This link has been bookmarked by 1 people . It was first bookmarked on 01 Oct 2008, by Lawrence Jung.
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01 Oct 08
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“If a guy has a good investment opportunity and he can’t get the funding, he won’t do it,” Mr. Mishkin, who’s now an economics professor at Columbia, notes. “And that’s when the economy collapses.” Or, as Adam Posen, another economist, puts it, “That’s when the Depression became the Great Depression.”
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Mr. Bernanke largely developed the theory that the loan officers’ lost knowledge was a crucial cause of the Depression. He referred to this lost knowledge as “informational capital.” In plain English, it means that trust vanished from the banking sector.
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Banks cut back on making loans and instead poured money into Treasury bills, which paid almost no interest but also came with almost no risk. On the loans they did make, banks demanded higher interest rates. Over the past two weeks, rates have generally continued to rise — and these rates, not the stock market, are really what you should be watching.
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So why aren’t some banks stepping into the void and taking advantage of the newly high interest rates to earn some profit?
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There are two chief reasons. One is fairly basic: bankers are nervous that borrowers who look solid today may not turn out to be so solid. Think back to 1930, when the American economy seemed to be weathering the storm.
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The second reason is a bit more complex. Banks own a lot of long-term assets (like your mortgage) and hold a lot of short-term debt (which is cheaper than long-term debt). To pay off this debt, they need to take out short-term loans.
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In the current environment, bankers are nervous that other banks might shut them out, out of fear, and stop extending that short-term credit. This, in a nutshell, brought about Monday’s collapse of Wachovia and Glitnir Bank in Iceland. To avoid their fate, other banks are hoarding capital, instead of making seemingly profitable loans. And when capital is hoarded, further bank failures become all the more likely.
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The crucial point is that a modern economy can’t function when people can’t easily get credit. It takes a while for this to become obvious, since most companies and households don’t take out big new loans every day. But it will eventually become obvious, and painfully so. Already, a lack of car loans has caused vehicle sales to fall further.
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