Credit Problems in Perspective

4 Apr

With all of today’s seemingly dire newspaper headlines, sometimes it is difficult to keep things in perspective. Consider, for instance, the current “credit crunch,” including mortgage-related write-downs and credit losses and their effect on financial institutions globally. Through April 1, over 45 of the world’s biggest banks and securities brokerage firms have announced a total of over $230 billion in asset write-downs and credit losses, according to Bloomberg.

This is certainly a very large number, but let’s view it in context. It is just 0.4% of the $57.7 trillion U.S. household net worth and less than 2% of our annual gross domestic product. In addition, only $26 billion of this is actual realized losses. In other words, over $200 billion has been due to valuation changes in the securities, whose underlying assumptions may or may not accurately reflect the eventual economic reality that will transpire. If losses actually turn out to be less than is implied by these valuations, we could see “write-ups” and/or higher returns on equity in future periods (owing to the smaller capital base caused by asset-writedowns) . But, of course, losses could also be larger than expected…

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