Thursday, October 09, 2008

The blame-game (3)

This crisis is so huge and complex that I don't think you can fairly cite anything as the main cause.  But it is certain that the way we account for securities has contributed, by turning illiquidity in various banks into insolvency.  Moreover, while deregulation played a role, so has regulation.  One of the reasons that severe markdowns are such a problem for banks is that the thin balance sheet triggers a ratings downgrade.  At that point, many large institutions are legally prohibited from investing in them; others are forbidden by charter.  The change in the government sanctioned rating kicks in government rules which ensure that bankruptcy rapidly follows a writedown.  Did I mention that financial firms are not allowed to restructure in bankruptcy?  They have to liquidate.

That's Megan McArdle.

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