There are two main views on the financial crisis that began last September. The mainstream view, as expressed by the US Federal Reserve, is that it was a problem of liquidity. Banks became frightened to lend, and so the Fed stepped in as “lender of last resort”. So given time, everything will soon be back to “normal”.
The other view, as expressed by Pimco, the world’s largest bond fund managers, is that the crisis was, and is, about solvency. As they describe it, US consumers have suffered a wealth loss of $15 trn, and global consumers a loss of “multiples of that figure”. As a result, Pimco forecast a “new normal”, for at least a generation, of “higher savings, lower consumption …and growth closer to 2% rather than (the historical) 3.5%”.
The blog continues to side with the Pimco analysis, for one simple reason. This is that it has long argued that the heart of the financial crisis was the reckless lending to the housing sector. Yet these loans are still on the books of the lenders at close to their original value, at a time when US house prices have fallen by more than 30% from their peak, and the number of foreclosures is still increasing.
Now, a very detailed article in the Wall Street Journal by 2 Stanford University professors analyses the real value of these loans. And they are “clear that the problem was not liquidity, but rather the insolvency risks of counterparties with large holdings of toxic assets on their books”.
It may suit the lenders, and the Federal Reserve, to maintain that the issue is just liquidity. But after reading this article, and the lack of transparency that it describes about the real value of these loans, the blog feels it is only prudent to follow Pimco’s analysis, rather than the Fed’s.