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Friday, October 10, 2008

Credit Crisis Treatment

Treat the disease, not the symptoms, as set out in The Big Picture | Fix the Credit Problem, Not its Symptoms:
How did this happen? Why are markets reacting so negatively to a near $1 trillion bailout? The short answer is that the Federal Reserve and the Treasury Department have been focusing on the wrong issues. They have been treating falling asset prices—houses, stocks, bonds—as well as the lack of confidence between banks, as the actual issue. This is the wrong approach. Falling asset prices and a lack of confidence are a result of the underlying problem. You don’t cure alcoholism by getting rid of a hangover; you cannot resolve confidence issues by merely cutting rates. The primary problem is that banks are refusing to extend credit to each other. Why? Because they do not understand the liabilities of their counterparties. Translated into English, that means they don’t know if the other bank whom they are dealing with will still to be standing tomorrow. *** What makes the current crisis so dangerous is that all these complex financial maneuvers have left the institutions themselves shell shocked. They no longer know who to trust. When Banks cannot tell if the other bank across the street has enough money to survive through tomorrow, they cease credit operations. As long as this condition exists, banks will be reluctant to lend money to anyone but the strongest financial institutions, who of course, do not need it.
The cure might hurt, but the disease is worse.

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