Wednesday, July 16, 2008

Financial Collapse Edging Closer?

The financial crisis in the United States and worldwide entered a new phase this week, as Fannie Mae and Freddie Mac, the two huge US home-loan institutions, began what appears to be a "death spiral" similar to that which claimed Bear Stearns four months ago.

In 1933, about a quarter of US banks failed, [but things were more solid] because US banks in the 1920s had been relatively conservative in their lending, with many banks requiring a 50% down payment for home mortgage loans, for example. The main problem in 1932-33 was quite simply liquidity; the Fed failed to supply adequate reserves to the banking system, so crises of confidence in individual banks led to panic withdrawals of deposits that caused the banks themselves to fail.

This time around, the problem is the opposite.

Fannie and Freddie are probably toast. Federal Reserve Board chairman Ben Bernanke's statement that the two companies can discount paper with the Fed may prolong the inevitable, but also increases its likely huge cost to taxpayers.

A total collapse of the US financial system, while not inevitable, is a contingency which should now be planned for.

[Excerpt of an article by Martin Hutchinson, a retired international merchant banker, writing in the Asia Times]

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