Solarbird (solarbird) wrote,

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A long note by Dr. Nouriel Roubini

Dr. Roubini has a rather long note on the 'Green shoots' theory of economic recovery, here. It's also about the most probable path of recovery - slow, and weak, and what has to happen in order for even that to proceed. In particular, I want to quote from this (rather long) paragraph:
In reality, true deleveraging by households, corporate firms and financial institutions has not really even started as private losses and debts of households, financial institutions and even corporations are being socialized and put on the back of the balance sheet of governments. Thus, the lack of true deleveraging – or appropriate debt restructuring – will lead to a corrosive debt deflation and limit the ability of households to spend, of firms to invest and of banks and other financial institutions to lend. In other terms if this is a crisis of credit and solvency rather than just illiquidity and confidence much more is needed than easy money and massive fiscal stimulus to resume high economic growth. Worse, the socialization of private losses – while private debts and leverage are barely reduced – implies that the process of re-leveraging continues with the public sector levering up to pick up the losses of the private sector. So, this policy solution creates – down the line – another dangerous debt and solvency problem, this time for the sovereign, with risks of a more severe financial crisis down the line once a refinancing crisis occurs and/or the ability by the sovereign to borrow more is curtailed. So, this fundamental misinterpretation of the causes of the crisis leads to a partially incorrect policy solution that exacerbates the debt problems of households, financial firms, corporate firms and governments in ways that are discussed in more detail below. The right way to resolve a problem of excessive debt relative to equity capital for households, firms and financial institutions is to reduce such debt and convert it into equity. Corporate debt should be converted into equity; financial sector unsecured liabilities should be converted into equity; and even households debts can be converted into equity by reducing the principal value of such mortgages and providing an equity upside to the mortgage creditor in the form of a warrant. If there is too much debt and too little equity in an economy a sector by sector conversion of debt (unsecured claims of creditors and bondholders) into equity is the right and efficient solution that allows agents buried under a debt overhang to start spend and invest again. Instead of this efficient debt conversion we are socializing the private losses and putting them on the balance sheet of governments and increasing public debts, thus increasing the overall leverage of the economy rather than reduce it and risking to create a sovereign debt problem while not reducing private leverage. This is not the proper growth-inducing way to resolve a problem of excessive debt and leverage.
This is the crux of the problem, as many of us hanging out in the deflation/bear camp have been arguing for some time. What we've wanted to force through quickly and early is what Dr. Roubini talks more about in another paragraph:
But how can households reduce their debt ratios that have increased from 65% of disposable income in the early 1990s to 100% in 2000 and to 135% today? And these debt ratio risk rising even further as price deflation leads to debt deflation, i.e. the rise in the real value of nominal debts. One solution is income growth that will increase the denominator of the debt to income ratio and thus reduce the overall debt ratio. But given the potential growth of the real income of US households that solution is not feasible. A second solution is to save a lot to reduce debt and rebuilt net worth: after all the change in wealth is by definition equal to the – properly measured – savings rate. But here the “paradox of thrift” prevents this solution to the debt deflation problem. If households sharply and rapidly cut spending and save more the recession becomes a near depression and the ensuing fall in income further increases the debt to income ratio. The only remaining solution is debt default and debt reduction: when firms have too much debt they go into Chapter 11 and have their nominal debts reduced; then they can start producing, hiring and investing again; when countries have too much debt (say Argentina, Russia, Ecuador in recent history) they default, reduce the principal value of their debts and start spending and growing again. The same holds for households: the overhang of excessive debt can be a burden to households’ ability to spend for a long time. Thus, for households buried under a mountain of mortgage debt, credit card debt, auto loans and student loans debt reduction – not just re-stretching of debt maturities or debt servicing relief – is necessary to eliminate the debt overhang and restore robust rate of consumption spending and/or of investment in physical capital (new home purchases).
It's a long article - his first one of this sort of breadth and depth in some time - and I recommend reading it.
Tags: economics
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