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The author of the article "Financial Engine Failure" compares the concurrent failure of the twin engines of the BA flight from China to Heathrow to the failure of the banking and financial markets in the US. He places blame on LBO debt, complex mortgage-backed securities and consumer and commercial-property lending for America's decline into recession, and concludes by claiming that the recent cut in interest rates by the Feds, due to the concern of bank failures, may not be the solution.
A drop in the stock market has increased adverse selection and moral hazards because it has resulted in a weakening of the market value of firms' net worth, so lenders are less eager to lend, as deficits from loans are likely to be acute. This decline in lending has then triggered investment and aggregate yield to decline. Also, the waning corporate net worth has increased moral hazard inducements for companies to make risky investments because they now have less to lose. Again this increase in moral hazard makes lending less attractive.
The failure of financial institutions in the mortgage debacle, together with the drop in the stock market has led to uncertainty in financial markets. It is more difficult to determine good from bad credit, which again has resulted to a fall in lending, investment and cumulative activity.
The source of the current bank panic therefore, is asymmetric information. The result is that loan funds have been reduced and the price of intermediation has risen, which has caused a drop in investment and a decline in aggregate economic activity (Mishkin). ...
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