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Deleveraging May Be Driving Stock Sell-Off


One word we're hearing a lot these days is deleveraging. Economists say it's one of the reasons why the stock market has been falling. Here to help us understand what's happening is NPR's Jim Zarroli. And Jim, tell us what deleveraging is.

JIM ZARROLI: Well, Michele, you have to remember that in the past decade or so, it's been really easy to borrow. There was a lot of money being lent and consumers, companies, governments; everybody basically took advantage of it. In the financial markets, you had an extreme version of this, Hedge funds and mutual funds, investment banks. They were all able to borrow huge amounts of money by leveraging their assets. In other words, they could borrow many times what their assets were worth. And they did this because it gave them more money to invest, and that worked really well for awhile because asset values were rising so it meant they made lots of money.

NORRIS: So how and when did these all become a problem for the US Economy or is it just the US Economy?

ZARROLI: Well, it is broader than that. It started when house prices began to fall. A lot of mutual funds and pension funds and so on had invested in the mortgage market, and they started to lose money. So when it came time to pay back some of the money they borrowed, they had trouble doing so. So they had to sell some assets they bought like stocks, and they had to sell many times the value of the assets on their own balance sheets because they'd leveraged so much. Well, when enough people are selling stocks or any asset, its value falls and a lot of people think this is what's happening right now on a massive scale; a lot of Hedge funds in particular have been trying to unwind their positions. They're selling stocks, bonds, commodities and that's why you're seeing prices falling in really every kind of asset class.

NORRIS: So what happens to companies when they're forced to reduce their borrowing or the amount of leverage that they can use?

ZARROLI: Well, here's an example. The parent company of Viacom supposedly has $1.6 billion in outstanding loans right now. It's having to sell stock to pay what it owns, and it has to do that at the very worst time, because its share price is low to begin with, that's lots of stock prices. There are a lot of rumors that it may have to sell some of the company's or some of its assets, some of the companies that they own. So it may well walk away smaller and weaker than it was before. It won't be able to raise as much money and they have to lay people off. So if companies already faced big challenges, deleveraging just really complicates everything. And that ends up hurting the economy as a whole and it delays the economic recovery.

NORRIS: Jim, I'm always a bit reticent to ask reporters to look into their crystal ball, but how long before this whole process runs its course?

ZARROLI: Well, if you take a broad view of this problem, the whole global economy, as I said, went on one big borrowing binge. You had governments borrowing; you had consumers taking out home equity loans so they could go on vacation. You had private equity firms borrowing so they could do deals. So the debt burden is huge and it will take a while to unwind that. And eventually the economy will work through all the debt, and you know, we hope to be in a much stronger position. But it's going to take a while and we don't know how long that really will take because we don't really understand how big the debt overhang really is. Look at Hedge Funds. You know it's clear a lot of them borrowed a lot. It's clear they sold off a lot of assets, but they're not very transparent. So you know, we don't know how much debt they really have. It also increasingly looks like a lot of foreign governments like Argentina borrowed heavily. So you know, this isn't just the US problem. It's a global problem, and it's even bigger than a lot of people thought.

NORRIS: NPRs Jim Zarroli in New York. Thanks so much, Jim.

ZARROLI: You're welcome. Transcript provided by NPR, Copyright NPR.

NPR transcripts are created on a rush deadline by an NPR contractor. This text may not be in its final form and may be updated or revised in the future. Accuracy and availability may vary. The authoritative record of NPR’s programming is the audio record.

Jim Zarroli is an NPR correspondent based in New York. He covers economics and business news.