Potential Costs and Origins of Credit Crisis Identified
The Economist this week highlights a couple of interesting pieces of research on the origins and costs of the credit crunch.
The magazine highlights a paper prepared by University of Chicago and Princeton academics for a recent meeting of the US Monetary Policy Forum. Under three different aproaches, the paper finds mortgage-credit losses are likely to be around $400 billion.
“That is a large number, but it is no worse than the losses that can be suffered on a bad day on Wall Street,” The Economist says. “The reason that the macroeconomic consequences are likely to be much bigger is that many of these losses will be borne by banks and other leveraged financial institutions that hold approximately half of all outstanding mortgage debt in America.”
If the losses are spread evenly (a big if), that suggests America’s banks are likely to take a hit of some $200 billion.
The Economist also reviews “the first big book on the credit cruch” that saw the crisis coming 3 years ago.
The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash, by former financial software executive Charles R. Morris, “deftly joins the dots between the Keynesian liberalism of the 1960s, the crippling stagflation of the 1970s and the free-market experimentation of the 1980s and 1990s, before entering the world of ultra-cheap money and financial innovation gone mad.”
He puts the eventual bill for the financial follies of the past few years at some $1 trillion—if all the excessive leverage (or borrowing) is wound down in an orderly fashion, which he considers unlikely.
Thanks to securitisation, poor-quality mortgages are marbled through the entire global credit system. And there is more to come: commercial property, credit cards, corporate debt, credit-default swaps. For the most exposed institutions, it will be death by a thousand cuts.
Taylor’s prescription:
- Originators should retain the riskiest portion of securitised loans
- Prime brokers should stop lending to hedge funds that fail to disclose their balance sheets
- Trading of credit derivatives should be brought onto exchanges for the sake of safety
- Some version of the old Glass-Steagall act separating commercial banking and capital-markets should be re-introduced.
You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.