I want to combine two posts from my favorite blogs. This post tells the story that the growth of consumer debt was quite faster than the growth in income, i.e. the bulk in spending increase is on the new debt. This post gives a fresh chart of mortgage equity withdrawal – the main vehicle of consumer debt load. Bernanke calls it “monetizing capital gains” – I suppose the opposite must be called “de-monetizing capital losses”.
The new trend that got pronounced in Q4 of ’07 is that the incomes and debt loads are decelerating simultaneously. I think we will call 2008 and 2009 the years of big deleveraging.
The front-runners of deleveraging are also the hedge funds, and here’s the best place to track how it goes. It was quite a shocker to learn that Carlyle fund was leveraged 30:1 at the moment it defaulted. This paper says that the rational behavior of a leveraged institution is to gradually unwind the position when capital losses happen to maintain the constant leverage ratio. It seems that many hedge funds do not do that. They just cross the fingers and maintain the full position despite all losses. Then they either get lucky and recover (investors never know what happened, the book is disclosed only once in a while, sometimes a year) or just implode to zero. The fees structure motivates that behaviors very well