Thursday, December 20, 2007

Credit crunch: A great synopsis of the problem

Here's a great summary of the mess we're now in with a nice comparison to the S&L crisis of the '80s.
...This has led to rational fears of credit risk among banks when dealing in the interbank lending market, severely exacerbated by the fact that the instruments in which the mortgages have become intertwined cannot be reasonably valued once they stop trading. This interbank credit crunch filters through the wider economy because companies, in particular, directly suffer the collateral damage of illiquidity at the heart of the financial system. It furthermore reinfects the housing sector, threatening a vicious cycle of house price decline and crunching credit.
Economics Blog : A Proposal for Reviving the Credit Markets

Here's the proposal from the writers of the above piece:
We believe that what is needed is a new Resolution Trust Corporation (RTC), based on the 1989 model that cleaned up the S&L mess. Obviously a different scheme is needed today, based on the new reality of mortgage holdings being dispersed throughout the financial sector. Congress would establish this new RTC to buy up subprime mortgages at deep discounts.
Here's what may happen if no action is taken:
But failure to enact an RTC to fish out the bad debt that is rotting our credit markets only makes it more likely that Congress and the Administration will instead adopt an election-year gimmick agenda with Sarbox-type haste and results.
More on the mess
Some more on the mess