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Storms Clouds On The Economic Horizon

Apr 24, 2008
The world's financial system is as fragile now as it has been in many decades. Federal Reserve Chairman Ben S. Bernanke has one gigantic problem on his hands: a very wide-ranging credit freeze up. This is a problem that mere cuts in interest rates cannot cure.

The exceptionally low interest rates of the early and mid-2000s and the continual bailing out by Alan Greenspan of any Wall Street player that got into trouble created huge temptations to speculate with borrowed funds and throw caution to the wind, completely setting aside any consideration for risk. Why worry about risk when it's not your own money and even if you get into trouble you can get bailed out? This problem is called moral hazard.

Now there's a problem. Those speculative derivatives do not have the value that the Wall Street conmen claimed they had. There's a desperate rush to de-leverage at almost any price. Of course, buyers have grown scarce. No institutional investor wants to add more highly overvalued speculative packages to his portfolio now that the true value of these derivative bundles is exposed in the light of day. We are in a liquidity crisis the size of which we haven't experienced since before World War II.

Commercial and investment banks sitting on overvalued and illiquid packages of mortgages and private equity loans mixed with derivatives can't sell them because they are of highly questionable value.

Hence the bailout by the Fed, in the form of longer-term financing at the discount window. What else can they do? Let the entire financial foundation of the globe completely lock up?

The government rescue of overleveraged financiers is still only beginning, and the signs that it will get bigger are everywhere. Real estate prices continue to fall. Loan funding is shrinking rapidly. Home Buyers are practically locked out of the mortgage market unless they have near perfect credit and a large down payment. The vast majority don't. The House Financial Services Committee has proposed letting the FHA underwrite up to $300 billion in mortgages to borrowers. The last time the federal government stepped so directly into the housing loan business was during the depths of the Great Depression. Does that indicate how bad this crisis is?

Right now we are on a path of hyperinflation. Creating a trillion dollars and injecting it into the economy is going to water down the value of our currency. Don't buy bonds. The inflation driven by rising prices of oil, precious metals, raw materials and agricultural products has only just begun.
About the Author
J Stromsteen is a small business owner with many years experience in the finance and insurance industry. She writes for the website Bush's Depression to provide up to date information on the unfolding financial crisis .
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