The slowing economy will create a second wave of defaults that will feed back to credit availability and then back to the real economy.....in the worst case we are perhaps 20% done.
Deleveraging has not played out as acutely as theory suggests; lags and support from monetary policy have helped mute the contraction. But the lags are catching up and the losses, now fueled by the economy itself,continue to mount. And new policy initiatives like the TALF and PPIP may be slow to help.
In the bear case, policy gets traction slowly, the economy languishes, and cumulative losses mount to $4 trillion.
The more intense deleveraging process associated with a further $3 trillion in losses beyond what has been realized so far will promote a much deeper recession: In that scenario the peak-trough GDP decline could be 5.8%, the unemployment rate might peak at 12%, and the risk of deflation would intensify. And in that case, lenders have taken only 21% of the 15% cumulative loss total in that scenario.
MORGAN STANLEY RESEARCH
NORTH AMERICA
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