Titolo

The debate with Bradford De Long

1 commento (espandi tutti)

current crisis seems determined by a bubble in the construction sector

This statement is, at least partially, misleading. What lies behind the current crisis is overlending. Existing buildings have been financed as new ones, and even more. Collateral lending has been used for other businesses as well (private equity leveraged buy outs, leveraged hedge funds, etc.). It's not necessarily associated to expected cash flows to refund the loans, that is the paramount issue. Collateral lending has pushed up the price of certain assets up to a bubble level. When the new lending flows have dried the price of assets has started to decline, the collateral has vanished and the loans have turned into toxic assets. Collateral lending in relevant size has the power to inflate asset prices. Collateral apparently looks safe but it is only temporarily. At the first stages it is the additional lending which support asset prices and collateral value. At the end it looks like a Ponzi scheme where the new loans backed the old ones. The difference is that the value of collateral cannot go to zero. Actually it can go down enough to spread painful bankruptcies and to block lending to the overall economy, as it is now.