INSUBCONTINENT EXCLUSIVE:
BY AARON BROWNThe National Bureau of Economic Research lists 29 credit contractions in the last 145 years, which works out to one every five
We’ve now gone more than 11 years since the one started in 2007, the longest run in recorded history
But credit is a lot like a forest
Trees grow before eventually becoming old and littering the ground with dry deadwood before some unpredictable spark triggers a fire that
So while it’s hard to guess when or where the fire will start, a map of forest conditions can provide a decent sense as to where damage is
most likely — just like with credit.
Nine of the 29 NBER credit events had banking crises
Eighteen had stock market crashes, 16 caused extended contractions in credit availability, and 21 caused monetary shortages
Only two, the Great Depression and the financial crisis that began in 2008, were quinfectas, resulting in each of those four bad things plus
a real estate collapse.
The graph below shows US commercial bank liabilities as a per centage of assets
Capital ratios are nearly twice as high as 2008, and rules have tightened considerably on asset and capital quality
There are two important caveats
First, the graph shows aggregates
Some banks have plenty of assets; others are shakier
In a credit crisis, some banks are likely to fail, because they are overexposed to the sectors that get hit hardest, or perhaps have hidden
risks or poor risk management
Second, if the credit crisis is big enough, many banks could fail
Banks won’t be unscathed by the next credit crisis, but damage should be limited unless a lot of other things go first.
The next graph
shows non-financial corporation liabilities as a per centage of assets
Here again the aggregate numbers look reassuring
You hear a lot of warnings about the lowest-rated investment grade corporate bonds, speculative-grade bonds and leveraged loans, but as long
as the overall non-financial corporate sector is healthy, there should be no waves of dominoes falling over.
Consumers are next
This graph shows total household liabilities as a per centage of assets and total household mortgage debt as a per centage of total home
Both rose sharply from 2000 to 2008, and we know how that ended
But both have declined and are now near 30-year lows.
The picture is less rosy for nonmortgage debt such as credit card balances, auto loans
and student loans, shown below as a per centage of household non-financial assets on the left scale and household financial assets on the
Non-mortgage debt looks small relative to financial assets, coming in a 4.4 per cent and falling
Unfortunately, households with non-mortgage debt aren’t the ones holding the most financial assets
Households have more non-mortgage debt than the sum of all their non-financial, non-residential assets, something without historical
precedent.
WLenders don’t expect consumers to sell their clothes or computers (maybe their cars) to pay non mortgage debt
Consumers reduce debt during bad times by postponing purchases, but even a lot of postponement will not make much of a dent in debt levels
Debt pressures, though, could cause a large decline in spending.
So, the vulnerable parts of the credit market in the next crisis are
households with debt and no financial assets, real estate or businesses
This is a large universe of people, and their problems could cause steep spending declines
They are not equipped to weather periods of rising unemployment or wage cuts, and will be a powerful political force for radical government
I don’t expect a banking crisis, stock-market crash, bond market meltdown or real-estate decline in the next credit crunch, nor an
extended credit contraction
But many individuals will suffer, and sectors of the stock market dependent on consumer spending will be punished
I expect strong fiscal and monetary responses based on both the political situation and the clout of the group that will be hurt
That could cushion the pain at the time, but exacerbate government fiscal problems and moral hazard.
None of this is certain
In particular, if the credit crisis is big enough, it can take everything with it, like a wildfire that grows big enough to burn a young,
healthy forest with little deadwood
Also, we always find surprises overlooked by aggregate data when things get bad
But today the financial system and the households that own financial assets seem reasonably prepared for the downturn
