Sunday, August 07, 2011
Bank's Balance Sheet
This summer has taken many turns in my research. This balance sheet is shown for instructional purposes, but reminds me of adverse selection.
Adverse selection is a market failure that occurs when those in need of insurance or a loan are the ones who seek the insurance or the loan. When a bank's balance sheet deteriorates because of many bad loans, there might be a tendency for banks to make riskier loans with a high payoff. This is essentially doubling down on a bet to make up for prior losses. A bank is this situation is putting capital at risk.
When an economy has a large current account deficit, the country is issuing a lot of debt. The US has seen a deterioration in bank balance sheets and a high current account deficit. Currently, our debt/GDP ratio is 100%. I believe we could be seeing the next currency crisis.
Since 2004, the dollar has depreciated against the Euro. (See FRED data series AEXUSEU). This means that our current account is negative. Today, the S & P downgraded US debt. If you remember 1997 and the Asian Financial Crisis, you might get a refresher soon.