Richard Koo: Are we seeing signs of a “Balance Sheet Recession”?

Despite recent gains in GDP and a 77-percent rise in the stock market, the prospect of a full economic resurgence remains tarnished by the fact that 44.1 percent of the 15 million unemployed Americans has been without a job for 27 weeks or more. This is the highest it’s been for this figure since the Great Depression, indicating that this recovery may be dramatically different from the others of recent decades.

Richard Koo, chief economist of Nomura Research, has stated that the United States is following a path similar to Japan’s prolonged depression that lasted from 1990 to 2005. According to this view, the U.S. is already seeing signs of what he calls a “balance sheet recession” – when high debt deflation triggers a prolonged period of deleveraging throughout the entire economy:

“[I]f US authorities were to require banks to mark their commercial real estate loans to market today, lending to this sector would be extinguished, triggering a chain of bankruptcies as borrowers became unable to roll over their debt.”…
“When large numbers of banks face the same problems, forcing them to mark their assets to market or to carry out quick disposals of non-performing loans can cause the situation to spiral out of control.”…
“In ordinary times, the Fed would seek to have banks write off their non-performing loans as quickly as possible. This is the correct approach when there are only a handful of distressed lenders."
“But during a systemic crisis, when many banks face the same problems, forcing lenders to rush ahead with bad loan disposals (i.e. sales) can trigger a further decline in asset prices, creating more bad loans and sending the economy into a tailspin.”

I believe this emphasizes the true economic danger of the bubble-blowing economy: assets drop to levels so low relative to the debt already in the system that years of painful deleveraging are then required to correct the problem. Instead of attempting to inflate our way out of this mess with another bubble, our leaders in Washington should pursue policies that promote capital investment and real economic growth among our nation’s businesses.


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