Here is a very easy to understand analysis of why the financial system is going to hell in a handbasket.

It is long so here is a snippet:

For example, a bank with an initial capital of $5 billion could
support $100 billion in outstanding loans and investments, based on the
requirement that its capital be at least 5 percent of the credit it has
granted. But if its capital falls to $4 billion, it must reduce its
outstanding loans and investments to $80 billion to be in compliance
with that requirement. In other words, a $1 billion reduction in bank
capital can cause a $20 billion reduction in outstanding bank credit.

Such announcements as that recently made by Citibank, that it would
reduce its holdings of home loans by 20 percent, are entirely
consistent with this phenomenon, as are the recent failures of banks
and brokers to make bids in markets for so-called auction-rate notes.
(These are credit instruments whose interest rates are set periodically
on the basis of auctions and that until recently were billed as the
equivalent of cash. Bidding for them would have placed banks at risk of
acquiring additional assets and indebtedness when they urgently needed
to reduce their assets and indebtedness.)

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Posted in Economics Main Page by Chris Gilbey No Comments Yet