Capitol Hill Blue Forums Political Issues Finance, the economy & Economics How will the financial crisis develop?

Kap, isn’t that the main problem we face—frozen credit markets and not necessarily mortgages gone sour?

If a money market fund loses money, that's called "breaking the buck." It's simply not supposed to happen. Except that it did, last week. On Monday, the Reserve Fund broke the buck. And people freaked out.Breaking the buck causes a little bit of panic. Frightened investors raced to escape money market mutual funds. It so happens that the main thing money market mutual funds own is commercial paper, the same financial short-term loans that make ordinary businesses possible. The system essentially shut down for about 12 hours.

The run on money market mutual funds is why, no matter how safe and trusted a company was, they couldn't borrow money last Wednesday. The people who usually loaned those companies money — meaning the many ordinary people with money market mutual funds — had hauled too much of their money out of the system.

This chain of events is part of what convinced Paulson and Bernanke that the situation had gone too far. If the panic had continued for more than a day, they reasoned, the wider economy would start to shut down.
What would happen is nobody would be able to borrow money, and how does capitalism work if you can't borrow money? You're back to bartering, pretty much. The extension of capital almost came to a halt — just ended, period.

I think a continuation and magnification of this is the biggest fear of Paulson et al. Whether US citizens like the system or not, it’s the system we have and it is currently in very real danger without willing creditors able to lend money, and large amounts quickly.