Saturday, March 15, 2008

We're now in a solvency problem

Now that we have hear news that Bear Stearns needed to be rescued by JP Morgan and the Federal Reserve to cover its borrowings, the real depth of the credit crunch is becoming apparent. We have moved from a liquidity to a solvency issue, where many non-bank lenders are now having extreme difficulty meeting their obligations. The LBO firm Carlyle group defaulted on an investment fund heavily invested in sub prime mortgage.

More and more firms will become insolvent as the assets backing their debts fall in value, forcing loans to be called and additional defaults. Bear Stearns will in all likelihood be acquired by another firm, as will many other companies who leveraged themselves to the hilt on easy credit.

The move by the Fed is a realization that monetary policy will do little to help the situation, and that partial nationalization of bad debts is the only way to avert a full solvency crisis. Better late than never.

All of these problems materialized because of a Federal Reserve, encouraged by a U.S. government that wanted perpetual economic growth, that kept creating money and generating excess credit and a devalued currency. The problem is that the Fed must allow the market to find a bottom and facilitate an orderly liquidation - delaying the inevitable by attempting to protect people from price drops will only exacerbate the situation.


It also appears that Lehman Brothers is having some troubles as well after the Bear Stearns debacle. This will bear watching.

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