Forecasts for American Financial System

There are worrying signs that the American financial system is facing real problems.

The Fed have rescued Bear Sterns and the US government nationalised Freddie Mac and Fannie Mae, however, the losses from the subprime debacle are placing at risk many other banks.
Lehman Brothers, seems the next in line which threatens to go under soon.

Lehman Brothers was one of the major non depository banks who made up the 'shadow banking system.' In other words, they didn't make loans based on deposits, but, they rebundled loans from one bank and sold them on. The idea was to spread risk, but, in practise it had the effect of hiding risk and giving banks a false sense of security to keep lending risky loans.

The Fed, are faced with a difficult dilemma. They have already exposed US taxpayers to substantial potential losses. There is also the danger of moral hazard. Rescuing banks which go under, may just help encourage more reckless behaviour.

Therefore, Paul Paulson has tried to limit the exposure of public funds to the rescue package of Lehman brothers. However, there is a danger, that without sufficient guarantees, market forces may not be sufficient to rescue Lehman brothers.

The American economy and financial system is facing an unchartered future. There is the real possibility of a collapse in 2009.