But
it’s even worse than that when most of these stocks, bonds and
derivatives have been purchased with borrowed money. The wiseguys who
now dominate the daily trading on Wall Street — the hedge funds and
private equity funds — typically put down $1 or $2 of their own and
their investors’ money for every $10 worth of the securities they
purchase.
Ultimately, all of these pieces of paper that are furiously being traded
on financial markets are tied to some company or some household in the
real economy. And that is where you run into the second problem. For it
turns out that those companies and households also hold record amounts
of debt, which makes them sensitive to any reduction in their sales or
profits or normal income flows. So even the prospect of an economic
slowdown causes them to save more and spend and invest less. While that
is perfectly rational behavior on the part of any business or household,
when everyone does it at the same time, it becomes something of a
self-fulfilling prophecy, turning what might have been a modest slowdown
in the economy into a full-blown recession.
Note -EU digest: as the Washington Post reports The coronavirus panic could threaten a $10 trillion mountain of corporate debt,
unleashing a cycle of layoffs and business spending cuts that would hit
the economy just as some analysts are warning of a recession. Using a broad measure of business liabilities, the ratio of debt to
assets is at its highest in 20 years, according to the Federal Reserve.
One potential trouble spot lies in the rapid growth of “leveraged
loans,” made by top banks such as Goldman Sachs and JPMorgan to scores
of cash-short companies.
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