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Debt Not the Lifeblood of the Economy


Suspending mark-to-market does nothing to reduce leverage.

I would like to chime in on Professor Depew's excellent (as usual) Five Things: Credit is the Lifeblood of the Economy.

Like Kevin, I had to laugh the first time I heard that absurd statement. After the next 20 times, it became more scary than funny.

This is why:

The flip side of credit is debt. Is debt the lifeblood of the economy?

Surely not. It's not that debt is bad in and of itself. Debt is fine, as long as it's being used in productive ways or is backed up by savings somewhere. No one can argue that savings shouldn't be loaned out.

However, the problem is that credit has been extended without savings to back it up, to those who had no possible means of paying it back.

Were it not for fractional reserve lending, this could never have occurred.

Clearly, debt isn't the lifeblood of the economy. By extension, credit isn't the lifeblood of the economy, either. Rather, savings is; without it, extending credit is nothing but a pyramid scheme that eventually implodes. Of course, that's what happened.

Amazingly, the "solution" in Congress is to encourage more reckless lending, even though we have no savings to lend. This Ponzi financing scheme can't possibly work.

Had banks not lent with leverage and instead put those loans on the books in a hold-t-maturity portfolio, then the banks wouldn't be in trouble.

The reason banks purposely put those assets into a mark-to-market portfolio is that this allowed them to increase leverage (the number of loans with nothing backing them up). With leverage comes increased profit potential and increased risk. Banks were speculating, pure and simple.

Without that excessive leverage, banks would have had losses, but they would have remained solvent. Leverage is therefore what's doing banks in, not mark-to-market rules. Unfortunately, suspending mark-to-market accounting does nothing to reduce the leverage.

The problem, once again, was fractional reserve lending that allowed banks and brokerages to lever up. That problem doesn't just go away if mark-to-market is ignored.
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