The Next Revolution in our Credit-Driven Economy

Chapter 8Why Government and Institutions Get Suckered into Debt Binges

The whole problem with the world is that fools and fanatics are so certain and wiser people are full of doubts.

—Bertrand Russell

The development of financial bubbles and subsequent busts I have described in previous chapters now looks surprisingly obvious and predictable. Unfortunately, economists used almost none of these rather obvious tools in their prediction of the downturn. There are predictable danger markers and these should be included in all models used to identify and head off dangerous financial bubbles. The market is not designed to self-correct; it is designed by bankers to maximize profits at the expense of the commonweal. Greed does not have a built-in moral compass. So, economists and ratings agencies need to incorporate the credit markers noted in previous chapters and do a better job of downgrading banks and/or publicizing hidden dangers so consumers and policymakers have a chance to react. Examples we looked at are:

1. Loan/deposit ratios (LDRs) above 1.15 are dangerous. Let's put it this way: Find a financial crisis that was not preceded by a financial system with a loan/deposit ratio of 1.15. You can't.
2. Market cap/deposits of banks above 30 are high and problematic. These high valuations tend to indicate bubbly overvaluation for banks and are more a sign of danger than a sign of health.
3. Bank market cap/total market cap of a country above 25 percent is a warning. In most banking crises, ...