Economist says renewed financial crisis looms unless government acts

Jan 23, 2009
Economist Anne Villamil says signs of a renewed financial crisis already have emerged, including tighter lending as financial institutions brace for surging unemployment that will leave people unable to repay mortgages, credit card bills and other debt. Photo by L. Brian Stauffer

(PhysOrg.com) -- Another crippling financial crisis looms unless the U.S. government thaws credit markets that are starting to freeze up amid a lingering and deepening recession, a University of Illinois economist warns.

Anne Villamil says signs of a renewed financial crisis already have emerged, including tighter lending as financial institutions brace for surging unemployment that will leave people unable to repay mortgages, credit card bills and other debt.

“Defaults will lead to more losses at financial institutions and potentially a return of the financial crisis,” she said. “Since U.S. debt is also held abroad, renewed financial turmoil also could lead other countries to reduce their exposure to U.S. debt, which would drive up U.S. interest rates, lead to exchange-rate swings and further worsen the U.S. economy.”

Villamil says President Obama is trying to jump start the sagging economy and ward off another financial meltdown through a proposed stimulus plan that includes $825 billion in tax cuts and new spending to create jobs.

But she says the new administration has yet to lay out a specific plan to stabilize the financial system, unlike Great Britain, which recently adopted measures to kick-start lending and quell concerns about the health of the nation’s banks.

In the U.S., Villamil says likely solutions are bank recapitalizations, potentially including government ownership; government acquisition of “toxic debt”; and federal assistance to homeowners, small businesses and displaced workers to prevent default.

Insolvent banks are a serious threat to the nation’s economy, already mired in its deepest downturn since the Great Depression, she said.

Troubled financial institutions may not provide consumer and business loans that are essential for commerce, Villamil said. Alternatively, imprudent loans could be made that effectively gamble bank funds at taxpayer risk in hopes of returning banks to profitability.

“Government intervention to address the financial crisis is essential because the government is the only agency that is big and patient enough to address the problem,” she said.

Villamil studies financial contracts and the impact of inflation on public finance. She is co-editor of the Annals of Finance and an associate editor of Economic Theory, the European Economic Review, and the Quarterly Review of Economics and Finance.

Provided by University of Illinois

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googleplex
not rated yet Jan 23, 2009
The tax payer bail outs are the biggest mistake of the past century.
If any support is given it should be to the healthy banks. There are plenty that did not recklessly gamble in the mostly un-regulated credit and cds markets. Those well run banks should get more funds to enable them to lend more. Giving bankrupt banks money is perverse! It rewards bad management and sets a precedence contradicts fundamental economics. Let the bad banks fail, extinguish the debt, support the remaining "good" banks and we can be through this downturn in a year instead of a decade or longer. Bankruptcy has worked wonderfully for years and is a healthy part of capitalism.
People don't realize that debt is being shifted from the investment banks to the tax payer. Am I the only one who can see what is happening?
Paradox
not rated yet Jan 26, 2009
I agree with googleplex. As for the banks, I'll bet that most people don't know that they're still doing the same things that got into this mess in the first place, giving out housing loans that are way too high for the borrower to be able to afford. My apprentice just got approved for 400,000$ and he makes 17$ an hour. WTF???
googleplex
not rated yet Jan 30, 2009
Amazing isn't it!
The reason why governments cannot just bail us out is that this problem is too big. The downward spiral is continuing to accelerate. The shockwaves will reverberate through the financial system for some time. From a cold detached economic standpoint this unwinding is going to be fascinating in its magnitude. From a humanistic standpoint lives will be lost, careers and dreams ruined. Why oh why don't they regulate now to minimize the damage and pull this sucker out of a nose dive? If Margerate Thatcher was still a player she would fix the mess in less than a month. This needs a true leader with balls. I hope Obama comes thru but I fear he will get obfuscated by the same people who created this mess.