What Does De-leveraging Mean To You?

In 2007, we had the the buzzword carry-trade, followed by sub-prime. Both have had devastating effects on global financial markets! The latest financial buzzword is "de-leveraging". In simple terms, it means that banks, consumers, companies, and the government need to reduce their debt.

From the early 1920s through 1985, the average level of debt-to-GDP in the U.S. was 155%. The highest peak in history (until the recent debt boom) was in the early 1930s, when debt-to-GDP soared to 260% of GDP. In the 1930s, the ratio then cratered to 130%, and it remained close to that level for another half a century.

In 1985, U.S. started to borrow, and last year, when U.S. finished borrowing, the country had borrowed 350% of GDP! To get back to that 155%, U.S. need to get rid of more than $25 trillion of debt!

For a start, U.S. banks have written off $650 billion of debt so far!

Global stock and asset prices in general have been the victim of the global de-leveraging exercise, pushing prices of equities and commodities to unrealistically low levels. This de-leveraging is being driven by the unwinding of over-leveraged positions, and compounded by fund redemptions and frozen credit markets.

The bottom of the markets will happen when this whole de-leveraging exercise ends - which for now is still uncertain. It is important to take note that Lehman Brothers reportedly has between US$40 billion to US$70 billion of assets belonging to hedge funds that are frozen in its UK arm - and negotiations are still ongoing with the administrator to release them.

When the time comes, prepare for another round of "de-leveraging" exercise!