The Economic Crisis

Originally posted on Half an Hour, November 23, 2008.

I don't want to belabour my remarks about the current economic crisis but I would like to make a few points worth considering in the months ahead.

The crisis is generally known by the title "the credit crunch" as a consequence of the proximate cause of the stock market meltdown and subsequent collapse of the financial system. Banks and other lenders were left holding what turned out to be worthless paper, much of it generated through the U.S. housing bubble. Even those that did not collapse outright were unable to extend lines of credit for more ordinary commerce - the borrowing a company would do, for example, to maintain its inventory.

Governments might not have enough money to resolve the crisis, however. We have already see Iceland go under and Switzerland is also in a crisis state. If a banking system such as Citibank goes under, there may not be enough

To get past the immediate impact of the crisis, the path taken by the U.S. administration (and, more quietly, by other governments) was the right one. The economy had essentially seized, and an injection of liquidity was needed to prevent it from grinding to a halt altogether. Although the amounts are staggering, it is important to keep in mind that the money advanced is a loan, and (in theory, at least) it should be returned to the government.

Once we had the opportunity to take a deeper look at the crisis, a secondary cause emerged. As noted above, many of the loans that bounced were essentially worthless paper. This was a result of financial institutions engaging in business practices that were, if legal, nonetheless questionable. Representing a bundle of 'D' loans as, collectively, an 'A' loan, for example. And they were able to engage in such practices because of a general lack of transparency in the financial system and a general lack of regulation that would have made such practices illegal.

Calls for a transparent and regulated financial system are therefore well taken.

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