Headline Nov 13, 2014/

''' DEBT: 


EVENTUALLY,  -the financial cycle peaks and the borrowers realise they do not have the income required to service further debt. 

At that point the cycle goes into reverse:

As asset prices fall, collateral constrains tighten, squeezing borrowing, which results in further falls in prices. Unfortunately, one thing does not fall :

The size of the debts that households and firms have incurred. The value of their liabilities remains obstinately fixed, as if written in sun-dried clay, even as value of their assets plunges.

Households and firms will respond by  ''deleveraging'' , seeking to lighten their debt burdens. They can do this in three ways: by defaulting, by selling assets or by spending less than they earn  -and using the proceeds to repay debt.

Although deleveraging helps repair household and corporate finances. at the level of the economy as a whole it can make things worse:

Since one person's outlay is another person's income, depressed spending will hurt incomes, resulting in what Richard Koo of Nomura Research Institute has called a ''balance-sheet recession''.

Even if incomes and prices do not actually decline, they will fall short of their previous trajectory, while the money value of debts remains unchanged. 

The economic weakness caused by debt can thus make debt even harder to bear, a trap that Irving Fisher, a Depression-era economist called ''debt deflation''.

The deleveraging of the financial sector can be particularly deep, quick and nasty.

Deep because banks hold a lot of debt relative to their equity (they are highly ''leveraged''). Quick because those liabilities are typically of shorter maturity than their assets, giving banks little time to put their balance-sheets in order.

Nasty because the process hurts their rivals and their customers alike.

In 2007 and  2008 fire sales of securities by investment banks and other dealers depressed their prices, devaluing the portfolios of other banks with similar assets.

Banks and other lenders also started calling in loans or at least withholding new ones, inflecting a credit crunch on the broader economy.    
Is such a wrenching balance-sheet recession avoidable?

In principle, as debtors spend less, savers could spend more, helping to sustain demand.

To encourage this, the central bank can cut interest rates, easing debt-servicing costs for borrowers and discouraging saving by the thrifty.

The Federal Reserve cut its policy rate from  5.25% in the summer of  2007 to 0-0.25% in December 2008 and the Bank of England followed suit.   

In addition the government can spend more than it collects in taxes, so that the private sector can earn more than it spends.

In another paper Mr Sutherland and his co-authors show that run-ups in borrowing by firms   -especially financial firms-  tend to cause subsequent increases in public debt.

That is precisely what happens in many rich countries in the aftermath of the crisis, when heavy government spending helped to compensate for severe cuts in corporate and household budgets-

And sparked a fiery debate about the risks that entails.

With respectful dedication to the Students, Professors and Teachers of the world. See Ya all on !WOW!   -the World Students Society Computers-Internet-Wireless:

''' Hearts And Minds '''

'''Good Night and God Bless

SAM Daily Times - the Voice of the Voiceless


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