financeguy
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"Credit Crisis II" by Christopher Laird, FSU Editorial 08/25/2008
Where are we now in the credit crisis, and why isn’t the massive Fed and ECB weekly lending working to loosen interbank lending? Why is the credit crisis not really improving? Where is this going next? We describe what may happen next as Credit Crisis II in this article.
Now that the credit crisis that started in 2007 is a year old, there has been a debate about whether the financial system will recover, or will the Western/world financial system end up like the Japanese financial system after the stock and real estate crashes in the 1990’s. In that case, the Japanese banks more or less carried their tremendous losses for ten years, and Japan entered a mild but painful decade of deflation. To this day, Japan is battling some of the deflationary forces from that time.
The question now becomes, will the Western financial system recover some normalcy, or are things merely going to get worse and the world end up with a financial malaise lasting ten years like Japan’s?
Bankrupt en masse
In effect, this means the Western banks, etc are bankrupt en masse. The only thing propping up the entire Western financial system, and its respective stock markets has been massive ‘temporary’ lending, on an ongoing basis, by the Fed and ECB. Both central banks are beginning to balk at this situation. Even as they are starting to have second thoughts, the Western financial institutions continue to borrow more money than ever on a weekly basis. Why aren’t things loosening up?
Can’t stop or else
And, if the ECB or the Fed stops the emergency infusions, or even admit who the borrowers are, another round of collapsing banks/bank runs ensues as investors flee and pull their money out. In other words, the central banks have no choice but to continue the weekly $30-50 billion or so of infusions each for the Fed and the ECB, or else face a cascade of bank runs around the world.
…And each week the Fed and the ECB are effectively taking on another $30 or $50 billion of the bad assets from the various and sundry financial institutions scattered across the EU and the US. So, week after grueling week, the Fed and the ECB keep adding another $50 to $100 billion of bad assets to their balance sheets, as ‘collateral’ and making ‘temporary’ loans they keep having to roll over and extend the repayment on. Ie, the junk stuff is becoming a permanent resident on the central bank’s balance sheets. If either the Fed or the ECB stop the weekly infusions, quite possibly the entire Western financial system stops dead. And we get a massive world stock crash.
The question now becomes, what happens when these two central banks finally decide they have to let go? You are not going to tell me they are going to keep infusing a combined $50 to $100 billion worth of financial bailouts each week forever? This massive temporary lending certainly has to end at some point.
And even with all this new money every week, the credit system is barely functional anyway right now. And this half dead world credit system is dragging economies downward, as there is less and less and less credit. This is a paltry return for all the bailouts and massive temporary lending.