Friday, February 15, 2008
Crisis of Faith in Financial System
The Michigan Higher Education Student Loan Authority has suspeneded a major student-loan-program after collapse of its auction-rate securities. These securities were used to obtain a lower interest rate for long term loans. Unfortunately, the securities contained a penalty clause that if the auction fails, the interest rate jumps. The auctions were not supposed to fail, but because of contagion in financial markets caused by failures in the sub-prime mortgage market, the auction-rate securities market has collapsed. According to Paul Krugman of the New York Times, The Port Authority of New York "saw the interest rate it pays leap from 4.3 percent to 20 percent."