Unblocking the pipes

I've just seen this article on Bloomberg. It is actually rather reassuring.

I said before that the financial sector needs to contract substantially. To do this, it needs to deleverage and it seems increasingly likely that this is going to be hard because, once its trash mortgage portfolios are marked at a realistic price, large chunks of the sector are going to be insolvent. If you are insolvent, the value of your assets is not sufficient to meet your debts. The only way to resolve this impasse is through bankruptcy, passing the shortfall on to your creditors. This is what needs to happen to unwind the leverage and restore credit-worthiness to the system. It is good to see this is happening, and that the mortgage portfolios are being marked more realistically in the process.

It looks like the US legislature will be able to pass the Paulson plan in some form this weekend. Hopefully, it will be discretionary enough, and its managers will be astute enough, to use it to cushion this process of deleveraging rather than as a wholesale recapitalisation of the system. This latter action would only serve to transfer the gap between the value of assets and liabilities onto the public balance sheet rather than liquidating it. In other words, rather than allowing the banks' creditors to suffeer the consequences of their unwise investments, those consequences would be met by the US taxpayer.