Friday, September 26, 2008

The Economy and the 1989 Loma Prieta quake

In 1989 the Loma Prieta quake hit the San Francisco Bay Area. Two of the bridges in the area had very different outcomes.

On the left is the Bay Bridge, which failed in a single section. The bridge was repaired in about a month.

On the right is the Cypress Viaduct portion of the Nimitz (880) freeway. It was a double-deck design (just like the Bay Bridge) but faulty construction in the columns allowed the entire section to collapse, killing many in the lower deck (and none too fun for those in the upper deck).

It's a good thing the single section failed on the Bay Bridge to dissipate the stress, or else the whole bridge may have come down.

In the past several years, the banking industry has worked hard to minimize risk on loans by chopping them up and selling pieces off to each other. That way, if a single loan fails, each bank loses a little but no one bank gets hit hard.

But what if many loans fail? That's the problem now. If many loans fail, the banks that own these Mortgage-Backed Securities no longer know how much they have. Which means that if someone walks into the front door to get a loan, the bank can't know if they have the assets to cover the loan.

Which means credit can freeze. And apparently that's what's happening right now. The NY Times has a headline, Credit Enters a Lockdown:
“Loans are basically frozen due to the credit crisis,” said Vicki Sanger, who is now leaning on personal credit cards bearing double-digit interest rates to finance the building of roads and sidewalks for her residential real estate development in Fruita, Colo. “The banks just are not lending.”
This uncertainty needs to be resolved so that business can move along. That's the move behind the current (estimated) $700B "bailout." The bad guys in this are many, but before we can punish them, we need to keep the market from freezing up entirely.

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