Against the tide: History is no guide to financial institutions’ woes

The rally in equities and other risk assets is based on the view that the market can see the end of the tunnel for losses in the financial sector. And so, as in past recessions, as confidence returns, so will the strength of the real economy. That’s how the argument goes.

But history is no guide this time. First, markets have failed to recognize the big impact that losses among financial intermediaries will have on credit creation. Also, the credit bubble is both a mirror of and a means to finance global imbalances. If the credit machinery that allowed the imbalances to burgeon is dead, so the imbalances will disappear. But this implies a far longer and more painful workout than the markets expect.

Earlier this year, I reckoned that total sub-prime and other larger credit losses would reach $1 trillion-plus. And give or take a few billion,...