You know things are bad on financial markets when an investment research note starts talking about Dante‘s visit to the nine circles of Hell with tormented lustful souls and gluttons living in filthy slush.
In the case of State Street Global Markets’ latest report, however, there is a more direct link than simple hyperbole about the way investors are feeling. The firm recently had a chat with former U.S. Treasury Secretary Larry Summers who defined what he saw as the five vicious circles of the current financial crisis.
It goes like this:
Circle One: House prices fall in value, putting some people into negative equity and leading some to default on mortgages. Foreclosures further erode asset values.
Circle Two: Falling asset prices erode bank capital, making banks more hesitant to lend, leading to further asset price falls and lower capital levels.
Circle Three: A slowing real economy reduces financial asset prices, leading to less lending and less investment. This causes the economy to slow further.