The ongoing turmoil in the financial markets has diverted me from my usual tax academic pursuits, including this blog, for which I apologize. This post explores the causes of that turmoil. My next post will explore solutions currently under consideration, including aspects of the so-called “$700 billion bailout.”
The current financial crisis has many causes, some long-term and structural. I focus here, however, on three immediate aspects of the crisis: the trigger, how problems generated by that trigger spread through the markets, and how this produced the liquidity freeze that persuaded Mr. Paulson and Mr. Bush to act (unsuccessfully thus far).
The Trigger: Teaser-Rate Mortgages
The media talks about “sub prime mortgages” – by which it means mortgage loans to borrowers with less than stellar credit. The real problem, however, was the advent and widespread use of teaser-rate mortgages in both the prime and sub prime markets. A teaser-rate mortgage allows a borrower to make relatively small payments for several years. At some point, the rate jumps dramatically, and the borrower faces much higher monthly payment obligations.
Not surprisingly, borrowers loved this innovation. Teaser-rate loans allowed folks who otherwise could never have afforded to own a home to buy one, at least until the rate reset. But it wasn’t just sub prime borrowers who liked teasers. Teasers sold like hotcakes; loan originators made correspondingly fabulous profits.
(Some have tried to blame teaser-rates on the Community Reinvestment Act of 1977, which encouraged lending to minorities and lower income Americans. But that act only applied to commercial banks. A majority of this crisis’s teaser-rate loans were made by unregulated originators not subject to the act. More fundamentally, there is no evidence the present crisis started in 1977. Teaser-rate mortgages first became widespread after Mr. Bush took office in 2001.)
In any event, it’s not hard to predict what happens when rates reset. All of a sudden, buyers who have been paying $1,000 per month face monthly payments of $4,000. Many, perhaps most, go into default.
The possibility that this would become a major problem became apparent as early as 2005. (I actually wrote that fall predicting the current crash.) Mortgage economists began publishing reset schedules – schedules of how many billions or trillions of dollars of mortgages would reset and when. In effect, those tables offered a rough schedule of how many mortgages would go into default and when.
As defaults increased in number, lenders ended up holding large amounts of foreclosed property. When they tried to convert the property into cash, they put downward pressure on housing prices. And this, in turn, made financing and refinancing more difficult and further defaults more likely – even of non-teaser loans. (A perfect vicious cycle, and we’re not remotely near the end of it. In parts of the country, more half the homes offered for sale are now foreclosures. Banks are desperate to get those homes off their balance sheets and are dumping them much faster than the market can absorb them.)
The Spread: Securitization and Debt Chains
But why did Lehman Brothers and AIG go under? After all, they don’t make mortgage loans. I turn next to how the problem spread.
Assume that A borrows from B to buy a home, giving a mortgage on the home to secure her debt. B then borrows from C, using A’s mortgage as security. C in turn borrows from D, using B’s obligation as security. And so on.
Now assume that A’s mortgage goes bad. What happens to B, C, and D? Answer: all the loans up the chain go bad as well.
And this isn’t all. If the loan is secured (as mortgages and many other links in debt chains are), the lender is typically less interested in the creditworthiness of the borrower. The lender relies primarily on the collateral, not the borrower, for assurance of repayment.
As a result, each financial intermediary can be thinly capitalized. So a company with $10.1 billion in assets and $10 billion in debt may have a small amount of net equity. Indeed, the more thinly capitalized a company, the higher the return it can make on its capital.
Unfortunately, what this means is that when A’s mortgage goes bad, it’s not just the loans up the chain that go bad – financial intermediaries in the chain often go bust as well. A thinly capitalized intermediary cannot absorb many losses. And that is why teaser-rate mortgage defaults triggered and are still triggering defaults and failures across the entire financial sector. Almost everyone was in the debt-chain business and extended themselves to the max to take advantage of the extraordinary profit opportunities of that business.
I’ve explained the transmission mechanism in terms of debt because readers have an intuitive understanding of how debt works. In fact, however, many of the most important links in the chain were not technically “debt.” Some were shares in “mortgage pools”; some, “derivatives”; some, “credit default swaps.” What they all had in common was that each transferred some risk of default up the chain to someone else. Wall Street sometimes calls links in such debt chains “toxic waste,” because today no one wants them.
AIG, for example, held about $500 billion in “notional exposure” on credit default swaps. In English, it was at risk to the tune of about $500 billion if mortgages down the chain went bad. When mortgages began to go bad in large numbers, the market realized that AIG might not be able to cover its obligations and began to sell AIG stock seriously short. Lenders stopped lending. End of story.
What made this more than just a corporate problem was that AIG was a domino at the head of many long chains of dominoes. If AIG had gone, some believed the world would have faced immediate economic collapse. So the US government bought an 80% stake in AIG in exchange for enough money to allow AIG to dissolve gracefully – over a couple of years – instead of imploding overnight.
The Crisis: Liquidity Freeze
None of this, however, would by itself have led a free-market US administration to propose a $700 billion general “bail-out.” Real estate is important, yes, but there are many parts of the economy not dependent on the market for home mortgages. What happened?
In ordinary times, most businesses borrow on a short term basis to fund payroll, inventory, and other operating needs. There are two principal sources of short-term money: banks and money-market funds. In the past several weeks, each of these has substantially reduced the amounts they are willing to lend. This is what’s called a liquidity or credit freeze.
Why did banks and money-market funds stop lending?
Let’s start with money-market funds. Investors put money into money-market funds when they want absolute safety and the ability to pull their money out at will. Put in a dollar, get out a dollar, whenever you want. In return, they accept a very low return. What happened was that The Reserve, the oldest and most highly regarded money-market fund sponsor, “broke a buck” – which means it paid back only 97 cents for every dollar investors put in.
The reason was simple: The Reserve had loaned short-term money to Lehman Brothers, a major participant in the debt chain business. Lehman Brothers went belly up, and The Reserve’s short-term loans to Lehman became uncollectible. (Remember that the Treasury and the Federal Reserve Bank, having bailed out Bear Stearns, decided to let Lehman Brothers go bankrupt to teach the market a lesson. In retrospect, this was probably a mistake.)
As a result, investor confidence in money-market funds plummeted. Fortunately or unfortunately, investors always have a secure place to park money, Treasury bills – short term obligations issued by the U.S. government. When The Reserve broke a buck, everyone moved their money into Treasuries. Money-market funds dried up. And that was the end of one major source of business working capital.
Another major source is the banking system. Unfortunately, banks and other financial intermediaries became reluctant to loan to each other. As a result, money in one part of the banking system stopped flowing to where it was most needed.
Why did banks stop loaning money to each other? When lenders lend, they generally look at borrowers’ financial sheets to determine how creditworthy they are before giving out money. Unfortunately, most banks and other financial intermediaries have large amounts of toxic waste on their books.
In situations like this, accounting rules require companies to “mark assets to market.” If an asset with a face value of $100 appears to have a market value of $40, the company is supposed to record a loss of $60 immediately, even before the asset is sold, and to carry that asset on its books at a value of $40. So banks and other financial intermediaries began reporting enormous losses on the toxic waste they held, and their balance sheets crumbled. (The head of the Securities and Exchange Commission was pressured to waive this rule, but refused. It was for this reason that Sen. John McCain demanded that he be fired.)
But recognizing market losses isn’t the most serious problem. If a lender can be confident that the asset in question really has a value of $40, it may still conclude that the prospective borrower is likely to repay the loan – notwithstanding the reported loss. If no one knows how much the toxic waste is actually worth, however, lenders can’t assess the creditworthiness of any prospective borrower with significant amounts of toxic waste on its books. Almost all banks hold toxic waste. So banks stopped lending to other banks. (Waiving the mark-to-market rule would not have solved this problem; it would simply have hidden the accrued losses. Banks are sophisticated enough to worry when accounting rules do not correctly reflect what's going on in the market.)
But why is the unavailability of short-term money so bad?
Remember what businesses use short-term money for – to meet payroll and put inventory on their shelves. When businesses lose access to working capital, they stop operating, not because there is anything fundamentally wrong with their products or markets or business plans, but simply because they can’t get the cash they need on a daily basis.
You might think of short-term money as the lubricant that keeps the world’s economic engine turning over smoothly. If there’s no lubricant, the engine freezes. No paydays, no goods on the shelves. Seriously.
This was the possibility that persuaded Mr. Bush and Mr. Paulson to change course and support a general “bail-out.” And it remains a very real possibility.
The $700 Billion Bailout
I will discuss the details of possible solutions in my next post.
What is important to emphasize here is that current proposals are primarily intended to solve the liquidity freeze part of the problem – to prevent the world’s economic engine from seizing up.
Mr. Paulson’s original proposal hoped to accomplish this in two ways. First, by buying up toxic waste at fair market value, Mr. Paulson could take toxic waste off financial intermediaries’ balance sheets. This would allow lenders to assess borrowers’ creditworthiness with greater confidence and, hopefully, get banks to start lending to each other again.
Equally importantly, however, Mr. Paulson requested authority to buy up that waste at whatever price he thought best. By buying toxic waste at higher prices than private buyers were willing to pay, he hoped to bolster the financial intermediaries’ balance sheets – to make them more creditworthy.
This aspect of the proposal was what made it a “bail-out.” And this was part of what led to its defeat in the House.
Note that Mr. Paulson’s proposal was not intended to solve the teaser-rate mortgage problem, either now or in the future. In the transactions that created the teaser-rate mortgages in the first place, both parties made bad decisions – the lender and the borrower. Mr. Paulson’s proposal was not intended to help either. One of its unavoidable side effects, however, was to relieve lenders of the consequences of their bad decisions, while leaving borrowers to suffer the consequences of theirs. This made it politically less palatable.
In addition, at least $500 billion more of teaser-rate mortgages are scheduled to reset over the next several years. In all likelihood, they too will go into default and become toxic waste. Nothing in Mr. Paulson’s original proposal was intended to do anything about this next $500 billion installment – or, indeed, to prevent lenders from making more teaser-rate mortgages in the future.
Similarly, Mr. Paulson’s proposal was not intended as a general Wall Street bail-out, although to some extent it would have had that effect. Note that the outstanding overhang of credit default swaps alone is estimated to be between $45 and $60 trillion – three to four times the size of our annual gross domestic product. The requested $700 billion, although the single biggest appropriation request in U.S. history, was miniscule when compared with the toxic waste problem as a whole. Mr. Paulson’s proposed solution was to cost just 1% of the size of the problem and was aimed only at a small part of that problem. (It is unnerving to realize that the U.S. government – the “beast” we have been starving for so long – may now lack the borrowing capacity to solve the problem as a whole. We need to get our financial house in order.)
All Mr. Paulson’s proposal aimed to do was to put lubricant back into the engine, to get short-term money flowing again to prevent our economic engine from freezing up. Now that the proposal has gone down to defeat, we can only hope that Mr. Paulson was wrong.
Even the Financial Accounting Standards Board’s couldn't figure out how to deal with the mark-to-market accounting shortly after the Enron debacle. Even the Arthur Andersen accounting firm had problems with it which led to its failure too. Enron filed for bankruptcy 2001. The Financial Accounting Standards Board’s has had 7 years and they did nothing. nomedals.blogspot.com
Posted by: Jason | September 30, 2008 at 04:21 PM
Dear Jason,
Could you be more specific about the difficulties you envision? We use mark-to-market in a number of places in the Internal Revenue Code. Oddly enough, taxpayers seem to have no difficulty with it when it is to their advantage.
I have no axe to grind here. What I want is a solution that works -- Republican or Democratic. Note that I have written in support of a plan proposed by a Republican Secretary of the Treasury and supported by a Republican President, even though I am not a fan of Mr. Bush. The proposal to eliminate mark-to-market was rejected by a Republican SEC Chair. If you think eliminating mark-to-market accounting and thereby allowing companies to overstate the value of their assets would help solve the problem, please explain why.
Posted by: Theodore Seto | September 30, 2008 at 05:02 PM
One question: why do businesses need short-term money to pay their employees? Shouldn't they be managing their businesses well enough to not have to borrow for day-to-day expenses? It seems to me that the real problem is an overreliance on credit.
Posted by: suburbancorrespondent | October 01, 2008 at 05:20 AM
Why does a business need short-term money to pay employees? Products are made before the customer purchases them. In order to make the products, employees have to work, and expect to be paid. There is a lag between the time when employees must be paid, and the customer pays. For an business which is expanding, the cash receipts continue to lag the expenditures necessary for making the product. Short-term borrowing fills the cash-flow needs in the interim.
Posted by: Caleb Standafer | October 01, 2008 at 08:17 AM
Interesting but with errors. The advent of teaser rates came far earlier. I was burned in 1984 by one I took in 1982 in Houston. They had 32,000 foreclosures annually for two years. I used one to my advantage in 2000 knowing I could manage it if I was wrong on the direction of rates.
The toxic facillitator of this was the Frannies. Their lobbying took the FHLB's out of the attempt to diversify the market at about 2002-2003. Their bought congressmen block reform pushed every year by this administration and by Larry Summers late in the Clinton years.
Posted by: David M | October 01, 2008 at 12:29 PM
Great explanation of the issue. I might also that some of these firms are in trouble because the SEC drastically lowered the amount of money that several of the failed firms had to keep on hand in case of emergency (the "haircut" they took)
To answer the question posed by the other commentors, from what i remember of my Corporations Law course, businesses are encouraged to be somewhat leveraged, meaning that they should take out loans and be in debt. I recollect that there were a few reasons for this, but one reason was so that they can be a less attractive target for a takeover. Businesses which have a lot of cash sitting around are ripe for the plundering. I think another reason was that businesses normally hope that their operations have a higher rate of return than the prevailing interest rate at which they borrow money, so they borrow as much as they can in order to produce more.
Posted by: john | October 01, 2008 at 12:30 PM
Just wanted to say thank you for this great post. I have been trying for a while to figure out exactly what the problem is that the "bail-out" is supposed to fix. This is the first source I have found that actually explains it in some detail.
Thanks!!!
Posted by: Clark Taylor | October 01, 2008 at 12:38 PM
Even if the teaser rates are a huge part of the problem, you seem to discount the role played by Fannie Mae and the Democrats that blocked efforts to regulate and shrink it down to size. Would that toxic waste have spread like that if there was no implicit govt guarantee? I think not.
Posted by: Jason W | October 01, 2008 at 12:46 PM
Nice post, but you lost a lot of objectivity with "Teaser-rate mortgages first became widespread after Mr. Bush took office in 2001." As a previous commenter points out, this was going on long before Bush. Partisanship occludes rationality.
Posted by: Buford Gooch | October 01, 2008 at 12:50 PM
wouldn't it be fair to say that the rate of lending increased, as the rate of mortgages increased, and that there exists a 'lending bubble'?
Since our sytem was built on inflated lending, shouldn't I expect a decline when the lending bubble burst?
Posted by: mark l. | October 01, 2008 at 12:55 PM
Couple of questions.
- You say: "In parts of the country, more half the homes offered for sale are now foreclosures. Banks are desperate to get those homes off their balance sheets and are dumping them much faster than the market can absorb them."
Where are these parts of the country and how many homes are invovled? As far as I can tell here in our southern California rural county that is not at all the case.
- Why didn't the banks renegotiate the loans rather than foreclosing on the loans? It seems kind of counter-intuitive unless the banks thought they could get more of their money back by foreclosing.
Posted by: Greg Marquez | October 01, 2008 at 12:55 PM
This is a very good post but I have to disagree with two portions of it. The Community Reinvestment Act may have started in 1977 but it was massively expanded in 1995 and the full weight of the Federal Government and media pressure were brought onto banks that did not lend sufficient amounts of money into formerly "redlined" areas.
Banks avoided these customers because their credit was lousy, but they were accused of lending with a racist bias and threatened with penalties if they did not find ways to loan to more minorities.
The Wall Street Journal did dozens of editorials about this at the time.
And there is a direct correlation between the rise in housing prices and the expansion of the CRA. Look at housing price versus inflation charts and you will see that housing prices track inflation year after year until about 1997 when they ramp up sharply without inflation just a few years after the expansion of the CRA.
Second; Separating mortgage originators from banks is pointless. Every mortgage and refi I've ever done was written by the same independent loan broker, but his money all came from SunTrust Bank and all of his loans counted for or against SunTrusts "affordable" housing quota, whatever the government said that quota was.
Posted by: VRWC | October 01, 2008 at 12:58 PM
This is without a doubt THE BEST explanation of the current crisis that I've found anywhere. Thank you so much for taking the time to explain this important issue - and to do so so very well.
Posted by: William Porter | October 01, 2008 at 01:06 PM
While you are correct about the teaser rate and adjustable rate mortgages being a source of the problem, the primary reason that they became the source of the problem was that the Fed increased interest rates over the period from 2003-2004 through 2006-2007 by about 5 points. Most of the teaser rate and adjustable rate mortgages were tied to increases in the Prime Rate or other interest rate sensitive indices.
Posted by: mongoose | October 01, 2008 at 01:06 PM
Very informative. The posting at least describes in understandable detail what was the apparent reason for the bailout -- even why it was a bailout -- and why it was being done.
It has been pointed out but teaser mortagages existed for a long time. I think they used to be referred to as 'adjustable rate mortgages' (or ARMs) usually with low initial rates and an adjustment afterwards.
Posted by: Personal Comment | October 01, 2008 at 01:08 PM
Great post with two asides:
1. No one can value the 'Toxic Waste' in part because the federal government is toying with buying large parts of it at some arbitrary amount. Who would sell if they think there's a chance the Gov is going to offer a better price sometime in the next week?
2. I also agree that this anaysis doesn't adequately address Fannie Mae's and Freddy Mac's role in the crisis.
Posted by: dan | October 01, 2008 at 01:09 PM
It does seem strange that your entire explanation (which is much appreciated) doesn't mention Fannie Mae and Freddie Mac. I was led to believe they had something to do with this mess...don't they?
Posted by: Yahonza | October 01, 2008 at 01:10 PM
I find the partisan comments here interesting. There are too many people in both Parties at fault here for Americans to be partisan. Lending to low-income, higher risk people did not create this crisis. Selling their mortgages as an investment did. Investors gambled homes wouldn't depreciate and lost. Anyone paying attention to the automaker's 0% financing, teaser lease options, and special mortgage deals with no money down could spot a crisis was coming from a mile away, just like the internet bubble. America, if it can survive the unraveling of this debt-ball, must live within its means again. Starting with paying back the 10 Trillion in Debt by running surpluses for decades to come. Everything must come under consideration for cuts, and that mean Defense as well. Homeland Security should take precedence over a global military presence. We'll save hundreds of billions simply by bringing our troops home from Germany, Japan, Korea and Iraq.
Posted by: JeffA | October 01, 2008 at 01:17 PM
Greg Marquez: You said "Why didn't the banks renegotiate the loans rather than foreclosing on the loans?"
The author incorrectly dismissed sub prime loans. The simple fact is that vast amount of mortgages were granted to people who had little chance of repaying them no matter what the interest rate.
I live on Long Island (NY). The foreclosures are highly concentrated in poorer areas. The simple fact is that buyers should not have gotten the mortgages in the first place. There have been sporadic news stories of people "buying" houses in these areas and never making a single mortgage payment.
Of course, the ease of mortgages in these poorer areas drove the prices up - more so than the better areas - because the houses were still cheaper than in better areas. Now many of those foreclosed properties are worth only half of what they sold for - a price that is actually closer to their true value.
Under normal circumstances these houses would be gobbled up by people looking for fixer uppers as investments and/or young buyers looking for affordable homes. However, the bad schools and high crime in these areas makes them very unattractive. When they're auctioned the bank always ends up as the buyer because the bids are so low or, in many cases, nonexistent.
Posted by: sparky | October 01, 2008 at 01:18 PM
One point not addressed in your explanation (which, otherwise, is quite good) is that the provision is only an *indirect* attempt to bring back short-term credit.
In effect, the powerpointed proposal is:
(1) due to the amount of toxic waste banks don't trust each other enough to be comfortable making short term loans to each other
(2) we'll use the bailout money to buy the toxic waste for more than it's arguably worth, thereby (a) partially recapitalizing troubled banks and (b) partially removing the source of interbank distrust
(3) ...and, of course, the newly-recapitalized banks will trust each other sufficiently to go back to "normalcy" in terms of short-term lending
The gap between (2) and (3) is where a lot of the *informed* opposition of the specific bailout proposal arises from:
(1) it's not entirely implausible that the proposed bailout would remove enough toxic waste from the system to get it running smooth-enough to be worthwhile
(2) but the historical experience is mixed (japanese banks tended to take their bailout capital and sit on it; it helped balance sheets but did little to ease their credit markets over the kind of timeframes that matter for "urgent" situations)
(3) and it's not at all clear that we wouldn't be better served by a bailout that more-explicitly targeted the short-term commercial loan market
So the problems that could arise should there be "no bailout" are not in question; the fact that the actual language of the bailout is too vague to make short-term commercial lending its goal leaves a lot of us very uneasy.
I think a lot of otherwise astute observers of the crisis who support the bailout are falling into this trap:
- they do understand the problem if the credit markets seize up
- they don't think many other people understand the problem
- they can see that there's a need to do something
- ergo, they are in support of the bailout
- and, b/c most of the anti-bailouts don't mention the dangers of credit markets seizing up, they don't take the anti-bailout outlook seriously
Some of us would take the bailout more seriously if it clearly targeted restoring the credit markets, rather than having to rely on our faith in Paulson's goals.
Greg Marquez: mortgage securitization makes mortgage rewrites problematic.
The old model: you took out a loan from a local bank or s&l, and the local loan originator usually held the loan to maturity. If you needed to renegotiate the only interested parties were really you and that local originator.
The new model: you take out a loan from a local loan originator, that then sells the loan on (often multiple times!) before it is aggregated with ~1000 other mortgages and then that aggregate is sliced into what are basically different products (called tranches).
So to renegotiate a mortgage you'd now have a situation where there may be several different parties each with some ownership interest in the mortgage, and with conflicting incentives. N-way negotiations are much more difficult, and the holders of the "aggregated" mortgages (who have partial ownership interests in thousands of mortgages) may not want to set a precedent (because they are potentially going to be engaged in 100s or more such negotiations if they start allowing them).
Posted by: seen it all | October 01, 2008 at 01:30 PM
To clarify one thing: I was trying to keep it simple here, but made something that some might take as a gaffe.
There's several distinct steps in the mortgage aggregation process:
- aggregating into a big pool
- slicing pool into tranches
- (sometimes) dividing tranches into smaller-denominated securities
It's possible for parts of a particular mortgage to be involved in multiple tranches and additionally possible for a tranche to have multiple partial owners; both have the potential to increase the number of interested parties in a mortgage renegotiation.
Posted by: seen it all | October 01, 2008 at 01:39 PM
JeffA
Your comment is incorrrect
"Lending to low-income, higher risk people did not create this crisis. Selling their mortgages as an investment did."
The root of the problem is people NOT paying back money tehy borrowed.
If the mortgages were not packaged and sold as investments then there would have been no money to lend in the first place. Where do you think that money comes from? Do you think there is some magic mortgage money pot from which money to buy houses springs forth? All mortgages are an investment by someone in the borrower with the home as collateral. Fannie and Freddie with their implicit and now explicit government guarantees) subsidized a huge wash of liquidity in the mortgage business creating a housing bubble. When President Bush and John McCain in separate proposals, proposed reining in their excesses Fannie/Freddies bought and paid for friends in Congress killed any chance of that happening. They bought people on both sides of the aisle but it is matter of record who took the most.
Posted by: DavidW | October 01, 2008 at 01:44 PM
You don't really believe "the beast" has been starving for the last X number of years, do you?
And the problem wasn't just teaser loans. It was offering loans at no money down, sometimes negative money down, which makes it efficient to walk away when prices go down, even if you CAN afford to pay.
Posted by: JP | October 01, 2008 at 01:44 PM
I think a lot of otherwise astute observers of the crisis who support the bailout are falling into this trap:
- they do understand the problem if the credit markets seize up
- they don't think many other people understand the problem
- they can see that there's a need to do something
- ergo, they are in support of the bailout
- and, b/c most of the anti-bailouts don't mention the dangers of credit markets seizing up, they don't take the anti-bailout outlook seriously...
Well. Some of the anti-bailout criticism does not deserve to be taken seriously.
But I would add that a lot of supporters of the bailout figure that between them Bernanke and Paulson have a tremendous amount of personal expertise as well as access to vast information and expertise.
Not that we are trusting of authority, but in this case we have experts offering a plan that *might* work opposed by critics offering not much.
The Republican "insurance" scheme was absurd - either they will only collect "premiums" (called "taxes" when a Democrat suggests it) from bad bonds, in which case where does the money come from, or they slap an ex post tax on good, performing bonds. Why is that fair and non-intrusive?
And Nancy Pelosi's vision of a world in which everyone in default on their mortgage was a victim requiring government assistance was hardly one that would encourage people to borrow responsibly and pay their bills. Quite the contrary, in fact.
Removing some of the toxic waste might unclog the system and encourage private capital to re-enter the financial services system. If not, its on to Plan C. Or D. Or whatever - we have 26 letters before we even get to numbers.
Posted by: Tom Maguire | October 01, 2008 at 01:48 PM
"One question: why do businesses need short-term money to pay their employees? Shouldn't they be managing their businesses well enough to not have to borrow for day-to-day expenses? It seems to me that the real problem is an overreliance on credit."
Bingo.
We've taken out debt based on expectations of a certain amount of economic growth (personally and collectively). That economic growth didn't materialize. Lots of prices inflated at rates faster than the economy was really growing. It was all illusionary growth in wealth. To cover our loses, we took out bigger debts based on other promises of future growth and the past illusionary collateral.
Posted by: Celebrim | October 01, 2008 at 01:57 PM