The sub-prime loans are only part of the problem with the economy. The shortfall and run on the bank at Northern Rock in the UK was due to the recent fad in the financial world - mastered in the US by the largest banks, that we suddenly had to have in recent years - where the banks hold little and extend themselves significantly by borrowing from other banks and then selling off their loans in bits and pieces. It's the same old story that when things are going up, hooray, people make money. This becomes a problem when the market softens and then suddenly the banks are overextended (holding cash to support a loan is soooo yesterday) and nobody is interested in buying the once high-flying bits and pieces. Suddenly a once large (perhaps inflated is better) bank is scrambling to find money and everyone else is already scrambling to keep themselves afloat so that cash is no longer available.
Bernanke is finally talking about regulation but whether it is too late is another question. Mr. Bubble had been completely asleep at the wheel and even talked about the problem being exclusively the sub-prime loans. Of course, they are part of the problem but banks overextending themselves may turn out to be a much bigger problem for the economy. As the higher rates kick in for adjustable loans and defaults increase, finding cash will be even more difficult because who wants to buy such risky securities now that the floor is collapsing? Northern Rock - a bank which is now worth a few billion less and had to be propped up by the Bank of England - could very well be setting the example for what is in store for US banks.
The global rejection of the dollar is another sign of the problems that are ahead. The movement towards the euro and other currencies is signaling a lack of faith in the US economy which is burdened with the high cost of Iraq plus the problems with the diving real estate market and the soft economic forecast. The sub-prime problems are clearly a problem, but only the most immediately obvious problem. Mr Bubble will surely be called into question again and again as the US banking industry stumbles as the market for selling off loans dries up. As the US learned in 1929, over-extending with small cash reserves to cover loans that are 10-20+ times the value eventually result in a messy situation. Just remember who failed to regulate and provide over site as this fantastic new system was rolled out.
