The Insolvency Crisis: How we got here, and what to expect

Pol/Econ: The Insolvency Crisis: How we got here, and what to expect | Saturday, 11 August 2007 Written by Garrett Johnson
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In late 1997 the hedge fund Long Term Capital Management was Wall Street royalty. With not one, but two Nobel Prize winners in economics on staff, they consistently generated 40%+ returns for their investors. Their mathematical models seemed to have conquered all the mysteries of high finance.

Then they lost $4.8 Billion in 1998 and nearly became insolvent.
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A large percentage of those new mortgages were 2/28's - a low, two-year "teaser" interest rate, which then resets to a much higher market rate. As those mortgages reset, foreclosure rates spiked.

"Normal foreclosure rate in the United States is anywhere from 300,000 to 500,000 per year. Now the projected rate is 1.7 million," said Jessica Cecere, president of Consumer Credit Counseling Service.
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This isn't 1998 all over again. We've gone beyond that.

Today we do not have only a liquidity crisis like in 1998; we also have a insolvency/debt crisis among a variety of borrowers that overborrowed excessively during the boom phase...the recent sharp widening in corporate credit spreads is not just a sign of a liquidity crunch; it is a sign that investors are realizing that there are serious credit/solvency problems in some parts of the corporate system.

If you needed any proof that there is a credit crunch in America today, look at what is happening with credit cards.

In a form letter, Capital One told her the interest rate on her credit card was about to almost double—she’d been bumped up from a fixed 8.9 percent rate to a "variable rate that equals the prime rate plus 6.9 percent"—or about 15.8 percent. The letter blamed rising interest rates across the economy for the decision.[...]
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