WSJ.com-Worst crisis since Great Depression
WSJ.com featured a great article summarizing the problems we find ourselves in. You may access the article by clicking this link.
Among the points that I found interesting-
* “This has been the worst financial crisis since the Great Depression. There is no question about it,” said Mark Gertler, a New York University economist who worked with fellow academic Ben Bernanke, now the Federal Reserve chairman, to explain how financial turmoil can infect the overall economy. “But at the same time we have the policy mechanisms in place fighting it, which is something we didn’t have during the Great Depression.”
* Fed and Treasury officials have identified the disease. It’s called deleveraging, or the unwinding of debt. During the credit boom, financial institutions and American households took on too much debt. Between 2002 and 2006, household borrowing grew at an average annual rate of 11%, far outpacing overall economic growth. Borrowing by financial institutions grew by a 10% annualized rate. Now many of those borrowers can’t pay back the loans, a problem that is exacerbated by the collapse in housing prices. They need to reduce their dependence on borrowed money, a painful and drawn-out process that can choke off credit and economic growth.
* At least three things need to happen to bring the deleveraging process to an end, and they’re hard to do at once. Financial institutions and others need to fess up to their mistakes by selling or writing down the value of distressed assets they bought with borrowed money. They need to pay off debt. Finally, they need to rebuild their capital cushions, which have been eroded by losses on those distressed assets.
* Today, Mr. Bernanke is taking out his playbook, said NYU economist Mr. Gertler, “and rewriting it as we go.”
* The latest trouble spot is an area called credit-default swaps, which are private contracts that let firms trade bets on whether a borrower is going to default. When a default occurs, one party pays off the other. The value of the swaps rise and fall as the market reassesses the risk that a company won’t be able to honor its obligations. Firms use these instruments both as insurance — to hedge their exposures to risk — and to wager on the health of other companies. There are now credit-default swaps on more than $62 trillion in debt, up from about $144 billion a decade ago.