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Global Financial Crisis end game: G20 Meeting shared Losses?




In the middle of 2008, total mortgage debt (actual amount of cash given to people to buy a home) amounted to about $11.4 trillion.   No model, mark-to-market, or sophisticated math is required to calculate this number.  We now have one boundary condition in solving this problem;  losses cannot exceed $11.4 trillion.  This would happen if the price of every single house with a mortgage was zero…rather an extrememe case.

The total o/s US mortgage debt is comprised of 85% prime and 15% sub-prime loans. (These are broad figures..but will suffice).   Let us assume that home prices decline 50% in the United States…what happens:

($ trillions)                 Total           Prime          Sub-Prime

Total O/S                      $11.4          $9.7                 $1.7
Loss    %                                      50%                 50%
Recovery %                                       20%                  0%

Total Losses                $3.75          $2.90           $.85

We get estimated losses of $3.75 trillion.  These losses are not contained within the United States and that is problematic.  Through the use of securitization, derivatives, credit enhancement techniques and other esoteric financial instruments the risks were syndicated far and wide.  For example, China owns about $360 billion of securities that financed home buyers in the United States.

In the reach for yield, many institutions took on default risk of others to get a higher interest rate on the piece of security they bought.

In the fight for who funds the $3.75 trillion or so in losses the broad economy suffers.  It should be the investor but the size of losses has meant the end of many institutions and others have been bailed out by governments using tax payer monies.  Some countries are so important as investors that …well you get the picture.

So my estimate has been to add another 30% to this bill which brings me to my round figure of $5 trillion of losses.

The 2007 Global GDP on a PPP basis was $65.5 trillion ….so we have blown roughly 7.6% of this amount…Which brings us back just above the 2006 Global GDP level of $58.6 trillion. ( All figures from World Bank).

So how does this help us:  The markets went up and up and up…now they have crashed. Since global GDP after these losses is around the 2006 levels how do the equity markets compare?

From Jan 2006 to today:  China is up 55%, US is down 40%, UK is down 40%, India is flat.  This is decoupling….the vast majority of these losses will be for the account of USA affecting current value and future investment.  UK and Europe fall into the same  camp.  China is up because they have conserved their reserves for this rainy day and will bear less of the losses.  India will bear few losses but is critically dependent on foreign capital for growth so the market has been written down to 2006 levels.

Of course, the key issue is China growth…if the US goes into a deep recession who will buy from China.  Realising the trap the Chinese have spent their reserves before they could be asked to bear some of the $5 trillion loss.

Regardless of how the G-20 discussions turn out, the dollar amount of losses will not change.  It will have to be borne by the world economy;  that has always meant a write-down to 2006 levels for global equity markets.  If the disagreements turn nasty and we get protectionism and tariffs then all bets are off.

I am betting that sense will prevail.




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