Does Spiraling Private Debt Lead to Financial Crises?

by Kyle Colona on August 14, 2012

Does Spiraling Private Debt Lead to Financial Crises?According to an analysis by Business Insider, a recent study by the National Bureau of Economic Research (NBER) concludes that the “unprecedented level of credit growth” exacerbated the depth of the financial crisis of 2008.

As the financial markets continue to wade through the ripple effects of the financial crisis and the numerous scandals that have washed in with the tide, the blame game has been focused on the evil doers and fat cats on Wall Street who caused the crisis. While this type of populist demagoguery is politically expedient in a presidential election year, some serious minded people are taking a hard look at the facts to see what can be learned from the financial tsunami that upended Wall Street, Main Street and everything else in its path.

And the NBER study, “The Great Leveraging” draws a bright line between private loan levels and corporate balance sheets. In short, that line reveals how the US banking system is larger than at “any other point in history.”

As a matter of fact, the banking sector grew at a rate that “dwarfed” the growth of public debt in the years leading into the financial crisis. And the Bureau’s study suggests that a number of factors contributed to the accelerated growth of the banking sector. Of these factors, the most intriguing is how the Federal Reserve played the role of “lender of last resort” while the back stop of deposit insurance provided by the FDIC “may have introduced a degree of moral hazard into the system.”

In simple terms, this really means that banks took on more and greater risk by making credit available to a broader base of individual and business consumers in the form of credit cards, mortgage loans and small business loans. In sum, these factors helped to create a big banking system that provided funds to people and projects “that were not worthy, and the banking system grew ever larger and more fragile.”

But all is not lost if the bankers and regulators account for “for private credit growth as a predictor of financial crises.” In other words when consumers and small businesses take on debt that is not sustainable, a financial crisis is more than likely to follow.

Could it be that the so-called fat cats on The Street did not act alone in creating the great tsunami? Is it possible that John and Jane Q. Public down on Main Street had a hand in creating the financial times in which we live? That’s a debate that might not sit too well with the electorate, but one that needs to be joined.

But the question remains as to whether the politicos and voters have the moral clarity and intellectual honesty to do so.

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Kyle Colona is a New York-based freelance writer and a Feature Writer forCompliancEX and the Wall Street Job Report. He has an extensive background in legal and regulatory affairs in the financial services sector and his work has appeared in a variety of print and on-line publications. You can find him on linkedin.

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One comment

You can’t be serious? Consumers are not responsible for this debacle – the banks are. When people loose their jobs, they default on their credit cards and mortgages, but those who had stable jobs, still lost their homes to a bait-and-switch mortgage that lenders “knew” would default, looking to cash in on the Guarantees of Credit Defaults (i.e. AIG). Even Maoff admitted he saw it coming but was in too deep. Every Wall Street investment bank was in on it.
I pray that it doesn’t happen again within the next 90 days -given an election year like last time, and they ask for a 2nd bailout! Maybe it’s Wall streets’ turn to loose their jobs – and the shirts of their backs.

by Paula on August 15, 2012 at 3:18 am. Reply #

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