Paul Krugman helps me understand something that had been puzzling me -- how can subprime lending problems be causing such widespread financial issues? He says we're seeing a kind of bank panic. Ever since the Depression, we've gotten used to their not being bank panics thanks to the Federal Deposit Insurance Corporation. But "consider the case of KKR Financial Holdings, an affiliate of Kohlberg Kravis Roberts, a powerhouse Wall Street operator."
KKR Financial raises money by issuing asset-backed commercial paper — a claim that’s sort of like a short-term C.D., used by large investors to temporarily park funds — and invests most of this money in longer-term assets. So the company is acting as a kind of bank, one that offers a higher interest rate than ordinary banks pay their clients.
It sounds like a great deal — except that last week KKR Financial announced that it was seeking to delay $5 billion in repayments. That’s the equivalent of a bank closing its doors because it’s running out of cash.
Since KKR and similar firms aren't technically "banks" the systems in place to prevent bank panics don't apply to them. But they function like banks. And the mortgage meltdown has made people skittish generally, creating panics in areas of the economy that aren't necessarily closely related to the subprime mortgage market.
The good news, it seems to me, is that when the dust clears it should be relatively easy to fix this problem. The programs aimed at preventing panics at traditional banks are, after all, highly successful. Maybe I'm wrong, but it doesn't seem like it would be hard to devise a way to extend the system. In the interim, though, who knows.
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