$2 Trillion Crunch

Again, with a number like that, it would seem logical that the numbers came from a blog.  But this is from Goldman economist Jan Hatzius .

 

According to him, if there are losses of $400 million, then the lenders have to shrink it's balance to maintain it's capital ratio. 

 

For those who are not familiar, a bank needs to maintain 10% capital ratio.  That means if a bank has $100, it can lend $90 and must have $10 in order to keep it's capital ratio of 10%.  In order to maintain the capital ratio of 10%, it must shrink its balance sheet by $10 for every $1 in credit losses.

 

But most stock investors don't react aggressively to capital losses the way banks and other lenders do. A bank that aims to maintain a capital ratio of 10 percent would need to shrink its balance sheet by $10 for every $1 in credit losses, the note said.

 

That means that if lenders end up suffering just half of the $400 billion in potential credit losses, they could be forced to reduce the amount they loan by $2 trillion. Such a drastic credit crunch could have dire consequences for the economy.