The U.S. Federal Reserve has moved quickly to avert a financial crisis. Earlier this week, the Fed slashed its key interest rate to calm international markets. The rush to provide liquidity is intended to head off a panic and the possibility of a global capital crunch. The Fed's action is only a first step. Now, banks must come clean on their balance sheets. Investors must have confidence in financial institutions if the market is to find a floor.
Economists have warned of bubbles in U.S. markets for some time. Financial regulators conceded that real estate markets were dangerously inflated but insisted the problem was local. In recent weeks, however, it has become clear that "frothy" markets have developed virtually nationwide. Worse, the credit instruments that generated the froth — subprime mortgages and the packages that combined them — were distributed throughout international financial markets, leaving the institutions that held them dangerously exposed if the bubbles burst.
The bubbles did burst, and it was discovered that most banks and investment companies were holding overvalued paper. Global financial markets have lost more than $6 trillion in value this month. Lending has virtually ground to a halt as financial institutions struggle to make sense of balance sheets. Consumers are also hurt: They have used rising real estate values to finance their spending, which has risen every quarter in the U.S. for 16 years.