Esoteric Dissertations from a One-Track Mind

March 15, 2008

Credit Crisis: Bear Naked

Filed under: economy, politics — Tags: , , — codesmithy @ 10:15 am

Paul Krugman has a good article titled “Betting the Bank.” He has a succinct description of what the Federal Reserves does and the power that it has.

The Fed’s economic power rests on the fact that it’s the only institution with the right to add to the “monetary base”: pieces of green paper bearing portraits of dead presidents, plus deposits that private banks hold at the Fed and can convert into green paper at will.

He also describes how the Fed will assume risker forms of debt.  Basically, converting bad home loans that are essentially worthless into cash.  It is essentially a $400 billion bailout.

There has been a lot of talk about liquidity.  About financial institutions are basically sound, however they have fallen victim to a run on the bank.  The symptoms are the same, but the disease is different.  Yes, a run on the bank can cause an otherwise sound financial institution to be pushed under because it is in their nature to loan some percentage of the deposits to people who need loans.  If all the depositors come to the bank and demand their money, of course they don’t have the money to give every depositor their due.  The bank loaned it out, and it hasn’t been paid back yet.  This is exactly the type of scenario that the Fed can solve.

However, what we are facing is much different.  The loans were bad.  Many people have taken their money and walked away.  People got a loan for a home they can’t afford and started defaulting on their payments.  In fact, many people are defaulting at the same time.  The assets are not worth the value of loans. The transitive effect of people not fulfilling their obligations have finally reached the financial institutions.

To the degree that the Fed injects liquidity, it just delays the inevitable.  The real money on a loan is made on the interest years in the future.  The differences in actual value and these investments initial perceived value couldn’t be more stark.

The short of it, someone is not going to get paid.  The elites and the politically connected are ensuring that the person not getting paid is you, the taxpayer.  Losses are socialized, profits are privatized.  We are living in a corporate welfare state.  If we don’t allow these banks to fail at at least have some semblance of capitalism and accountability, we are not on the road to serfdom, we are at the destination.


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