It's the main bubble principle. Any bubble has to expand or die.
Credit expansion = credit derivative expansion. In case of the
credit bubble, as long as marginal borrowers get cheap rates and
expand their debt, they stay afloat. Then, this debt is counted as
an asset on the books, against which new credit is extended. Thus,
the credit bubble expands. What happens when the marginal borrower
stops borrowing, and starts to pay loans back? The assets on the books
decline. Thus, the bank imposes more strict rules on borrowing, and
requires higher interest. Then, other marginal borrowers can't pay.
Those assets (loans to these borrowers) get sold, and rates for these
borrowers rise. More borrowers, who used to be not marginal, become
marginal and default. And so on. Liquidity evaporates. It has to expand,
because the marginal borrower has to borrow more in order not to default
on the loans he already has. If he can't borrow more, he will default, the
rules will become more strict, and others will default. |
