Double bubbles trigger U.S. financial crisis

Current economic mess in America is steamed from and centered in the financial mess, and then spill over to other sectors of economy. This crisis, like most others in rich countries, emerged from double bubbles: property bubble and a credit boom.

House prices doubled only in five years. The scale of the bubble was about as big in America’s ten largest cities as it was in Japan’s metropolises. But nationwide, house prices rose further in America and Britain than they did in Japan. So did commercial-property prices.

In absolute terms, the credit boom on top of the housing bubble was unparalleled. In America private-sector debt soared from $22 trillion (or the equivalent of 222 percent of GDP) in 2000 to $41 trillion (294 percent of GDP) in 2007.

Judged by standard measures of banking distress, such as the amount of non-performing loans, America’s troubles are probably worse than those in any developed-country crash bar Japan’s. A recent estimate by Goldman Sachs suggests that American banks held some $5.7 trillion-worth of loans in “troubled” categories, such as sub-prime mortgages and commercial property. That is equivalent to almost 40 percent of GDP. As a comparison, non-performing loans in Japan they hit 35 percent of GDP at the peak of the crisis, according to the IMF. In Sweden reached 13 percent of GDP.

Today’s financial crash is not just in regulated banking sector. America also faces simultaneous collapse of the shadow banking system, the universe of investment banks and hedge funds responsible for much of the recent securitization boom as well as for the sharp rise in financial leverage.

As a result, standard measures of banking distress, such as the level of non-performing loans, understate the contraction pressure. So far most of the credit collapse in America has come from the demise of securitization. In 2007, for instance, $668 billion of non-traditional mortgages were securitized. Last year that figure dropped to $40 billion. Rapid deleveraging outside traditional banks also means that cleaning up banks’ balance-sheets may not break the spiral that is driving down asset prices and stalling financial markets. Financial-sector debt was the fastest-growing component of private-sector debt in recent years. Many of those excesses are being unwound at warp speed.