Balance Sheet Recession

In today's world of CDO's, CDS's and ABS's add another term: "Balance Sheet Recession". Albeit, all the CDO's, CDS's and ABS's brought and sold using debt have led to a balance sheet recession, plunging the economy in a downward spiral. Or in other words, the former is causing the latter pulling the economy down with it.

Alex Leijonhufvud, Professor of Economics at UCLA, explains why the current recession is no ordinary recession, and why if we do not fix the balance sheets of banks soon, this recession can drag on for a long time to come.

It resides in the state of balance sheets. The financial crisis has put much of the banking system on the edge – or beyond -- of insolvency. Large segments of the business sector are saddled with much short-term debt that is difficult or impossible to roll over in the current market. After years of near zero saving, American households are heavily indebted.

The holes that have opened up in the balance sheets of the private sector are very large and still growing.So the private sector as a whole is bent on reducing debt. Businesses will use depreciation charges and sell off inventories to do so. Households are trying once more to save. Less investment and more saving spell declining incomes. The cash flows supporting the servicing of debts are dwindling. This is a destabilising process but one that works relatively slowly.

Martin Wolf also writes about the balance sheet recession for the Financial Times