Deleveraging May Be Driving Stock Sell-Off Stocks have sold off sharply in Europe, Asia and the U.S. One analyst says much of the decline stems from a global "deleveraging" that will continue for a while.
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Deleveraging May Be Driving Stock Sell-Off

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Deleveraging May Be Driving Stock Sell-Off

Deleveraging May Be Driving Stock Sell-Off

Deleveraging May Be Driving Stock Sell-Off

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  • <iframe src="" width="100%" height="290" frameborder="0" scrolling="no" title="NPR embedded audio player">
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Stocks have sold off sharply in Europe, Asia and the U.S. One analyst says much of the decline stems from a global "deleveraging" that will continue for a while.


One word we're hearing a lot these days is deleveraging. Economists say it's one of the reasons why the stock market has been falling. Here to help us understand what's happening is NPR's Jim Zarroli. And Jim, tell us what deleveraging is.

JIM ZARROLI: Well, Michele, you have to remember that in the past decade or so, it's been really easy to borrow. There was a lot of money being lent and consumers, companies, governments; everybody basically took advantage of it. In the financial markets, you had an extreme version of this, Hedge funds and mutual funds, investment banks. They were all able to borrow huge amounts of money by leveraging their assets. In other words, they could borrow many times what their assets were worth. And they did this because it gave them more money to invest, and that worked really well for awhile because asset values were rising so it meant they made lots of money.

NORRIS: So how and when did these all become a problem for the US Economy or is it just the US Economy?

ZARROLI: Well, it is broader than that. It started when house prices began to fall. A lot of mutual funds and pension funds and so on had invested in the mortgage market, and they started to lose money. So when it came time to pay back some of the money they borrowed, they had trouble doing so. So they had to sell some assets they bought like stocks, and they had to sell many times the value of the assets on their own balance sheets because they'd leveraged so much. Well, when enough people are selling stocks or any asset, its value falls and a lot of people think this is what's happening right now on a massive scale; a lot of Hedge funds in particular have been trying to unwind their positions. They're selling stocks, bonds, commodities and that's why you're seeing prices falling in really every kind of asset class.

NORRIS: So what happens to companies when they're forced to reduce their borrowing or the amount of leverage that they can use?

ZARROLI: Well, here's an example. The parent company of Viacom supposedly has $1.6 billion in outstanding loans right now. It's having to sell stock to pay what it owns, and it has to do that at the very worst time, because its share price is low to begin with, that's lots of stock prices. There are a lot of rumors that it may have to sell some of the company's or some of its assets, some of the companies that they own. So it may well walk away smaller and weaker than it was before. It won't be able to raise as much money and they have to lay people off. So if companies already faced big challenges, deleveraging just really complicates everything. And that ends up hurting the economy as a whole and it delays the economic recovery.

NORRIS: Jim, I'm always a bit reticent to ask reporters to look into their crystal ball, but how long before this whole process runs its course?

ZARROLI: Well, if you take a broad view of this problem, the whole global economy, as I said, went on one big borrowing binge. You had governments borrowing; you had consumers taking out home equity loans so they could go on vacation. You had private equity firms borrowing so they could do deals. So the debt burden is huge and it will take a while to unwind that. And eventually the economy will work through all the debt, and you know, we hope to be in a much stronger position. But it's going to take a while and we don't know how long that really will take because we don't really understand how big the debt overhang really is. Look at Hedge Funds. You know it's clear a lot of them borrowed a lot. It's clear they sold off a lot of assets, but they're not very transparent. So you know, we don't know how much debt they really have. It also increasingly looks like a lot of foreign governments like Argentina borrowed heavily. So you know, this isn't just the US problem. It's a global problem, and it's even bigger than a lot of people thought.

NORRIS: NPRs Jim Zarroli in New York. Thanks so much, Jim.

ZARROLI: You're welcome.

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Official Or Not, Consumers Sense A Recession

Damien DeNeir, 14, helps his grandmother Kim DeNeir move out of their Arvada, Colo., apartment, which was condemned for sewer and rodent problems. The owners of the complex blamed the subprime mortgage meltdown for the reduction in maintenance. The bursting of the housing bubble is the root of the current financial crisis. Chris Hondros/Getty Images hide caption

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There are plenty of complicated things about recessions, but consumers don't need any declaration or stamp of approval from economists to know when the economy has soured. They can feel it.

A swirl of negative factors, including the collapse of the housing market, consecutive quarters of rising unemployment and the dearth of lending by banks, hit consumers especially hard in September and October, shattering their confidence.

When it comes to the financial turmoil, "it's the worst crisis since the Great Depression," says Jeffrey Frankel, an economics professor at Harvard's Kennedy School of Government, who sits on the Business Cycle Dating Committee of the National Bureau of Economic Research, a nonprofit organization founded in 1920. The committee, which comprises several economists, is responsible for officially calling recessions. And it typically weighs in several months after the fact — once the members have had an opportunity to analyze a broad range of statistics.

So are we in a recession? Most economists say yes and expect the NBER to follow suit. The committee has yet to call this a recession because there hasn't been "even one negative quarter of GDP" so far this year, says Frankel. But that may change next week, when the Commerce Department announces the gross domestic product number for the third quarter. On Thursday, White House Press Secretary Dana Perino said the administration expects the number "not to be a good one."

Frankel says that what's so unique this time around is the depth of the financial crisis. Speaking personally and not for the committee, he says that "it's extremely likely" that we're now in a recession, given the serious problems that have plagued the financial system since mid-2007.

Economist Bruce Yandle, dean emeritus at Clemson University's College of Business and Behavioral Science, says the sharp declines in both total employment and industrial production have created an unsavory stew: "You put all of that in a pot and stir it, and what I taste is recession."

Calling A Recession

Recessions affect the real economy, which encompasses things like jobs, consumer spending and the production of goods and services. Yandle notes that we had a slowing in the real economy long before the financial economy went south with the bailout frenzy. But in September, the financial economy "infected" the real economy, he says, and that's when more economists started using the R-word.

There's no rulebook or checklist that NBER follows to arrive at its decision, but the economists use their definition of a recession as a starting point. They say a recession is "a significant decline in economic activity spread across the economy" that lasts for more than a few months and that manifests itself in real gross domestic product, real income, employment, industrial production and wholesale retail sales. The term "real" refers to figures that have been corrected for inflation.

Others define a recession as two consecutive quarters of decline in real GDP growth. NBER says its definition is broader to incorporate both the depth and duration of the economic downturn.

In general, the economy is either in a recessionary stage, when it is contracting, or in an expansion. But NBER notes there can be diminished economic activity, or a slump, even during an expansion.

Consumer Sentiment

Dennis Jacobe, the chief economist for Gallup, says polls it has conducted demonstrate that people have felt like they're in a recession "for a long time." He says that 80 percent to 90 percent of people believe the economy is worsening. Gallup has registered historic lows in consumer confidence and increased pessimism about the jobs market, which Jacobe says is an indicator that jobs numbers will continue to worsen.

In a mid-October poll, Gallup found that two-thirds of the people surveyed said they've been financially hurt by the financial crisis and 70 percent thought that their financial situation "will be harmed in the long run."

The frozen credit markets have had more than just a fiscal impact. "It's not only the unavailability of money but the psychological effect," Jacobe says. Consumers and small businesses "always thought they could fall back on their credit lines as an emergency source of funding."

But home equity lines of credit have dried up, leaving some dreams in the dust. What's more, the credit culture has chipped away at Americans' savings habits: Jacobe says surveys indicate that only 40 percent of the U.S. population has $10,000 or more in savings that can be easily tapped.

Not Your 'Garden Variety' Recession

Economists say that each recession is unique. So what kind of recession are we in?

Nigel Gault, chief U.S. economist for Global Insight, says the credit problems that underlie this recession have made monetary policy — the Federal Reserve's decisions to infuse funds into the economy or withdraw them — "quite ineffective" in supporting the economy. As a result, Gault says, it's "not a common or garden variety recession at all."

John Schmitt, an economist for the Center for Economic and Policy Research, says he was encouraged this week by Federal Reserve Chairman Ben Bernanke's call for a stimulus package, as it was an acknowledgment that fiscal policy was needed because "monetary policy isn't enough right now."

During the course of the third quarter, the U.S. switched from a "slow motion" recession into a "full-blown recession" when consumer spending took a sharp dive, says Gault.

A number of economists who spoke with NPR used the term "severe" to describe the current scenario. Gault said the prime characteristic of a recession is the breadth of the decline, noting that the large declines we've seen so far have been broad-based across the whole economy — an indication that it's not just one sector that's weighing us down. What's more, he says, it's global in scope.

Labor Market Recessions

Schmitt says labor market recessions, which are different from the recessions identified by NBER, are "what the vast majority of Americans are concerned about." Why? Because in these recessions it takes much longer — several years — for the job market to recover.

The recessions of 1980-1982, 1990-1991 and 2001 all are examples of official recessions, identified by NBER, that were substantially shorter than the labor market recession, says Schmitt. In 2001, the official recession lasted about half a year, but the labor market recession went on for close to three years, he says.

Schmitt says the current recession started in December 2007, and he expects it will be "long and nasty," driven by a continued decline in house prices; he thinks prices may fall another 10 percent to 15 percent. He estimates that we might start to emerge from the recession in December 2009, but the labor market recession probably won't end until 2011, he says.

Recession Deja Vu

Cycles have always been a part of the economic landscape. Recessions are an inevitable part of this, says Gault, because people make mistakes during periods of excessive optimism and confidence.

The recession we're in now is caused by the "bursting of bubbles," especially in the housing market and consumer spending, says Gault. In that aspect, it is similar to the 2001 recession, which followed the collapse of the technology sector.

Economists note that many of the post-World War II recessions were ones that started out with inflation out of control. The Federal Reserve typically responded by raising interest rates, which caused a recession, and inflation came down. The recession between 1980 and 1982, one of the most severe, is a good example of a "stagflation" episode, in which extremely low or negative growth combined with high inflation. But this isn't the case today.

Frankel, the Harvard economist, says the recession between 1973 and 1974 is a "good parallel" because it was severe even though the Fed was following a relatively easy monetary policy, somewhat akin to the situation today. In the 1970s, however, a financial crisis wasn't part of the mix.

He says that the decade of stagflation that Japan went through in the 1990s and the Great Depression in the U.S. may also have some parallels to the situation today: Both were ushered in by the crash in real estate and stock markets. "Hopefully, the difference," he says, "is we know how to handle it better this time."