Solvency, or just liquidity?

Krugman says some big financial institutions are probably insolvent, not just illiquid. But is he right?

Paul Krugman answers the question I raised yesterday: he says that the housing crunch is creating solvency problems, not just liquidity problems, for some large financial institutions. If so, it’s not just homeowners who are in for a rough ride.

But I’m not sure Krugman’s argument supports his conclusion. Yes, there are clearly lots and lots of bad loans out there; how many, and how bad, we won’t know until housing prices stabilize. But since not every home with negative equity will go into foreclosure, and the loss to the mortgage-holder in a foreclosure varies, the fact that a 20% drop in housing prices would put 13.7 million mortgages under water doesn’t tell me whether the banks that hold those mortgages are broke or not.

I read somewhere that Warren Buffet is buying bank stocks. That seems reassuring.

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: