the economy and realize the next generation will continue to have reckless people who will be happy to live above there means should the trust worthy gov't and media tell them it is a good idea to take out these loans.

I admit my "solution" isn't perfect and i by no means advocate wiping out debt's everytime people get in the hole, but this is once in a 150 year event (debt forgiveness when the total debt in the system reaches beyond society's ability to pay) and those who inevitably think they will be bailed out the next time they go in the hole..........would get to learn there painful lesson should they think they will get a free ride everytime......and yet the economy will get to recover and responsible people will have a healthier job's market.

[edit on 9-11-2008 by cpdaman]