Quote:
Originally Posted by competentone
The banking/lending-institution situation (including what Freddie and Fannie are facing) is pretty serious, no matter how you slice it.
The problem is much greater than the "sub-prime" lending already discussed heavily in the mainstream media. The problem extends into the entire mortgage market (and the entire lending market for that matter, but I'll limit my comments here to primarily mortgage lending).
Many "prime" mortgages are a problem on the balance sheets of the lending institutions because the collateral (the houses) have declined so drastically in value. Even those who had 30%-40% equity in their homes just a couple of years ago, may now, in some markets, be "up-side-down" -- owing more than the market value of their homes.
This puts the banks in a bad situation. The bank was able to lend at a low interest rate because the institution not only had the "promise to repay" from the borrower, but also had the collateral -- the value of the home/property -- to protect its loan if the borrower defaulted.
With the collateral worth only partially what is owed on the loan, the "rating" on the mortgages (or "re-packaged instruments" the mortgages might have been rolled into) is not as high as it was when the collateral was worth more than the amount owed under the loan.
Banks/lending institutions have certain standards they need to meet in order to be considered "solvent." With the "ratings" on their loans (or mortgage-backed securities) dropping, due to the declining value of the collateral underlying those loans, the banks can quickly enter a position of technical insolvency.
The government, primarily through the actions of the Federal Reserve, is trying to "pump" money into the financial system with the hopes of keeping housing prices up -- in order to protect the value of collateral supporting all the outstanding mortgage loans.
The problem with the government's actions is that it is inflationary. If the new money pumped into the economy pushes all prices up (as it will) the banks may return to a safer position of "solvency," but the inflation then creates new problems.
The banks/financial industry has trillions in outstanding loans at very low interest rates. An up-tick in inflation can easily make those low-interest rate loans poor quality investments. Imagine a bank that had lent money on a mortgage at 5% and the inflation rate is now running at 10%! That loan is losing money.
The Federal Reserve is "hoping" to walk a "very fine line" and pump just enough liquidity into the system to keep home prices from declining and "save" the banking system, but not put too much liquidity into the economy to create a situation where price inflation turns all the outstanding loans into declining assets -- which would then push the banks back into a position of insolvency!
My opinion: The Fed cannot succeed in saving the banking system. The credit bubble was just too big. Its collapse is going to take a lot of banking institutions with it.
It is going to be a mess.
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An interesting footnote is that the "credit bubble" was actually created by the Fed when it kept interest rates below the levels the marketplace would have set them. The credit bubble was literally decades in the making; its collapse will take just as long no matter what actions the government/Fed tries to take now. In fact, the more actions the government tries to take to "keep things going" the longer full recovery will take. A "hands off" policy by the Fed (I know it won't happen, but theoretically speaking) would allow market forces to correct the problems a lot quicker.
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I thought I'd bump this up.
In case you haven't noticed, the "mess" is here.
Pay attention to those (like me) who are warning about the risks of price inflation now. Just as I was right back in April, you will see that I'll be right about the price inflation coming to the economy.
Got gold?