Monday, December 17, 2007

More on the Solvency Crisis

Here are several interesting pieces that lend support to the view that more liquidity--even if creatively injected through the new term action facility--will not solve the lack of interbank lending. The reasons is because this is not crisis of liquidity, but of solvency.
John M. Berry

This is more of a credit and confidence problem than a liquidity one similar to that which followed the Sept. 11 attacks on the World Trade Center... The issue now is the large losses -- both announced and unannounced -- that many financial institutions have experienced from securities backed by subprime mortgages, many of which have gone into default.
Stephen Cecchetti
(This is a great piece for understanding the new term action facility)

Why are big private banks unwilling to lend to each?
Clearly, they were worried about the quality of the assets on the balance sheets of the potential borrowers. My guess is that banks were having enough trouble figuring out the value of the things they owned, so they figure that other banks must be having the same problems. The result has been paralysis in inter-bank lending markets. Banks have not been able to fund themselves. And, as I will discuss in a moment, non-US banks faced an added problem – they could not get dollars. This was either because they could not get euros or pounds to then sell for dollars, or once they got their domestic currency they were unable to make the exchange.

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