Thursday, April 17, 2008

The Basic Problem In a Nutshell

From the WSJ:

But large financial institutions have grown more cautious about lending to even highly rated companies since their capital reserves have been depleted by subprime-related bonds that have soured and loans to speculative-rated, or junk, companies that are stuck on their books. Such a curbing of lending is another worrying sign for the sagging U.S. economy since it means companies will have a more difficult time raising money during what is already a trying time.

The US -- and every other developed world financial lender -- uses a fractional reserve lending system. All this means is a bank can make loans so long as it maintains x% of assets related to the loans.

But all of these writedowns we're hearing about lower the amount of a bank's capital that is available to make and back-up loans. So long as we're having these problems, expect to hear about problems in the credit markets.