Deleveraging: A fate worse than debt

Economist ^ | 09/25/08

[TigerLikesRooster]

Deleveraging
A fate worse than debt

Sep 25th 2008

/snip

IT IS ugly, but deleveraging is the word of the moment. Financial institutions, desperate to repair the damage inflicted on their balance-sheets by mortgage-related securities, sell assets. In doing so, they exacerbate the problem. Forced sales push down the prices of assets, worsening the balance-sheets of other investors, forcing more asset sales, and so on. In the end, the government is the only entity left in the game with a balance-sheet strong enough to keep buying.

The Bush administration’s bail-out plan, even if it gets through Congress, may not be the end of the finance industry’s problems. The travails of investment banks will inevitably cause problems for hedge funds, which depend for their finances on institutions such as Goldman Sachs and Morgan Stanley.

Many hedge funds have already cut positions since the credit crunch started in the summer of 2007, and banks have tightened the terms on which they will do business with them. This has been particularly true for those that sought funding through the prime-brokerage arms of Bear Stearns and Lehman Brothers before they were wiped out.

The volatility of financial markets may intensify the pain, since both brokers and hedge funds use models which lead them to sell assets when prices move down sharply. Some hedge funds may have to give up altogether. Around 15% more were liquidated in the first half of 2008 than in the first half of 2007, according to Hedge Fund Research, a consultancy.

What hurts finance affects the rest of the economy in spades. Tim Bond, of Barclays Capital, reckons that, thanks to the gearing effect, a shortfall of bank capital of around $170 billion may reduce the potential supply of credit by $1.7 trillion.

[TigerLikesRooster]

From the article:

thanks to the gearing effect, a shortfall of bank capital of around $170 billion may reduce the potential supply of credit by $1.7 trillion.

[TigerLikesRooster]

Ping!

[pointsal]

yikes...

[se_ohio_young_conservative]

Looking at that chart.

You notice that whenever the debt starts to climb, we go into a recession. Intresting.

[PGalt]

"What hurts finance affects the rest of the economy in spades."

The supremacy of finance capital over all other forms of capital means the predominance of the rentier and of the financial oligarchy; it means that a small number of financially “powerful” states stand out among all the rest. The extent to which this process is going on may be judged from the statistics on emissions, i.e., the issue of all kinds of securities. - Vladimir Ilyich Lenin

[gunnedah]

This bailout is nothing but repeating the same mistake over. Throwing money down a hole for the fat cats to steal and bailing out some influential Congress people and their families.

[se_ohio_young_conservative]

absolutely.

But it is in our best intrest that the market stablizes. and the reformers win the election.

[Oatka]

Key Sentence: The Bush administration’s bail-out plan, even if it gets through Congress, may not be the end of the finance industry’s problems.

Stand by for:
1) Bailout II - The First Salvation Was Too Little
2) Bailout III - This One Is THE Salvation
3) Bailout IV - This One REALLY Is THE Salvation
4) Bailout V - This Is Honest-To-God The Last Salvation
5) Bailout VI - We-Really-Didn't-Know-It-Was-This-Bad Salvation
6) Bailout VII - The China Syndrome Salvation

Maybe we won't get past II before VII kicks in.

[screaminsunshine]

Lets have a recessionNOW I even want a recession. Please GIVE US A RECESSION. We will soon get by it and the crooks will go down. NOT this stupid continue the PONZI scheme at all costs song and dance these crook polititions and banker types are pushing.

[Batrachian]

It has yet to be shown that the $700 billion will go back into circulation in any meaningful way. What's to prevent the recipients of this bailout from simply buying treasury bills with it? Safe, secure, no muss, no fuss.

Is any one so naive as to believe that they'll go back to the buying and selling of CDOs, MBSs, CDSs, SIVs, and all those other funky instruments that pumped so much liquidity into the markets but then caused so much trouble?

They won't, and that's the fatal flaw of this proposal, now a done deal. Besides, the problem is so much bigger. We're talking tens of trillions of dollars of leveraged assets.

[PGalt]

“Bradford Levy, a Goldman Sachs vice president who co-chairs the consortium of 16 broker-dealers that maintains the CDX Index, sees big things for the market but acknowledges that some kinks need to be worked out.”

http://www.cfo.com/article.cfm/5009978/1/c_5038012?f=insidecfo

Not to worry. This has been just a kink. (Are apologies due to Ray Davies? /sarcasm)

[ari-freedom]

you are crazy

[Travis McGee]

“The Bush administration’s bail-out plan, even if it gets through Congress, may not be the end of the finance industry’s problems.”

That’s an understatement!

[decimon]

Financial institutions, desperate to repair the damage inflicted on their balance-sheets by mortgage-related securities, sell assets. In doing so, they exacerbate the problem. Forced sales push down the prices of assets, worsening the balance-sheets of other investors, forcing more asset sales, and so on.

IOW, the current deleveraging is the inverse of the former leveraging.

[TigerLikesRooster]

Yes, it always works that way. The same mechanism going in reverse.

[screaminsunshine]

I am crazy? Well I am watching C-Span right now. Bawnwy Fwank is on explaining how this bailout will work. If you do not pay your mortgage the governmet will take over and you will only pay what you can afford. This is akin to buying fire insurance after the fire. Now who is crazy. Me or Them.

[ari-freedom]

you want a recession a few weeks before an election. obama is the biggest socialist around. you know he’ll take advantage of it.

[screaminsunshine]

Only the government will still invest in a government run PONZI. Last I looked Repubs have been in thick as thieves with it with only some mild resistance. It is OVER> We are going to have to pay the Piper.

[RegulatorCountry]

You must be seeing a different chart. Looks to me as if we spent our way out of the Carter recession, and haven’t looked back since.

We have no such ability, in the current situation. Look at the hundreds of billions that have already been spent, since March. All it has bought has been a little time, less and less each go ‘round. We’ve gone from months initially, to weeks, and now, apparently, to days.

[Paladin2]

Looking at that chart, one is certainly struck by the spike around the time of the start of the depression.

However the y axis is a ratio.

It looks like the peak is after 1929. If debt were constant and the economy shrank (say because of a depression) the ratio would rise without any increase in the debt.

The current situation would appear to be different with a long rise in the debt even as the economy grew. The current situation would appear to be the final assembly of a "rogue" wave caused by a lack of internal savings, over expansion of low quality, long term debt, high oil prices and an inelasticity of oil demand with oil sucking even more money out of the US than the long term ,lousy balance of payments would otherwise do, deficit spending by the gov't (not doing the spending on real long term investments) and apparently an overhang of naked "derivatives".