Sanyajit Das on how "nuclear de-leveraging" will hurt us all

One commentator I keep a close eye on is Satyajit Das. He is a risk consultant who wrote a book called Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives He has been right on the money through this crisis in warning of the destructive effects of the unwinding of much of the derivative based lending and hedge fund investing that has pumped up housing and stock values in the last 5 years. He has appeared on Andrew Patterson's Sunday Business show on Radio Live (which I'm also on) a couple times.  Here he talks about the risks of what he calls "nuclear de-leveraging", where multiple layers of lending have amplified the scale of asset sales and margin calls when debt starts being withdrawn from the system.  

Personal balance sheets will also de-leverage. Consumers in the USA and to a lesser degree in the UK, Ireland, Australia and New Zealand have used borrowings (against inflated real estate values) to offset a reduction in real incomes. Falling real estate prices and the reduced availability of easy credit will force de-leveraging. Inflation is also a factor in the de-leveraging in personal balance sheets. Higher prices for the necessities of life reduce cash flow available to support debt. Higher food and energy cost, especially over a sustained period, may affect the degree of de-leveraging if income levels do not adjust. An economic slowdown will exacerbate the de-leveraging. A fall in asset values can be sustained where the borrower has sufficient income and cash flow to service the debt. In the US economy, the household, housing and financial sectors constitute over half of all economic activity. A (perhaps protracted) slowdown may be difficult to avoid. US demand is a significant driver of global activity. Recent reductions in global growth forecasts reflect these concerns. Reduction in corporate cash flows as revenues slow down reduces the ability of companies to sustain leverage. Loan covenants (debt and interest coverage) will reinforce the de-leveraging. There has been a systemic financialisation of corporate balance sheets. Changes in financial markets will have a significant impact on many companies that now rely on financial engineering rather than real engineering. The problems of GE may not be isolated. For personal borrowers reduced personal income and unemployment will sharply accelerate the de-leveraging. Uncertainty about the future and market volatility will also accelerate the de-leveraging as companies and consumers reduce debt and aggressively save. De-leveraging in the real economy may result in increasing defaults. Firms and individuals with unsustainable borrowings will fail. This will result in further losses to financial institutions setting off negative feedback loops as both asset prices and the level of aggregate leverage adjusts. Central banks and governments actions have been directed at maintaining liquidity and (increasingly) directly supporting the financial sector. In the US and Spain, direct fiscal stimulus is already being administered. These actions are designed to prevent a catastrophic collapse in the financial sector. They are also designed to help maintain a normal supply of credit to creditworthy business and individuals. These actions are designed to help the real economy from slowing down to a degree that the de-leveraging accelerates further. At best, these actions will smooth the inevitable de-leveraging and adjustment to financial asset prices.