Friday, September 26, 2008

What to Do When Doctor Says All Options are Bad?

Wall Street's big money boys charge each other pay day loan rates. Since they don't pay that kind of effective interest, credit dried up. One analogy for the credit crisis is clogged arteries. Given the patient's lack of health insurance, the government is currently evaluating treatment options.

One, spend $700,000 billion for a cardiac catheterization, balloon angioplasty, and multiple stent insertion. This involves scraping and collecting the calcification inhibiting the circulatory system, including a Lehman valve replacement.

Two, do nothing. Hope the patient improves its credit diet and the fat cat starts exercising. This requires dramatic change and high costs. Large interest rate increases are needed to cut the fat and fuel the exercise needed to shed those unwanted pounds.

What are the risks? Heart attack in either scenario.

From the nonclinical view, the market didn't price credit adequately in the past. Interest rates didn't properly account for the risk of repayment. Banks and investment houses are in free fall as a result. The government proposal is to take over their failed products. What happens if they don't?

Interest rates will reset to address the heightened risk. How high might they go? A look at the piece of mind rates on Wall Street credit provides some insight. Credit default swaps are a form of coverage used by investors holding an organization's debt instruments. The annual rate for $10 million of Wall Street investment house credit rose from $100,000 last summer to $900,000 on Thursday, September 18. The rate hovered between $400,000-$700,000 since that dark day.

Might they double, triple? Who knows, but the reset will likely be major. A $700 billion bill for economic good health or a monstrous increase in interest rates? Both options are bad for this sick patient....