Credit Crunch Will Go On

Excellent find Snuffy...it's nice to read thoughts based on economics
(on this economic issue) rather than politics. From the end of the piece:

...
Logically this cannot last. Credit has already shrunk dramatically (40%-80%) in markets for securitized debt, leveraged-buyout credit and even corporate issuance. AIG's collapse was caused by its excessive focus on insuring credit rather than its traditional sectors of life, casualty and property. But its inability to get out of its current financial mess was due to a lack of private-sector financing.

Bank lending cannot escape the process forever. The current level of losses in the financial system is ultimately consistent with a 4%-6% contraction of credit. That is quite something when you consider that the global economy needs a 10%-15% expansion of credit to grow by 3% in real terms.

When bank credit does contract, the impact on the real economy will be more marked than we have seen thus far. The reason is that most bank credit is the sort of money that gets spent in shops and garages, or is used by the corporate sector to invest in real assets. NDFI money is used to invest in financial markets, causing security prices to rise and fall, which only indirectly affects the real economy by changing the value of wealth.

So, the outcome will be a long gray, global recession -- not unlike what Japan experienced after the bursting of its "bubble economy" -- in which policy measures (low interest rates, huge liquidity injections and fiscal spending) will attempt to keep it from developing into a deflationary collapse while the credit system adjusts.

Global recession will also mean further losses in the credit system. This time the losses will be smaller as a percentage of higher quality assets, but will affect much bigger pools of debt (e.g., prime mortgage markets are seven times bigger than subprime, and other consumer debt markets are four times as big). This means that, even with lower loss ratios, potential losses could be as big as subprime losses and destroy as much bank capital, causing further credit contraction.

But all is not gloom. There will be an end, as there is to all things. When we emerge from this it will be to a world in which thrift has replaced leverage and scarce capital is invested more productively.

Mr. Roche is president of Independent Strategy, a London-based consultancy

Refreshing to hear the hard truth without the Armageddon angle.