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The Financial Crisis, Part Two? Some Global Thoughts

The U.S. credit boom that preceded the Great Recession saw credit zoom from 143% of GDP to 177% in 2008.  A similar event occurred in Japan which was followed by two lost decades. China’s corporate and household debt has risen dramatically, from about 120% of GDP in 2008 to 170% today. This type of increase is normally followed by a crisis of some sort, and it appears China is on the path to its own crisis. 

The question is what form will the crisis take? Given the lessons the Chinese leadership learned by watching the U.S. response, and given that the major China banks are state-owned and run, we can expect that the credit bubble will not lead to a U.S.-style meltdown and that China is not about to take the global economy down with it.

What we expect to see is that it will take years to reign in this credit problem and that those years will most likely be characterized by slower growth. 

On the topic of credit, Wall St. is once again investing in CDOs (collateralized debt obligations) and the securitization of mortgages (slicing and then reselling these reconstituted investment vehicles). The values have dropped significantly since 2006, but they are once more on the rise. CDOs have climbed from a 2009 low of $4.3 billion to $88.8 billion today. Securitized mortgages have climbed to $848 billion.

These numbers are small in comparison to the 2006 peaks that led to the financial market crash, but the rise indicates we are going in the wrong direction and that Wall St. is loading up on risk again.  We are a long way from a crisis, but we are moving in that direction if Wall St. continues on its current path.

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