A moving goal post

I wonder when this gyration in the market will subside. When will deleveraging, or the unloading of debt to boost return, be done?

(1) For investment firms, if I understand the process correctly, the deleveraging goal post might be moving, prolonging a rather painful process. (Leverages are essentially debt that firms borrow to boost return. Say if I have $1's worth of asset, borrow $4 and invest $5, then a 10% increase in return, ie $0.5, is almost equivalent to a 50% increase in return, since the original amount of asset was $1.) The problem is that the $1's worth of asset might be devaluing, which lengthens the deleveraging process. Say a firm wants to reduce its leverage from 20:1 to 10:1, it will have to sell assets. If the market is under massive deleveraging pressure, prices of assets are also driven down. Even if a firm has reduced its position from 20 to 10, if the value of assets are similarly driven down from $1 to, for argument sake, $0.5, then a 10:0.5 ratio is effectively a 20:1 ratio.

Given how long it took to build up this leverage and the size of it, the unwinding process will take time or that quick action will surely cause turmoil. Quick action is what is being observed now, driven in part by margin calls, redemption requests (or anticipation of such), or flight to safety from volatile assets to something safe.

(2) The next to deleverage are those consumers who loaded up with debt for purchases. I wonder how much banks and other financial institutions have marked down or set aside sufficient amount of reserves for the anticipated defaults on credit card, auto and loans on other purchases. (I still see ads where you can buy furnitures and don't pay until 2010 or 2012...)

One bright spot is the falling fuel prices that helps keep money in people's pockets, but it may not last long, given that some refined products' prices, such as a barrel of reformulated gasoline (RBOB), are less than a barrel of benchmark crude oil. This assumes, of course, that crude oil prices stay in the same range.... more later...