Friday, August 10, 2007

Krugman on the Current Liquidity Crisis

Economist Paul Krugman has posted an essay on the current turmoil in financial markets around the world. He doesn't paint a pretty picture.

When liquidity dries up, as I said, it can produce a chain reaction of defaults. Financial institution A can’t sell its mortgage-backed securities, so it can’t raise enough cash to make the payment it owes to institution B, which then doesn’t have the cash to pay institution C — and those who do have cash sit on it, because they don’t trust anyone else to repay a loan, which makes things even worse.

And here’s the truly scary thing about liquidity crises: it’s very hard for policy makers to do anything about them.

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