Wider Implications of the Credit Crunch

The news on the financial front has gone from bad to worse. Eric S. sent us this: ECB lends $500 Billion to lower rates, and Stephen in Iraq found this article: Fed Loans Banks [Another] $20 Billion. And if that weren’t enough, K.L. in Alaska sent us this: ACA Capital Holdings Inc. was just de-listed by the New York Stock Exchange. K.L.”s comment was blunt: “[ACA Capital Holdings] is essentially bankrupt. It is one of the insurers of the financial instruments such as municipal bonds, hedge funds and CDOs that have been infected by toxic mortgages. These funds are becoming impossible to insure because their losses are greater than any insurance company can handle. Other insurance companies that bear watching are (stock symbols) ABK, MBI, AGO, RAMR, and MTG. The whole system is starting to come apart at the seams.” I concur.

Here is the significance credit crunch in a nutshell: The sub-prime debacle only served to point out a systemic weakness in the modern banking system: Because of endless CDO/SIV debt “re-packaging” and hedge fund aggregation of countless assorted debt instruments it is impossible to properly assess the risk of most loan offerings. A lot of loans are quite safe and a few are garbage. But given the extensive debt market re-packaging it is hard to tell one from another. (Perhaps the comedians John Bird and John Fortune had it right about “dodgy debts”.) The central banks are frantically trying to pump up liquidity–literally throwing money at the problem. There have also been calls to reduce the banks’ reserve requirements, because assets have been marked down so heavily that banks are now struggling to meet their paltry reserve obligations. But here is the rub: lowering reserve ratios might make depositors nervous and perhaps lead to more banks runs. (As was recently seen with the runs on Northern Rock bank, in England.)

Despite the desperation moves by the central banks, there is a fairly significant possibility that the entire global credit market will collapse in the next few months and plunge the world into a deep, long recession if not a full scale depression.

OBTW, I’m not the only saying this. Shortly after I drafted the foregoing, Matt in Texas forwarded this article link, which echoes my conclusions: The coming collapse of the modern banking system. It is time to batten down the hatches, folks.