Recession

The inequality generated by decades of neoliberalism and the resentment it has caused across the world have in recent times led to uncertainties that only intensify the fear of recession.

• Growth is decelerating worldwide, including United States which is experiencing 50-year low unemployment rate. China lost momentum with industrial growth at a 17-year low. Prospects for the third quarter are gloomy as well.
• The performance of major economies affects the rest of the world economy. For example, depressed Chinese demand caused the fall in Thailand’s second quarter growth rate to the lowest since 2014. 
• Scattered talk has given way to widely expressed fears of an impending recession affecting financial investment behavior, with investors dumping stocks and shifting to government bonds, resulting in a slump in stock markets.
• The deeper malaise is the depressed demand due to extreme inequality in assets and incomes that has resulted from decades of neoliberal growth across the developed world. Globalization moved productive activities to cheap labor locations had depressed wages across countries with large profits for a few and tax concessions for the rich have accentuated inequality.
• Incomes in the top percentile have exploded, those in the middle and lower ranges have  stagnated sapping consumption demand. Growth came by finding ways of stimulating demand not depending on current income, but driven by credit. That, beyond a point, is not sustainable and the fear of another recession is likely.
• The USA-China trade war and other countries responding with similar measures, the world is faced with a proliferation of beggar-thy-neighbor policies that makes a bad situation worse. The unknown consequences of Brexit cannot be anything but adverse. These uncertainties intensifies the fear of recession.
• The challenge for capitalism was finding an alternative way of reviving demand depressed by underlying inequality. In the past the states used to step in to lift economies out of recession with their spending for a short a time. With neoliberalism that has shrunk the revenues of the state and public spending being is mostly debt-financed, this option was shunned. The only way to drive private demand is with credit in the form of near zero interest rates and getting central banks to hugely increase liquidity in the economy.
• Capitalism’s current predicament arises because this policy has not worked, though it has been experimented with very low interest rates and in some countries even have turned negative. While this policy has not delivered growth, it has encouraged speculation financed with cheap credit. This has led to accumulation of corporate debt as firms borrowed mainly to speculate in financial markets and pay off their rich shareholders with costly share buybacks resulting in asset price inflation and financial fragility. But with low growth central banks were compelled to continue this policy regime.
• But as the threat of recession looms, erstwhile advocates of fiscal prudence and austerity such as the IMF are calling for adding fiscal stimuli to the policy mix. Infrastructure upgrades, expanding public housing stocks and targeted tax cuts should all be considered. This is the recipe for a return to more robust growth and inflation.

The recession threat is immediate and policy is likely to respond too slowly. If the recession does set in, it can be devastating. In 2008 China, Germany and India were affected less and this time they are among the countries whose performance could drive the recession. Corporate debt often denominated in foreign currencies at high levels, a recession would find many debtors defaulting on payments and forced to sell assets. That could result in asset price deflation and will have reverberations in an over-committed financial sector. Only a set of freak occurrences can prevent another recession.

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Bank's bad loans, a global phenomenon

• Total non performing loans (NPL), world wide, are about $3 Trillion (i.e. Rs. 200 lakh crores) i.e.  4.2% of world GDP. 
• European banks have NPL's of 1.2 trillion Euro, Italian banks NPL's are 360 billion Euros i.e.20% its GDP & 15% of total loans.
• In many advanced countries loans supported by artificial collateral values, real estate & equities, are face increasing risks. Debts based on low interest rates are unsustainable because any normalization threatens insolvency of over-indebted borrowers.
• NPL problems are apparent in emerging markets viz. India,China & Brazil also. India's NPL's are over $150 billion i.e.15% of bank's assets. The problems are driven by over-leveraged borrowers, PSU's, family owned conglomerates, infrastructure companies and govt-driven trophy projects with dubious economics to which PSU banks are pressurized to lend.
• China's NPLs are 15% of total loans i.e $1.3 trillion with potential losses equivalent to 7% of GDP (forecasts are at 20% of GDP).
• In the past, Bank's crises are due to lending to real estate sector, leveraged buy-outs and telecommunication sectors. Current crises involves apart from these, lending to over valued housing markets and energy sector as well. Lending to energy sector alone amounts to $3 trillion, where borrowers are struggling to service the debts due to falling prices, weak growth, over capacity, rising borrowing costs and in some case cases weak currency.
• Seeking higher returns banks have financed less-credit worthy borrowers. Abundant liquidity have increased asset prices and banks have financed against these over valued assets. Low interest rates have allowed weak borrowers to survive.
• In developing economies, strong capital inflows seeking higher returns has encouraged increased leverage. State policies encouraged debt funded investment & consumption to create economic activity have resulted in problems.
• Highly leveraged banking sector problems can trigger doom loop. Small loss can wipe out out significant portion of its capital increasing risk of insolvency. For example a 5% assets loss can result in erosion of capital buffer by 50%.
• Large banking systems facilitating payments and essential supply of credit and any banking disruption could result in economic slowdown.
• Solutions to banking crises requires capital infusion, strong earnings, isolation of bad loans and industry reforms. The ability of banks to write off losses is limited. Low & negative interest rates lower banking profitability.
• Banks business models requires reforms for entailing consolidation and reduction of costs which are unlikely due to fear of loss of jobs and lack of competition. Access to new capital is limited. Inefficient bankruptcy procedures are barriers to new investments in banks or distressed assets. 
• In emerging markets, reluctance to foreclose because of politically difficult business closures and job losses. Political factors are impeding recapitalization of banks.
• After the 2008 crisis, new regulations were made to make banking system safer and eliminate the need for future tax payer financed bailouts. The success or failure of new regulations will not be known until next crisis. But in major crises still govt guarantees would become necessary for payment systems functioning.
• The financial system acts as reservoir of deadly pathogen - bad debts  - which is spread by banks creating financial crisis.

Careful person seldom commits a mistake

My View:
Banks have deviated from traditional banking business in pursuit of higher returns indulging in high risk activities with the money which is not theirs. Underlying ethical corruption is the root cause. As long as political meddling continues banks losing money is certainty. Viability of new projects funding must be done very carefully and debt/equity ratio should be ensured in safe limits. Banks should never fund high risk financial products which are speculative in nature. There is only one way to deal with NPL's. Liquidate them at prevailing market rates and write off irrecoverable amounts. Recapitalize banks and direct them to do future banking prudently. Any other method is only postponing the eventuality and more expensive at the end.