Root Out Bad Debt or More Pain Will Follow

The devastating credit squeeze that has been gumming up the interbank and commercial paper loan markets for months shows few signs of letting up. The underlying problem remains firmly in the market for subprime mortgages.

During the savings and loan crisis of the late 1980s, dud mortgages were held by the banks that issued them. This made identification of the infected institutions simple and the solution obvious: shut them and sell their assets at a steep discount. The bill to the US taxpayer was considerable, about $125bn, but the damage to the wider economy was minimal because the crisis was well contained.

The subprime virus is far more difficult to quarantine. Securitisation of mortgages has spread the financial risks around the economy in such a way that banks are no longer likely to go bust from holding the bad loans they originated. read more