The problem is too much leverage

in institutions who have implicit guarantees from the government. If you make the guarantees, you need to control the risk, or you will get the wrong amount of risk. We had lots of ‘risk-shifting.’ Financial services firms with implicit guarantees swinging for the fences and taking riskier and riskier bets as things got worse and worse.

But now we are so levered that we are either heading towards—or in a situation of— Debt overhang – Wikipedia, the free encyclopedia.

Debt overhang also applies to financially distressed firms, where the existence of debt removes the incentive to invest in positive NPV projects. This is because if debt repayments are large enough, any benefits from good investments will go straight to the creditors, who have seniority over equity holders.

But it was not caused by CRA–those who say so are misleading, at best.

I should add: we are not in a liquidity crunch for the financial services firms, but I think that instead, many of them are insolvent and should close.

Explore posts in the same categories: Uncategorized

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: