Paul Krugman, The New York Times, December 14, 2007
On Wednesday, the Federal Reserve announced plans to lend $40 billion to banks. By my count, it’s the fourth high-profile attempt to rescue the financial system since things started falling apart about five months ago. Maybe this one will do the trick, but I wouldn’t count on it.
In past financial crises — the stock market crash of 1987, the aftermath of Russia’s default in 1998 — the Fed has been able to wave its magic wand and make market turmoil disappear. But this time the magic isn’t working.
Why not? Because the problem with the markets isn’t just a lack of liquidity — there’s also a fundamental problem of solvency.
Let me explain the difference with a hypothetical example.
Suppose that there’s a nasty rumor about the First Bank of Pottersville: people say that the bank made a huge loan to the president’s brother-in-law, who squandered the money on a failed business venture.
One of the major factors in this loan crisis is that people have taken loans with a variable interest rate. Adjustable rate loans enable lenders to allow for inflation.
Now, with the danger of inflation, banks have begun raising their rates, causing monthly mortgage payments to go up.
People take the added risk of payments going up in the future, because fixed rate loans are higher. For example, a fixed rate loan might be at 5%. At the same time, the exact same loan, but adjustable – is at 4 3/4%, this allowing initially, for a smaller monthly payment. But when interest rates go up all hell breaks loose.
If there was no inflation, there would be no need for these adjustable rate loans!
The Fed can stop inflation, and therefore this nonsense, any time it wants to. Please politic for, by law, a non-inflating dollar.
Grimgold
Comment by grimgold — December 14, 2007 @ 11:48 am
Suppose that there’s a nasty rumor about the First Bank of Pottersville: people say that the bank made a huge loan to the president’s brother-in-law, who squandered the money on a failed business venture.
Flashback to 1987 at the silverado S&L where
the Bush brothers made unsecured loans to itself
and in retrospect of Prescott Bush’s Nazi warcrimes tribunals paid back pennies on the dollar in fines, The silverado fines amounted to about the same dollar figure as the nuremburg ruling but in the case of silverado the cot to taxpayers was estimated around one billion.
Comment by Rainlander — December 15, 2007 @ 1:24 am