Deleveraging: How Will It End?
By Satyajit Das Oct 06, 2008 9:30 am
No fairytale conclusion for this crisis.
The drama and tumult of recent events are not symptoms of the disease but the cure. The "disease" is the excessive debt and leverage in the financial system, especially in the US, Great Britain, Spain and Australia. In the words of a Bruce Springsteen song, many have "debts that no honest man could pay".
The "cure" is the reduction of the level of debt (the great "deleveraging"). In 1931, Treasury Secretary Andrew Mellon explained the process to President Herbert Hoover:
"Liquidate labour, liquidate stocks, liquidate the farmers, liquidate real estate. Purge the rottenness out of the system. High costs of living and high living will come down... enterprising people will pick up the wrecks from less competent people."
The initial phase of the cure is the reduction in debt within the financial system. The overall losses to the financial institutions (net of re-capitalisation via new equity issues) are $400 to $600 billion and may well go higher. This requires reduction in financial sector balance sheets (assuming bank system leverage of around 10 times) of around $4 to $6 trillion through reduction in lending and asset sales.
For example, the bankruptcy of Lehman Brothers resulted in $600 billion of debt being eliminated. In turn, this inflicts losses on holders of Lehman debt that in turn flows through the chain of capital. The destruction of Lehman Brothers’ capital (around $20 billion) also permanently diminishes the capacity for further credit creation in the future.
The second phase of the cure is the higher cost and lower availability of debt to the real economy. This forces corporations to reduce leverage by selling assets, reducing investment and raising equity (for example, as GE has done). This also forces consumers to reduce debt by selling assets (where available) and reducing consumption.
Feedback loops mean reduction in investment and consumption lowers economic activity, placing stresses on corporations and individuals setting off defaults that trigger losses for the financial system that further reduces lending capacity. De-leveraging continues through these iterations until overall levels of debt reach a sustainable level determined by lower asset prices and cash flows available to service the debt.
The process of destruction echoes W.B.Yeats’ words: "All changed, changed utterly: A terrible beauty is born."
Within the financial sector, de-leveraging is well advanced. In the real economy it is in the early stages. Fairy tales in financial markets focus on the "superhuman" abilities of regulators and governments to avoid the de-leveraging under way.
Central banks and governments have aggressively supplied liquidity to the money markets accepting an increasing range of collateral. Central banks may soon accept baseball cards and Lehman Brothers, Bear Stearns and Washington Mutual ("WaMu"), Fortis and Dexia
memorabilia (mugs, stress balls, desk-decoration cubes that open up to reveal Lehman Brothers’ key operating principles - "demonstrating smart risk management").
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2008-10-06 09:45:47
Cards
Ha! Can i turn in my basball cards? Will it be mark-to-market or mark to whatever i say they are worth?
2008-10-06 10:23:27
Scheherazade
A beautiful analogy for an elegant reduction to the principles of this problem. Thank you.
You almost lost my attention in the second page, but made up for it with the conclusions and recommendations. Well done.
"cash flows available to service the debt"-- excellent! Let's add "with emphasis on a real economy, which only comes from real needs and real available resources."
In a way, I think you have done very well illustrating the point that the "losses" being seen are losses on BALANCE SHEETS, not real losses of real money. These balance sheet numbers were fantasies all along, based on the fantasy of perpetual growth in a closed, delusional system. When leveraging fantasy upon fantasy, it would help if the government was paying attention to the part that says it happens in "fairyland". The money is only as real as the future we build is useful to our children. When we expect our children to be our PRESENT cashflow, then the system has gone kaput.
You almost lost my attention in the second page, but made up for it with the conclusions and recommendations. Well done.
"cash flows available to service the debt"-- excellent! Let's add "with emphasis on a real economy, which only comes from real needs and real available resources."
In a way, I think you have done very well illustrating the point that the "losses" being seen are losses on BALANCE SHEETS, not real losses of real money. These balance sheet numbers were fantasies all along, based on the fantasy of perpetual growth in a closed, delusional system. When leveraging fantasy upon fantasy, it would help if the government was paying attention to the part that says it happens in "fairyland". The money is only as real as the future we build is useful to our children. When we expect our children to be our PRESENT cashflow, then the system has gone kaput.
2008-10-06 10:56:20
deleveraging
it seems that this article describes the downwards spiral. Q. is who is going to pay us back for deleveraging Iraq of its Al Qaeda forces so we can stimulate our economy a bit after spending hundreds of billions of US dollars supporting theirs. I agree with the War Effort but wonder why we have to pay so much.
2008-10-06 11:41:04
deleveraging
WE don't get paid back. The oil companies got paid back.
All according to plan.
All according to plan.
2008-10-06 12:10:51
None so blind...
as those who will not see.
The American people are addicts. Addicted not only to oil but to credit...with all the obvious symptoms of over-consumption, arrogance and greed. Like all addicts they will not acknowledge reality without outside intervention.
The 'war on terror' is just another symptom. Any non-addict willing to look at reality would be asking the obvious question:
Why doesn't the United States, the supposed purveyors of 'freedom and democracy' support the 'terrorists' instead of the dictators who keep them in subjugation?
But that, of course, is like asking an addict to turn on his dealer.
When the delusional American people stop asking if 'its over yet' and start to face just how much has been squandered during these last 50 years maybe then we can begin the long, painful recovery to a nation that can actually be proud of itself again.
The most important thing that needs to be 'deleveraged' is our sense of entitlement.
2008-10-06 12:17:44
deleveraging
Come on ---- what the h@ll does that mean? How do you mean "the oil companies got paid back"? It's time we realize that US Oil companies do not impact and are to blame for every possible thing on this planet! "When all else fails ---- blame it on US oil!" Get real ---- oil in the ground is being devalued $zillions as we speak!
2008-10-06 12:24:17
This article is awful. The most negative spin I could imagine!!!! If we have a severe recession, which I believe we will if people like you continue to place the very worst light on what is happening, then I hope your website is the first to go bankrupt!!!! Why should we have to read your childish ranting! Tell us what we need to do. Don't tell us what has already happened. This is not entertainment. Just wait - your site will go down when the recession hits!!!! You will not have any one to pay for advertising on your site. If I were Ameritrade, Inestors Intelligence, and the other advertisers I would stop advertising on your website right now. This website is not for investors it is for kids!!!!
2008-10-06 13:25:23
"Why should we have to read your childish ranting! Tell us what we need to do. "
With all due respect, I find it hard to believe you could juxtapose those two sentences. Really, this "shoot the messenger" nonsense belies profound irresponsibility and childishness. If you want your daily Pollyannaish propaganda, you should turn on CNBC.
With all due respect, I find it hard to believe you could juxtapose those two sentences. Really, this "shoot the messenger" nonsense belies profound irresponsibility and childishness. If you want your daily Pollyannaish propaganda, you should turn on CNBC.
2008-10-06 13:32:22
No Dave, this article is great!
The websites that are always showing the world in a better light than it is, are the websites for kids. Kids are the ones that need to be sheltered from reality ...... adults are supposed to deal with it. We have a crisis that needs to be explained so that hopefully something will be done by our leaders to change it and prevent it from happening again. Should we ignore all the history about what happened in WWII? or about the negative effects of a global nuclear war?
I for one am sick of all the hype about anything and everything in general and I for one hope that this site stays up forever. Great job guys, keep it up!
I for one am sick of all the hype about anything and everything in general and I for one hope that this site stays up forever. Great job guys, keep it up!
2008-10-06 14:16:43
deleveraging
The plan was to go into Iraq and stop Hussein from monkeying with the oil markets. His antics would raise the price of oil to 25, then drop it to 14 because of the unpredictability of how much oil he was going to sell.
Target was 30.00/bbl. Civil undressed pushed the price to 150. Ooops.
Now, everyone is wondering what happened to their money as it flows into the pockets of oil companies and oil countries. We lost only a few sons, daughters, and a bunch of arms and legs, but look at how much money the IOCs made. Sure sounds like a good 'surge' to me.
I don't 'blame' the oil companies. I blame the idiots around me and myself for not pushing hard enough to get the truth out of the government. Secret meetings, secret groups, secret organizations. It's time to dig up some truths while they don't have money to bury our heads in the sand. A depression will be the best time to do it. Look in those dark closets when you're picking up the soup kitchen supplies, willya?
Target was 30.00/bbl. Civil undressed pushed the price to 150. Ooops.
Now, everyone is wondering what happened to their money as it flows into the pockets of oil companies and oil countries. We lost only a few sons, daughters, and a bunch of arms and legs, but look at how much money the IOCs made. Sure sounds like a good 'surge' to me.
I don't 'blame' the oil companies. I blame the idiots around me and myself for not pushing hard enough to get the truth out of the government. Secret meetings, secret groups, secret organizations. It's time to dig up some truths while they don't have money to bury our heads in the sand. A depression will be the best time to do it. Look in those dark closets when you're picking up the soup kitchen supplies, willya?
2008-10-06 14:36:09
This game is getting over right now, but they will start another financial game in the next year. It's realy a good investmenst to play with...
2008-10-06 22:15:04
deleveraging
So, you/we unilaterally attacked them and you think we should be paid back?
Wha?
Wear the shoes. If you were here minding your own business and they came here and attacked you, would you pay them there costs for doing so? Or would you fight to the death to evict the attackers? Think about it.
Wha?
Wear the shoes. If you were here minding your own business and they came here and attacked you, would you pay them there costs for doing so? Or would you fight to the death to evict the attackers? Think about it.
2008-10-06 22:18:22
None so blind...
We need to deleverage our sense of entitlement?
I think congress did that for us, one and all including unborn children, already with the boondoggle $700B Bank Bailout bill.
I think congress did that for us, one and all including unborn children, already with the boondoggle $700B Bank Bailout bill.
2008-10-06 22:20:19
deleveraging
Wake up. Oil companies swept in and leveraged rights to the oil in the ground there. If you missed it, do some research cause the poster is right that they got paid. fwiw
2008-10-06 22:25:01
What we need to do?
Ok.
Heres what we need to do. Start living within your means instead of on credit. Stop interfering in free markets and allow them to work. Let those who took errant risks pay for their failures. Let them fail. Hold them accountable. Don't bail them out. Doing so reinforces the bad behavior and sets in motion more of the same. Vote out all incumbants for public office and vote in all new candidates every election cycle. Do it every time. Eventually they will represent you because they won't be there established long enough to be bought off by lobbyists and special interests and corporations. There will be no incentive cause they will know that they're one term is the one they are serving. Say to yourself, Enough is Enough. Mean it and live it. Spread the word and be part of the solution.
Heres what we need to do. Start living within your means instead of on credit. Stop interfering in free markets and allow them to work. Let those who took errant risks pay for their failures. Let them fail. Hold them accountable. Don't bail them out. Doing so reinforces the bad behavior and sets in motion more of the same. Vote out all incumbants for public office and vote in all new candidates every election cycle. Do it every time. Eventually they will represent you because they won't be there established long enough to be bought off by lobbyists and special interests and corporations. There will be no incentive cause they will know that they're one term is the one they are serving. Say to yourself, Enough is Enough. Mean it and live it. Spread the word and be part of the solution.
2008-10-07 01:51:51
What to do?
I have heard two suggestions (generally) about what to do: something and nothing. Doing nothing, say the free-market capitalists, will punish the guilty. Doing something, say the economic socialists, will ease the pain of the innocent.
I'll tell you what we need to do: we need to find out how we got into this mess first. Sarah Palin's call on Joe Biden (that he was looking to the past, not the future) may have been an innocent request, but I doubt it. A shipping company who keeps losing ships to icebergs had better figure out quickly how they managed to put their ships at risk! I am not suggesting that I trust Obama/Biden over McCain/Palin; only that the farce that we can go forward without looking back is the most dangerous suggestion that I have ever heard. It is only through past mistakes (and successes) that anyone can learn.
I do not believe that there is a 'magic bullet' to 'fix' the problems. I do believe that they can be 'handled' in a responsible way. The problem is that we can not responsibly deal with a catastrophe if we do not have the courage and willingness to look at its origins and causes. Congress passed a 'rescue plan' within a few, short weeks. Congress did the same with the 'Patriot Act' and quite a number of other boondogles. The LAST thing I want congress to do is to have only one term (as the amount of cash flowing to candidates will become obscene as businesses vie with one another over which candidate will get them the best deals).
The internet may be the only means of discovering some truths--the problem is that it is too easy to 'publish' on the internet. How does one separate the truth from idiocy? How can one be sure of the facts involved if there are conflicting reports? Many conservative friends of mine claim that they only watch/listen to Fox as all the others are biased (implying that Fox is not). They do not give any proof of this claim, they take it as a given. The US Government is in debt up to it's eyeballs (the same with many of its citizens). The trade systems of the world are skewed because we have a minimum wage (and a nearly mandatory requirement for our businesses to provide health care) while China does not. Japan can subsidize ever business by providing health care to its citizens yet American producers are expected to compete with such unfairness.
These are just some of the challenges we face. It is going to require thought, discussion, possible trials/failures and soul searching. One thing is very certain: the USA has got to start paying as it goes.
I recommend a 'balanced budget' amendment to the Constitution (which can give exceptions for certain cases). Canada did this (and it was sometimes painful) and have finally gotten control of their spending. If we don't do something like this soon (within a few years) our democracy will go the way of all democracies that wiped themselves out due to fiscal mismanagement: we will collapse into dictatorship--which may be the actual goal of our politicians in the first place.
I'll tell you what we need to do: we need to find out how we got into this mess first. Sarah Palin's call on Joe Biden (that he was looking to the past, not the future) may have been an innocent request, but I doubt it. A shipping company who keeps losing ships to icebergs had better figure out quickly how they managed to put their ships at risk! I am not suggesting that I trust Obama/Biden over McCain/Palin; only that the farce that we can go forward without looking back is the most dangerous suggestion that I have ever heard. It is only through past mistakes (and successes) that anyone can learn.
I do not believe that there is a 'magic bullet' to 'fix' the problems. I do believe that they can be 'handled' in a responsible way. The problem is that we can not responsibly deal with a catastrophe if we do not have the courage and willingness to look at its origins and causes. Congress passed a 'rescue plan' within a few, short weeks. Congress did the same with the 'Patriot Act' and quite a number of other boondogles. The LAST thing I want congress to do is to have only one term (as the amount of cash flowing to candidates will become obscene as businesses vie with one another over which candidate will get them the best deals).
The internet may be the only means of discovering some truths--the problem is that it is too easy to 'publish' on the internet. How does one separate the truth from idiocy? How can one be sure of the facts involved if there are conflicting reports? Many conservative friends of mine claim that they only watch/listen to Fox as all the others are biased (implying that Fox is not). They do not give any proof of this claim, they take it as a given. The US Government is in debt up to it's eyeballs (the same with many of its citizens). The trade systems of the world are skewed because we have a minimum wage (and a nearly mandatory requirement for our businesses to provide health care) while China does not. Japan can subsidize ever business by providing health care to its citizens yet American producers are expected to compete with such unfairness.
These are just some of the challenges we face. It is going to require thought, discussion, possible trials/failures and soul searching. One thing is very certain: the USA has got to start paying as it goes.
I recommend a 'balanced budget' amendment to the Constitution (which can give exceptions for certain cases). Canada did this (and it was sometimes painful) and have finally gotten control of their spending. If we don't do something like this soon (within a few years) our democracy will go the way of all democracies that wiped themselves out due to fiscal mismanagement: we will collapse into dictatorship--which may be the actual goal of our politicians in the first place.
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