Tuesday, February 5, 2013

US BANKING: DEBT HANGOVER

Having paid a price for their ‘irrational exuberance’, economies in general, and financial institutions in specific are suffering from a hangover of their own mistakes, says B&E’s Gyanendra Kumar Kashyap

It’s true that S&P 500 Index’s 64% jump since March 2009 has made investors richer by restoring $5.4 trillion to their wealth, but the figures are not proof of growth problems to come. The fact that the treasury has recovered two-thirds of TARP investments as well as $17 billion by means of dividends & warrants is certainly good news. But at the same time, both Fed Chairman, Ben Bernanke and his Treasury Secretary, Timothy Geithner should keep in mind the downside of the stimulus binge, while rejoicing over the fact that the May 2009 stress test results have helped financial institutions raise over $140 billion in high quality capital & over $60 billion in non-guaranteed unsecured debt (and hence the repayment). Such bailout bursts pump up growth initially, but the macroeconomic hangovers can carry on.

Even assuming some budget trimming, the IMF expects government debt in advanced G20 economies to reach 118% of their combined GDP by 2014, up from 78.2% in 2007 (just before the economic crisis). For the Japanese economy (whose deflationary hangover is world-renowned) the public debt is forecasted to exceed 110% of GDP in net terms in 2010, and will represent 225% of GDP in gross terms. Getting to a more sustainable 60% level will involve raising taxes & cutting services. And here lies the greatest problem.

In an environment where debt is large and growing, low interest rates are preferred by nearly everyone: the government, bankers and... everyone. The desire for low interest rates will put incredible pressure on the Fed and the central banks across the world to keep rates low. Raising taxes to reduce debt may delay the recovery process, while trimming spending will in all probability erode the safety net and damage competitiveness in the long run. Apparently, the road to repairing balance sheets is likely to be a long and winding for both the economy and the financial system.


Source : IIPM Editorial, 2012.
An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).

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