The Real Reason Why Mature Markets Are Losing Steam – The Indian Wire

There would be little or no need for commercial banks if everyone always paid their debts in full and on time. Everyone would then have the best credit rating possible, would not require monitoring, and could borrow or lend at the default-free rate of interest. Although many formal macroeconomic models (implicitly) assume a default-free system in their so-called trans- versatility assumption, this isnt a feature of the real world. Indeed, the probability of default (PD) is a critical concept in any assessment of financial fragility. The term financial fragility is most commonly associated with Hyman Minskys financial instability hypothesis (FIH), which was published more than 30 years ago (Minsky, 1975). According to the FIH, during an upswing of a business cycle, a capitalist, market economy naturally progresses through three states or regimes. Synopsis With rising non-financial corporate debt and evidence of elevated borrowing levels among non-bank financial companies, the fragility caused by excessive leverage has returned to haunt developed-country financial markets. The fact that the failure of a little-known family office firm like Archegos Capital Management resulted in massive losses for leadingbanks suggests that the failure of a rogue, overleveraged speculator can have systemic consequences similar to those seen in 2008. At the end of March 2021, when the world was exhausted from fighting the ongoing pandemic for more than a year, news broke that Wall Street traders were looking for the source of a $19 billion fire sale of tech, media, and other stocks. That burst of selling resulted in the collapse of stock prices for companies such as Viacom CBS, Baidu, and Tencent Music, wiping out approximately $33 billion in share values. The Archegos Incident: Too Big To Fail? Archegos, the family office of former Tiger Capital Management portfolio manager Bill Hwang, captured the attention of investors worldwide in mid-March when the firm suffered catastrophic losses as a result of a portfolio with two major flaws: high leverage and intense concentration in a few stocks. The Archegos messdrew global attention not only because of the magnitude of the losses but also because of its distinct pre-financial-crisis vibe. There were derivatives, huge losses, exposure for large international banks, counterparty risks all of the hallmarks of the 2008 meltdown. However, as disastrous as the Archegos trade unwinding was, the billions of dollars in losses that accrued at the banks (specifically, their prime broker units) that facilitated the trades did not spill over into other markets. Specific stocks in the portfolio were certainly hammered, as evidenced by Viacoms share price, and the dealers who took losses, such as Credit Suisse and Nomura, saw a hit to their stocks as well, but overall market volatility did not rise. In other words, a multibillion-dollar meltdown at a massive fund to which some of the worlds largest banks had massive exposure was largely ignored by the financial system as a whole. AND, Thats fantastic news, it shows that the reforms enacted in the aftermath of the global financial crisis to increase the number of capital banks hold were successful. Global Banking System Turns Protectionist The US banking system was highly leveraged as it approached the meltdowns of 2007 and 2008. Bank borrowing accounted for more than 90% of risk-weighted assets and is increasing. Tier 1 capital, which includes first-in-line-for-losses equity and internally generated earnings, contributed only about 8% of the funding. That figure is much higher and more stable post-crisis, at 12 percent. Banks are accumulating more capital and borrowing less in relation to their assets. Leverage has decreased, while capital has increased. This is importantbecause if a bank has capital equal to 8% of its assets, it is technically insolvent if the value of its assets falls by 8%. Banks have raised the bar for insolvency by increasing capital levels in the event of a sudden drop in the value of their assets. Financial fragility is recognized as a significant issue for individual well-being. According to various estimates, between 46 and 59 % of American adults are financially fragile and thus vulnerable in terms of their well-being. We argue that the role of financial control in shaping well-being outcomes has received less attention in the literature than the role of financial fragility, it is equally or even more important. The total amount of household debt in the United States is $13.5 trillion (Federal Reserve Bank of New York 2019, i.e., 80 percent of the total amount of debt in the United States). Gross Domestic Product (GDP) (International Monetary Fund 2019). It is currently at an all-time high, putting American debtholders in a vulnerable position and increasing their vulnerability to external shocks (e.g., COVID-19 pandemic). These high levels of debt were previously linked to a lack of financial planning skills, poor financial management, and harmful consumption behaviours resulting from beliefs that material possessions can lead to happiness. The Curse of Covid-19 Aside from soaring infection rates, the COVID-19 pandemic has resulted in widespread lockdowns, a shattering decline inoutput, and spikingpoverty. Behind these trends, a quieter financial crisis is gaining traction. The financial fallout from the pandemic disregards regional or socio-economic differences. Nonperforming loans are on the rise in financial institutions around the world. COVID-19 is also a regressive crisis, disproportionately affecting low-income households and smaller businesses with fewer assets to avoid bankruptcy. Macroeconomic policies have sought to offset the sharp declines in economic activity associated with widespread shutdowns since the outbreak of the pandemic. Wealthier countries have been able to respond more quickly. Multilateral lending institutions have also aided in funding the response to the health emergency in developing countries. Temporary moratoriums on bank loans to households dealing with unemployment and struggling businesses have also aided the macroeconomic response. Financial institutions in all regions have granted grace periods in loan repayment. The understandable rationale has been that because the health crisis is temporary, so is the financial distress of businesses and households. However, as the pandemic has progressed, many countries have found it necessary to broaden these precautions. Banking regulation has frequently been lax in terms of provisioning for bad loans and determining which loans are nonperforming. Even with available vaccines, significant financial damage has already been inflicted. Forbearance policies have proven to be an effective coping mechanism, but even extended grace periods must come to an end. As 2021 progresses, more will be revealed about whether the problem confronting countless firms and households is insolvency or illiquidity. High leverage will amplify the financial sectors problems. This type of balance-sheet damage takes time to repair and frequently precedes a lengthy period of deleveraging. Financial institutions lending practices become more cautious. A credit crunch is typically a significant impediment to recovery. Consequences It has been suggested that the interventions by the government can be ossifying or liquifying and the destabilizing consequences of the policy of the government should take into consideration in the areas of the bank, taxation, monetary control and also the lender of last resort. Activist governments will be unable to rid their economies of financial fragility, and efforts to reduce fragility may backfire by causing unintended consequences. Knowing that financial factors can act as shock sources or propagators does not always translate into effective options for mitigating ossifying financial effects. Financial fragility is an unavoidable byproduct of a dynamic capitalistic economy.

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The Real Reason Why Mature Markets Are Losing Steam - The Indian Wire