http://money.cnn.com/2007/10/17/news/ec ... tm?cnn=yes
Third, there has to be a complete discrediting of the view that says asset prices are not that out of line and it's only a matter of time before liquidity comes back to the market. The opposing view - that, in fact, liquidity can't return in earnest till bond prices fall to levels that look enticing - has to become the new orthodoxy, all the way up to the Fed.
Bernanke seems to be a committed proponent of the former view. In explaining the Fed's recent actions Monday, he said a central bank has to do things that will prevent sales of assets that "will drive the prices of those assets well below their longer-term fundamental values, raising the risk of widespread insolvency and intensifying the crisis."
Banks basically loan out your money. When you go to the bank and make a deposit, they take your money and make loans on it. To be FDIC insured, government guaranteeing you against loss, they are required to keep a certain amount of assets on hand so that if you come and want to withdraw $100 of your $10,000 you can.
What has been interesting is how the definition of assets has changed or been loosely regulated. For instance, some people estimate that for every $1 in assets on the books, there are 20 loans counting this asset as backing. This happens because a dollar allows you to turn around and loan a portion of that out, then that loan is taken repackaged and now claimed as an asset which is again leveraged to make another loan ect... Debt supporting debt, are you scared yet?
So what is going on now, and has been all summer regardless of how its been portrayed as a sub prime crisis, is that suddenly no one knows really what this repackaged debt is worth. Used to be that people could only use high quality loans as assets, but repackaged debt has taken good loans and subprime loans and comingled them into a unit with a somewhat arbitrary value. These were being traded on the stock market and between that and each bank's extensive pricing model a value was determined and used to make new loans. Now the market for subprime loans, and really most real estate period is non existent, so you can't see this restructured debt at all, yet banks are stuck with tons of it backing other loans.
What happens if the banks write down the value of these assets? They can't make any loans. The backing of debt with debt multiples the effect... perhaps 20x. So people feel that Ben of the Fed is basically going to try and prop up the values of this repackaged debt so the banks don't have to write down their assets and effectively create the real "credit crunch" (where people with good credit can't get loans because there is no money to loan). More than simply propping up the values of this debt, they are propping up home prices because even if you have high quality loans (based on credit score) if you have a $400k mortgage on a houes that is worth $300k on the market you don't have a high quality asset.
The only way to avoid a credit crunch is to either allow banks to lend more money than they have assets to back (forcing the tax payer to take on additional risk because FDIC is the government) or force the banks to sell off all these poor assets (at fire sale prices) so that they can start all over again at zero (and some going bankrupt / getting bought out in the process).
You want to know whats really funny other than the people proclaiming that this was a sub prime problem all summer and Greenspan claiming even up to 2 years ago that there was not a bubble market in real estate? Remember the Japanese buying up America in the 80s and the decade long recession in south east asian economies? That was japanese banks lending stupid amounts of money to people to buy american property at inflated prices then refusing to write down their assets after it became apparent that the loans were not going to be repaid and the assets were not worth the purchase price so that the economy had no capital for investment loans. American banks were forced to write down and this is largely credited with the success we've had in our economy relative to the stagnation in south east asia. Along the way, a bunch of American banks consolidated and got bought up or ceased operation.
China made a bid for a large stake in Bear Sterns. We're in for a painful history lesson unless Ben pulls his head out of his ass.