Suppose you are the CEO of a financial institution, say some speculative fund. Here is how you operate. People invest money with you, and you use that money as collateral to borrow five times more.
With all the money you have now, you start speculating for instance in real estate. As long as the value of the stuff you buy goes up, all goes well. You use the cashflow you receive to pay the interest on your loans and you make big bucks. Furthermore, you use the real estate you own as collateral to borrow more....
But... suddenly there is a downturn in the housing market. As you used those walls and bricks as collateral, the banks you borrowed from, will ask for more collateral or even require immediate payment of your loans. Suddenly you have a liquidity problem.
But only you as CEO knows how big that problem is. You know that you borrowed from bank A, B, .... K. But the individual banks know only the amount of their own loans.
Do you think you are going to tell them, before you really have too? Of course not! And that's why the magnitude of the credit liquidity problem is still a big, but unknown number.
No comments:
Post a Comment