by Nagy David
How much wealth has vaporized?:
[Via HorsesAss.Org]
On Thursday The Big Picture had some excerpts from the January newsletter of GMO, a global investment firm. The comments were written by Jeremy Grantham, the chairman of GMO’s board, and are absolutely fascinating, if not easily quoted on a blog like this.
The excerpts at The Big Picture were run under the title Grantham assigned the first section of his newsletter, Greed + Incompetence + A Belief in Market Efficiency = Disaster, and they are worth a moment of your time. If you want to worry about the people Obama has picked to pilot the boat during this storm, check it out.
The Big Picture is a great blog to find out about financial matters. But the report discussed here had some very sobering numbers.
From GMO Quarterly Letter (PDF.)But let us look for a minute at the extent of the loss in perceived wealth that is the main shock to our economic system. If in real terms we assume write-downs of 50% in U.S. equities, 35% in U.S. housing, and 35% to 40% in commercial real estate, we will have had a total loss of about $20 trillion of perceived wealth from a peak total of about $50 trillion. This relates to a GDP of about $13 trillion, the annual value of all U.S. produced goods and services. These write-downs not only mean that we perceive ourselves as shockingly poorer, they also dramatically increase our real debt ratios. Prudent debt issuance is based on two factors: income and collateral. Like a good old-fashioned mortgage issuer, we want the debt we issue to be no more than 80% of the conservative asset value, and lower would be better. We also want the income of the borrower to be sufficient to pay the interest with a safety margin and, ideally, to be enough to amortize the principal slowly. On this basis, the National Private Asset Base (to coin a phrase) of $50 trillion supported about $25 trillion of private debt, corporate and individual. Given that almost half of us have small or no mortgages, this 50% ratio seems dangerously high. But now the asset values have fallen back to $30 trillion, whereas the debt remains at $25 trillion, give or take the miserly $1 trillion we have written down so far. If we would like the same asset coverage of 50% that we had a year ago, we could support only $15 trillion or so of total debt. The remaining $10 trillion of debt would have been stranded as the tide went out!
Grantham goes on to argue that “somewhere between $10 and $15 trillion of debt will have to disappear.”
[More]
Those numbers are mind-numbing. No matter what some people are saying, it is going to take a long time to unwind all of this. Japan tried to do it slow and did not succeed. I may just be best to write it off, take a hard hit and start over.
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