Bank capital is 4-12% of assets, depending on the bank. A bank going from 5% to 4% is legally insolvent. Further, banks guaranteed claims against these and no one knows how much they are because the loans have been sold and resold so you cannot calculate who owes what to whom, so no one trusts anyone.
Further, if a bank loses capital it must reduce loans. A $1 loss in capital is between an $8 and $25 reduction in loan making ability. So, if banks lose 1% that means they must reduce lending at least 8%. A bank with $100,000,000 in mortgages that loses $1,000,000 must stop lending until it has between $75,000,000 and $92,000,000 in loans. If the bank has a lot of consumer loans that pay down quickly, it can do this through market mechanisms. If not, it has to borrow money and sell assets. Banks have stopped lending to one another and won’t buy each others assets, so bank lending is grinding to a halt.
The last time this happened, a 3% reduction in the supply of money resulted in a 24% unemployment rate within 12 months. John McCain’s stunt this weekend truly is endangering the nation. If a deal isn’t done soon the nation will go over a tipping point, like kicking over a line of dominoes that once started will be outside government control or intervention. If it isn’t solved soon the system will seize up and layoffs could start in weeks or months if we are lucky.
Related posts:
- Sen. John McCain on sub prime mortgages from SentinelSource.
- Home loans with low down payments require PMI insurance, so why are banks losing money on sub-prime mortgages?
- Why cant the government offer to buy all mortgages and stop the meltdown?
- Is the current economic meltdown affecting the prices of all mortgages in America, or just the bad mortgages?
- What caused the home mortgage rates to sky rocket, causing people being unable to pay their monthly mortgages?
