LEVERAGE WITH A VENGEANCE

Because of losses in the sub-prime and other markets, banks and other lending institutions will have less money to lend. How much less is open to debate but one estimate is $400 billiion. If banks loan-to-reserve ratio is 10:1, then this represents a loss of $4 trillion in credit.

Banks' losses could put $900 billion squeeze on consumers
Troubled loans – from homes to cars – could trim economic growth by 1 percentage point, a new forecast says.
By Mark Trumbull
Staff writer of The Christian Science Monitor
from the March 5, 2008 edition
(excerpts)

With losses also rising on loans for everything from cars to commercial real estate, banks effectively will have less money available to make new loans – perhaps $900 billion less.

The most likely outcome is that mortgage losses in the current cycle will total $400 billion, concluded the four economists involved, Jan Hatzius of Goldman Sachs, David Greenlaw of Morgan Stanley, Anil Kashyap of the University of Chicago, and Hyun Song Shin of Princeton University.

When the stock market loses that much money (as can occur on a single bad day), it doesn't rattle the economy. But credit is a vital underpinning of much economic activity, and when banks lose that much money, it depletes the capital reserves that they rely on for making new loans.

Not all those losses will be borne by banks. But even nonbank financial firms often operate on the same principle of leverage: Each $1 of capital can fund perhaps $10 of loans.