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.
Friday, August 10, 2007
Economist Paul Krugman has posted an essay on the current turmoil in financial markets around the world. He doesn't paint a pretty picture.
Posted by Bruce Prescott at 10:42 AM