The news is coming at a furious pace right now -- and none of it is good. We're seeing Central Banks injecting money, more funds going under and lenders getting hit by a credit crunch.
First, a brief primer. Liquidity makes the current economy work. "Liquidity" is an eco-geek way of saying there is usually a buyer for a specific product at a specific price.
Secondly, here's a basic example of how this liquidity works. Let's say you go to the bank to get a home loan. After making the loan, the bank sells the loan to an investment bank like Morgan Stanley, Citigroup and the like. These investment banks package the loans into pools of similar loans (the same interest rate, size etc..) and sell these pools to investors like pension funds, mutual funds and insurance companies.
Here's the problem right now. In the above-descried chain of buyers and sellers, the investment banks aren't buying right now. Nothing. And that's freezing up the whole financial system because the system depends on the upstream, institutional buyer always being there.
Here's the latest example:
NEW YORK, Aug 9 (Reuters) - Two of the largest U.S. providers of home loans, Countrywide Financial Corp (CFC.N: Quote, Profile, Research) and Washington Mutual Inc (WM.N: Quote, Profile, Research), on Thursday said difficult mortgage market conditions are likely to hurt operations in the near term.
Countrywide, the largest mortgage lender, said it faces "unprecedented disruptions" in the debt market and secondary market for mortgages. It said these "could have an adverse impact on the company's earnings and financial condition, particularly in the short-term."
Washington Mutual, the largest U.S. savings and loan, said liquidity in the market for less-than-prime home loans and securities backed by the loans has "diminished significantly." It said that while this persists, its ability to raise liquidity by selling home loans will be "adversely affected."
If these guys can't find buyers, then no one can.
To remedy the situation, central banks around the world are injecting liquidity.
Central banks in Europe and Asia injected billions more dollars into the banking systems Friday as they again moved to boost liquidity in markets suffering from the subprime credit crisis.
The European Central Bank said it had provided 61 billion euros ($84 billion) to banks in a three-day tender offer.
The loans came on top of the roughly 95 billion euros it handed out in its biggest ever cash injection Thursday after overnight interest rates spiked.
.....
In Asia, the Bank of Japan supplied 1 trillion yen ($8.48 billion) after a rise in the overnight call rate. And The Reserve Bank of Australia injected A$4.95 billion ($4.17 billion).
Basically, the central banks are giving lenders money so they can make loans. Will this work? Who knows. But this is what central banks can do at times like this.
The short version is this is getting uglier and uglier.
I want to add this caveat. The US financial system is very strong and can withstand a tremendous amount of stress. My guess is we're going to come through this without a major catastrophe like a bank failure or the like.
But -- we're going to test the systems strength right now. And that means there will be plenty of nail biting.
Update [2007-8-10 9:42:43 by bonddad]:: I will be on KTLK AM 1150 in Los Angeles at 12 PM Pacific Time to talk about what is going on. Here's a link to the radio station. They are supposed to have a live stream on the site.