Why A Former Fed Official Fears A Global Meltdown
Are we headed for another global financial crisis? The market convulsions of the past week reflected a continuation of a market selloff that began on the first trading day of 2016. Investors have reasons to be fearful—but not terrified.
This year is likely to be one of financial crises in industries and countries around the world. Whether those turn into a global financial crisis is an open question, and the answer will likely turn on the health of the U.S. financial industry and broader economy. No crisis is global if American financial markets hold up. The best I can foresee, at this moment, is that a true global financial crisis is not likely.
Pundits are focused on collapsing oil prices, which reflect the technological revolution in production among nimble private producers, combined with weakening global demand for their product. The result has been layoffs in the energy industry, and there will be more. Weak and highly leveraged energy firms have gone bankrupt and more will. But bankruptcy doesn’t necessarily mean that production will decline.
Creditors who lent to these energy producers will suffer losses on their loans, and they too might become financially impaired. If past is prologue, those lenders will be reluctant to fully realize their losses, and they will continue to view future energy prices through too-rosy glasses. Banks will be reluctant to mark down the value of nonperforming loans and book losses, or even set aside sufficient loan loss reserves. They will instead “extend and pretend”—i.e., extend maturities and pretend they expect the loans to be paid back. Will federal and state banking regulators aid and abet the process?
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