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I thought this piece in FT.com was very interesting. I look to the group to verify or shred these paragraphs.
Summary: Economists aren't panicking.
Summary: Economists aren't panicking.
A key point about the frenetic pace of financial innovation is that it is financial players – not mainstream companies – that have generally become highly levered. Thus, while interest rates have been low, the remarkable record of world economic growth over the past four years – the best run in over 30 years – has not been on the back of a corporate borrowing binge, fuelling investment in worthless assets.
On the contrary, corporate debt in aggregate has been falling and balance sheets growing ever more healthy. As a result, the cost of borrowing for companies with stronger finances, and even for those with junk bond ratings, has generally been flat or even falling over the past month, irrespective of the turmoil (see chart, attached). Similarly, creditworthy households have been enjoying a period of falling long-term interest rates, which is far from recessionary.
The one area where growth has been fuelled by excess borrowing has been in US subprime mortgages. But the net economic losses are too small to put a big dent in US growth, let alone the global economy. The Federal Reserve, for example, currently estimates that net losses from subprime will be between $50bn (£25bn, €37bn) and $100bn. But Lehman Brothers points out that even losses of $200bn would be “far less in nominal terms than the half-trillion US savings and loans debacle of the mid-to-late 1980s”. It adds: “As a per cent of the world bond market, this is about five-tenths of one per cent; a large absolute number but small on a relative basis.”
Indeed, policymakers may even welcome what is occurring. After all, central bankers around the world have repeatedly warned over the past year that markets were pricing risky credits too cheaply. Thus, as Jean Claude *Trichet, the European Central bank president, pointed out this week, one upside of current events is “a normalisation of the pricing of risk”. Mervyn King, the governor of the Bank of England, went further last week, calling the events “a more realistic pricing of risk, and that’s to be welcomed”.
If credit does become more “normally” priced, this will benefit anybody who has not become over-levered in recent years. In the corporate world, for example, mainstream companies are now better able to compete against buy-out rivals. “Deleveraging an overleveraged system is always dangerous,” notes Credit Suisse. “[But] better to deleverage when in a strong economy than a weak one . . . when there are plenty of strong cash buyers waiting in the wings [and] when past over-investment is not threatening a profits bust.”
. . .
But at the moment, the focus among policymakers remains on trying to smooth the necessary adjustment to a more deleveraged world in the markets – so that the badly needed repricing of risk can continue without wider disruption. The aim, in other words, is to ensure continued growth without bailing out those who have lent or borrowed unwisely. And if central banks deliver this – and it remains a big “if” – it will be a true measure of maturity and *success in the global economic system.
On the contrary, corporate debt in aggregate has been falling and balance sheets growing ever more healthy. As a result, the cost of borrowing for companies with stronger finances, and even for those with junk bond ratings, has generally been flat or even falling over the past month, irrespective of the turmoil (see chart, attached). Similarly, creditworthy households have been enjoying a period of falling long-term interest rates, which is far from recessionary.
The one area where growth has been fuelled by excess borrowing has been in US subprime mortgages. But the net economic losses are too small to put a big dent in US growth, let alone the global economy. The Federal Reserve, for example, currently estimates that net losses from subprime will be between $50bn (£25bn, €37bn) and $100bn. But Lehman Brothers points out that even losses of $200bn would be “far less in nominal terms than the half-trillion US savings and loans debacle of the mid-to-late 1980s”. It adds: “As a per cent of the world bond market, this is about five-tenths of one per cent; a large absolute number but small on a relative basis.”
Indeed, policymakers may even welcome what is occurring. After all, central bankers around the world have repeatedly warned over the past year that markets were pricing risky credits too cheaply. Thus, as Jean Claude *Trichet, the European Central bank president, pointed out this week, one upside of current events is “a normalisation of the pricing of risk”. Mervyn King, the governor of the Bank of England, went further last week, calling the events “a more realistic pricing of risk, and that’s to be welcomed”.
If credit does become more “normally” priced, this will benefit anybody who has not become over-levered in recent years. In the corporate world, for example, mainstream companies are now better able to compete against buy-out rivals. “Deleveraging an overleveraged system is always dangerous,” notes Credit Suisse. “[But] better to deleverage when in a strong economy than a weak one . . . when there are plenty of strong cash buyers waiting in the wings [and] when past over-investment is not threatening a profits bust.”
. . .
But at the moment, the focus among policymakers remains on trying to smooth the necessary adjustment to a more deleveraged world in the markets – so that the badly needed repricing of risk can continue without wider disruption. The aim, in other words, is to ensure continued growth without bailing out those who have lent or borrowed unwisely. And if central banks deliver this – and it remains a big “if” – it will be a true measure of maturity and *success in the global economic system.