It's irrational to confuse liquidity (or the lack of it in this case) and the level of interest rates. Interest rates at 1 per cent or 10 per cent make zero difference to market liquidity, consequently anyone thinking that a reduction in official rates will help provide liquidity are going to be very disappointed!

Mark Leonard, Morpeth, England

Banks have been lending money to their own SIVs and to outside investors to buy their securitized loans. This is called leverage. Buy one mortgage- or commercial-backed bond at 7%, and we will finance your purchase of nine more bonds at a spread of 1%. This means you get a net 16%! Great deal, eh? And with off-balance sheet SIVs, banks have been able to do do this infinitely without hitting their reserve ratios.

Another genius came along and said, how about instead of nine bonds (limited supply, asset-backed), we'll give you nine credit defeault swap derivatives (unlimited supply, not asset-backed). That way banks can ship make 10x the money with the same bond supply.

A lot of commercial paper (ABCP) now has this structure. Investors figured out that 10x the default risk isn't so hot for 9% more coupon, and the CDS can't be sold and are worthless if the counterparty goes under. Nobody wants it anymore, and the banks are left holding the bag, deservedly so.

Steve, Los Angeles, USA

What's wrong is not so much that the banks don't know their 'sub-prime' totals. One could compare this to reinsurers trying to find out their total loss on a hurricane: they ask all their ceding insurers, who ask their local offices who collate their losses, and the further up the reinsurance spiral you are, the longer it takes to find out the total loss from all the levels of cedant. So the financiers will be making enquiries and trying to work back down the chain, assuming of course that an information chain exists in the same way that it does in reinsurance. Where it's gone wrong is that the reinsurers absorb business on the basis of knowing their cedants and their underwriting standards, and try to ensure that the basic insurance is being properly written. In contrast to the primary banks and mortgage lenders who seemingly abandoned proper standards without the financial market being aware? So, was it fraud by the mortgage lenders or negligence by the financiers, or a bit of both?

Ivor Duarte, Shepperton, UK

and these bwankers are the best we can do
gerrards twossers.
eaton,oxbridge waste of space.

richard barter, cherigne, france

this crisis appears to be caused by the same factors as the ENRON scandal. Bankers loaned to people who were not able to repay the loans and the bankers knew it at the time. The bankers made the loans because they made money on it and they knew that the government reserve banks would have to provide the liquidity to save the financial system. Enron created financial paper that had no value. In the present case, American home buyers who previously did not qualify to borrow money because they had no savings and inadequate incomes were given mortgages. This forced home prices above what working people could afford by traditional loan qualification standards. The problem is that a corrupt banker is not overseen by the banking industry until there is a crisis.
Today, in the US, most people live in homes that they cannot afford. Businesses are hiring people from overseas to do the work in their countries.

Martin, DAVIS,

I think that the whole financial system should be simplified. It is just so complicated that it lends itself to these crippling domino effects. Banks should re-emerge as the main financial props to institutions and investors should just stick their money in savings accounts and wait for the interest to accrue. In a world of ever shifting fortunes, where the fate of companies constantly ebbs and flows, the risks are obviously going to be immense. The system just makes it even more riskier, with everything being sliced up and sold on, hedge funds hedging their bets on futures and options and balance sheets ever more complicated.

Anjuli Davies, London,

Clement, You should put no faith in the IMF or the World Bank, these are effectively US run organizations and as such are part of the overall problem of the ponzi fiat currency system.

ADScott, Bangkok, Thailand

The liquidity problem is also related to our huge negative trade balance which is now hovering around $700-800 billion annually. We can only borrow $200-300 billion and perhaps get an additional $100-200 billion in foreign investment in U.S. corporations or property. That leaves a $200-500 billion shortfall which is real money no longer available for use in our economy. In the last few years this has totalled at least one trillion, perhaps as much as two trillion dollars a substantial part of our Gross Domestic Product. Clearly this cannot go on for much longer and sadly, there is no easy fix. We have had ample warning but the increasing cost of oil and the huge trade we have with China feeds this deficit. To facilitate more export sales we can devalue the dollar, not a pleasant thing to do and even a reasonable move in that direction would not be enough. I'm not sure that the Democrats should be so eager to get control of the Presidency and the Congress, it won't be pleasant.

George J. Brown, Ensenada, Mexico

Although by implication the newer banking concepts of securitisation and selling on packages of derivatives of client indebtedness to other banks or investors are enabling of off-balance sheet events, this is the first report I’ve seen which mentions that status.

The caution with which off-balance sheet items are sometimes viewed is based on the change to the perception of soundness which can be implied by removing items of possibly dubious quality from a time window of audit, though leaving some form of exposure to such.

The incremental release of information regarding the causes of turbulence in financial markets is building a picture in the public domain of managed opacity behind the façade of institutions of whom expectations are high.

Fear of the unknown can pose greatest danger, not only from the possibility of finding things worse than expected, but also from difficulty in devising safe solutions without full details of problems..

dr venables preller, Warminster, UK

Yes Sue.... that is exactly what the article is saying.

It is my understanding that in America at least, a bank can legally loan up to ten times the amont of cash it actually has in its vaults.

It then has to sell on those loans in a hurry.

The problem is... no-one now wants to buy those loans because we've become aware that the banks and financial institutions , mostly in the States that issued them have basically been swindling both ends of the system... swindling the customers who took out morgrtgages with false promises about ever rising home values and ultra low starting rates.....then swindling those they sold those loans on to ( Pension funds etc) as being high return, low risk "assets".

DaveGood, Coventry,

Most contracts contain pricing boilerplate which drops in reference to the Libor, but that index has now hit the jackpot. Questions regarding the safety of such clauses will now be asked of large law firms, who will in turn address these to their insurers. I know of only one firm which announced, during the current year, that it's liability would in future be limited to the amount of its fees.

This triggered a (rather overripe?) fantasy: what if bankers, brokers and traders, recipients of fees, bonuses and other gratifications, PERSONALLY bailed out sub-prime defaulters dragged into their schemes? It would make great TV, L!ive.

Dion Per Sona, Cardiff, UK,

Oh no ! Banks may have a hard time with , well , banks ! Good luck with dealing with a bundling and barely tolerable business acquaintance who cares little for anyone but himself in the often nastiest and self preserving way.

rob, Derbyshire, UK

This problem was caused because central banks reduced interest rates in order to avoid taking the necessary steps to address the previous crisis - this then laid the foundations for an even greater crisis in the future ie now - are we now going to compound the error by once again reducing interest rates rather than dealing and confronting the underlyiong fundamental issues, If we dont investment in wheelbarrows and gold may be the smart move .
If we dont the analogy throwing petrol on the flames comes to mind

JM, NI, UK

It sounds like banks are going to have to charge more for mortgages even if BOE interest rates stay the same.

When the banks have to buy so much commercial paper it doesn't leave much left for them to set aside for mortgages unless good rates can be charged.

The same applies to savings rates, which we now see regularly exceeding the BOE rate. The writing's on the wall.

Chris, Lichfield,

And all this has been caused by the very people running the show. Big bonuses, big houses, big cars and very small brains - sounds just like Gordon Brown's wonderful economy and party.

Frederick, Dubai, Dubai

I would call it greed modulation. People get stung. Slowly they want to supply\aquire more credit and sure enough someone in the chain slips up. This time it is the subprime market. But i dont forsee a total crash. Just USA loosing preferential interest rates on its national credit card in a fashion. A lot of it is due to the say $1.5 trillion bill it has foot so far for the iraq war. If our americans think they dont pay high taxes on oil that is wrong.

Scott Burton, Birmingham, England

Coming so soon after the Coventree and Sentinel affairs, we're taking this really seriously at Housing Doom blog. The great unwinding of structured finance deals will inevitably lead to a school-of-hard-knocks re-thinking of opaque money deals. We and many of our blogging colleagues have been following the subprime crisis since January, but the far reaching effects of mortgage defaults among a small minority of American homeowners has been simply astounding.

John McLeod, Halifax, Canada

Lowering interest rates again would be a big mistake. This will cause a Japanese style bubble. It will re-inflate real estate markets (which will just exagerate already record debt levels), and unleash more fools who will do bad deals and basically rape the economic system. This will provoke in a year or two an even worse crash, which will tilt the economic system into a depression. Here is what the government must do: hike interest rates to the levels we see in Iceland (13 %), shake out all the bad deals and debt (high interest rates will get people saving again), and de-flate the housing market.

Bob Macdonald, London,

The, um, "quality" of the comments here indicate pretty clearly what the root cause of the crisis is.

People are willing to borrow significant amounts of money to buy houses who don't have a clue about what they are doing.

No wonder they ended up in trouble. They were completely out of their depth.

Instead of English schools teaching happiness and self-esteem, wouldn't it be a good idea to teach basic everyday economics?

jon livesey, Sunnyvale, CA/US

Yes Sue.... that is exactly what the article is saying.

It is my understanding that in America at least, a bank can legally loan up to ten times the amount of cash it actually has in its vaults.

It then has to sell on those loans in a hurry.

The problem is... no-one now wants to buy those loans because we've become aware that the banks and financial institutions , mostly in the States that issued them have basically been swindling both ends of the system... swindling the customers who took out morgrtgages with false promises about ever rising home values and ultra low starting rates....

They made sure thier fees were front loaded.....they then packaged up these "loans" (Charging another fee for doing so).....then sold them on at a profit, swindling those they sold those loans on to ( Pension funds etc foriegn banks, governments etc) as being high return, low risk "assets.

That's how a few tens of thousands in City made 14 billion in bonuses this year

DaveGood, Coventry,

It appears that the precipitate rush by some investment bankers, seeking to maximise their personal bonuses has led to an unprecedented explosion in risk-taking.
Based primarily on ( U.S. ) mortgages and the hitherto unshakeable belief that house prices only go up, an enormous bubble, pumped up by the banks, is starting to deflate. Those who took all the gain ( investment banks, hedge funds, rating agencies ) should now have to endure the ensuing pain and not expect the taxpayer to underwrite their future comfortable existence.

Rick, London, England

A sad point to this is that people who are careful to stay out of debt and actually do save money are penalized with the continued lowering of the prime rate. To ensure a reasonable return on savings, one must ride the risky markets rather than rely on a solid, interest bearing vehicle.

The upshot of all of the Fed's "fixes" is to continue the debt cycle. We have become addicted to that debt.

Blaze, Duvall, USA/Washington

These unregulated financial clowns are the true terrorists of the modern day. Their profiteering gambling has created this problem. The fall out could bring misery and suffering to hundreds of thousands of people. You can't have your cake and sell it. These monkeys eat the cake and then speculate on the value of it as when it is re-gurgitated. Sell the forecast value of the regurgitated cake to another monkey who then splits it into smaller gobs of cake and sells the value of those smaller gobs. So tragically ironic that none of the fat bankers know how big the cake was in the first place, and who now has it, or what it looks like.

Ian, London,

within this crisis through there is oppotunity for mergers - look at the depressed state of Standard Chartered Bank - where its profits are generated in asia and middle east business is booming and no problems - a timely point for a large instituition with emerging markets ambition to make the bid sooner rather than later

Asian Growth, LONDON, UK

Despite all of this, banks are still offering loans to people ill equiped to make the payments. I have read about a student who was offered a loan, and told that if he did not take it, his credit rating would be viewed as low, and he would struggle to get a loan later on in life. The worst companies are those who always advertise around tea time, offering consolidation loans. If people can't really afford loans, they can't really afford to consolidate them either - these ads play on the lack of financial understanding by people who have no training and little experience, and should be banned.

tony, birmingham, uk

Costas

Unfortunatly Cyprus is also not on 'the good diet' - we have a massive property bubble here, fuelled by a massive credit bubble, and an economy that is reliant on consumption and tourism. We are just as vulnerable, if not more, than the UK and USA when this thing spills over into the wider economy.

Wake up and smell the keftethes !

Yiannos Ioannou, Limassol, Cyprus

Eric, the UK is much the same as the US when it comes to lending rediculous amounts of money to people who clearly cannot afford to ever pay that money back, subprime mortgages and property flipping.

The official figures for our subprime is 8% but I doubt that figure is all that close to the truth, I suspect it will be much higher once its effects kick in with our very shakey economy.

The UK is now a nation built on nothing but debt.

Mf Flibble, Cambridge,

It was reported, several months ago, that many that got these subprime loans, were illegal aliens...mostly out West. They should never been allowed to purchase a home, while here illegally or not being a citizen! Reports said many didn't even understand what they were signing.....but oh no...the main stream media and PC folks won't report much on this.

Bobbie, USA, USA

People who complain about the inadequacies of the banking system should perhaps look to the flaws of the alternatives - from the Soviet Union to the UK's own experiences in state planning, other ways of allocating capital are simply much worse.

To adopt Churchill's quip about democracy, the global capital markets are the worst way to keep the economy functioning, except for all the other systems that have been tried before.

James, London,

The slow down in home sales in the US is just starting to fall off a very large cliff and by spring we will look back and see the dramatic negative effects to the US and World economy. The slow down in US consumer purchases and lower dollar will slow the US economy and then slowdown the world economy. Witness that the last reported trade deficit for the US was down even though forecasts were it would be up. The slow down has begun already.

Gwilym McGrew, Los Angeles, California / USA

Rank idiocy masquarading as financial sophistication and masked by the most crass and arcane gobbledegook invented to disguise how dumb the financial world has actually become. The bottom line: do you REALLY want your money back when you lend it to someone? Why don't you just give it away and stop pretending you'll get it back!

Chris Thomas, Oxford, England

What happened in the USA - Part 2.
The banks really didn't care too much about whether the loans were properly underwritten or not...they simply sold most of the ones they did not want to keep in house. Wall Street ate this up by packaging these into large groups to be sold to investors and hedge funds & insurance companies. The rating agencies did not do a good job of correctly rating these grouped securities as is evidencd by sudden big drops in the ratings starting as early as December 2006. This started freaking out the stock market. The loans they sold these folks started to adjust upwards and they became behind in their payments. European bankers are musch ore conservative and most of these subprime loans would not have been made at all. But the real problem falls squarely at the feet of Greenspan, who after 9/11 flooded the market with low rates and liquidity (good) BUT LEFT IT WAY TO LIQUID TOO LONG. All this cheap capital tempted all the above to people who never should have.

Eric, Washington, USA

Here's what's been happening in the USA the last 4 years:
People with poor credit scores (high risk to borrow to and not so good at paying bills, often even coming out of bankruptcy, were loaned money to buy a home. Real estate prices were moving steadily or even rapidly up in some markets. Investors saw rapidly rising markets and bought properties to flip. Both of these groups did not have much in anything to put down, but no problem, the banks and mortgage brokers were glad to sell them loans anyway as they are paid on commission. Many but not all of the lenders lowered their underwritng guidelines so they could compete and get the loan sale. The appraisers saw rapidly rising markets and appraised properties to fit the loans (if they are too conservative then the mortgage brokers do not refer customers to that appraiser and he goes out of business) The underwriters often took these loans without doing a good job of verifying income...just a stated amount will be fine... end Part 1

Eric, Washington, USA

Property is theft. Haha

ZAP, Londonein,

Almost aways, the rich get richer -- no matter up or down. But this time, a rare moment of great satisfaction to the hapless prols, only some of the rich will get richer -- for they all will have to savage each other to see who gets the surprisingly small remainder.

Rick, Orlando, USA

In Cyprus we say "the man who doesn't have the money to buy his bread is lucky because he is on a good diet". This is not the case in the USA and the UK; if you don't have the money to buy something you simply borrowed. Now the time has come to pay and your fat bulk can't move fast enough to adapt to the new conditions. Maybe the man on the "good diet" is more clever than you.

Costas Papadodulos, Nicosia, Republic of Cyprus

Risk is like a wild animal. The fact that you bring it home and cuddle it does not make it tame. This is what banks and investors should have known when they were pricing risk as if it had been outlawed. In fairness to the Bank of England it did warn the banks that they were living dangerously but everybody was enjoying the party too much to listen. There is nothing unusual about what is happening. It's just a simple case of Mr Risk making a collect call on the bankers.

anthony, london, England

As the Chinese appear to wish to diversify their holdings of T bonds and other dollar denominated assets into other assets they are unlikely to be buyers of US government debt. This suggests it will have to be made more attractive to other buyers.

So how do you square the circle?

Yields on T bonds need to go up to attract the buyers, but US interest rates need to come down to avert a credit crunch.

Print dollars instead of issuing debt?

N Reed, Truro, UK

"The Bank Of England's remit is to control inflation. So why are we suddenly keen to feather bed banks who have lent money irresponsibly? Banks have earned fantastic returns in recent years. Let them live with their mistakes. The Bank should concern itself solely with inflation. "

Go and watch 'Its a wonderful Life'. If the banks start to fail, as they might, then the financial system goes in to meltdown as in 1929 and the years following. The financial system depends on confidence, as it's all an illusion.

I would love to see the scummy bankers and city whiz kids bakrupted and broken. But the scumbags would take us all down with them.

"The Bank Of England's remit is to control inflation. "
Thought it was look after the financial system as a whole.

Neil Murphy, cromer,

This has all come about because of poorly thought out types of transactions being put together simply to 'justify' paying massive bonuses. Result- nobody has a clue what losses are out there and who has them. Even big banks don't yet understand the possible scale of their own losses, because no-one knows the market value of the 'assets'. What a shambles- all to enrich a bunch of incompetents who clearly don't understand the businesses they run.

Doug, Glasgow,

The sub-prime debt is all secured with real properties with
real buildings on them! The shady world of the yen carry market and similar inventions of the "smart money" men to cover their losses in crooked deals in the mid-east and China is a very different matter. These are the same people who bankrupted Barclays. Expect more bank collapses.

Paul Robbins, Alamosa, Colorado, USA

NRK has around £1Bn in cash, if it has to self-fund it's obligations (the £8Bn mentioned), how will it do this, or will it simply default on it obligations (perhaps even go bust)?

Andrew Price, London,

The Bank Of England's remit is to control inflation. So why are we suddenly keen to feather bed banks who have lent money irresponsibly? Banks have earned fantastic returns in recent years. Let them live with their mistakes. The Bank should concern itself solely with inflation.

David B, Larkhall, UK

So we pay bankers £1m+ a year each to lend billions of our money to people who can never possibly re-pay it, who don't bother to take a note of what they lent to whom, then when it all goes wrong and the economy slows, we lose jobs and homes while the bankers laugh all the way to...the bank.

Global capitalism is a sick joke, but only the rich are laughing. When are we going to realise it isnt working?

julian, london,

Yippee! Roll the on the mother of all property crashed...

cww, Ipswich,

How do you ensure yourself against this Sue? Buy Gold.

Linus, Leamington,

To quote:

"...In the short term, the credit crunch is forcing up the cost of borrowing and the Bank is concerned that this could spill over into the wider economy, making it difficult for businesses to raise long-term finance...."

I don't understand this. The Learned Economist at the Times, David Smith and the Council of Mortgage Lenders both assure us that there is no Sub Prime problem and I am sure that they have a logical foundation for this.

In the mean time why can businesses and the consumer not keep borrowing against their properties most of which are still 'worth' £200-500k for the moment? Prime Minister Brown Unelect can always put pressure on the BOE to allow the printing of the 'money'

For me, I think I will invest in wheelbarrows....

Pete Balchin, Solicitor , Bristol, UK

Is it any wonder that financial ineptitude is apparent in the way a large proportion of the general public run their budgets. Here we have the "clever" money men running for cover in an extremely unstable market riddled with unsupported debt. Those same clever people have just spent ten years encouraging the public by every means possible to rack up as much debt as they, the banks, were prepared to support. Now there is a whole load of chickens coming home to roost I fear for Joe Public who will ultimately pay the price of others incompetence.

mike gee, bournemouth, uk

Typical media scare-mongering. Stock markets will shrug this of imminently, and by next spring will be 20% or more higher than now.

Mike M, Brookline, USA

Are you telling us that banks have loaned more money in total than there exists in total, so the Federal Reserve and the European Central Bank, and maybe the Bank of England, are simply inventing more cash from nowhere? They are just printing money and using it as if it has really been created by wealth makers when it doesn't really have value to back it up?
This would mean a massive devaluation of every currency this is geing done to, Euros, and Dollars, and Pounds as well if the BoE is involved. We will be back to bartering for goods and services like they were in Siberia! What value my bank balance then?
If this is true they are going to have us all in the same hole as Zimbabwe.
What do these central banks do if not make sure the money they are regulating is of real value? Wages would be worthless, jobs not takeable.
And to reality - what do I do to ensure myself against this?

Sue Doughty, Reading, UK

Here you! Banker. I have a large brown parcel which contains
securitys worth £100million but they will be worth £200million in
6months.i,ll let you have them for £75million.Is the financial system
that stupid?

colin, peterborough,

There are strong divergent views on the subject:while the IMF says that the subprime crisis will impact the US and the global economy in general, while the World Bank economist (Francois Bourguignon) said that" the US housing finance crisis will be resolved in a couple of months without much impact on the broader US economy...any effect on the subprime crisis on the expansion of the US economy would off-set by the faster-than expected growth in the first half of 2007... as a matter of fact,we aree not even modifying our forecasts". Bottom line: nobody knows really and that is positive.

Clement, Paris, France