11/10/2008 05:12 am ET Updated May 25, 2011

Breaking The Fever: Could This Crisis Also Be The Cure?

The first phase of this cure is reduction of debt throughout the financial system. So far, overall losses to financial institutions are $400 billion to $600 billion, and that may well go higher. This requires cutting balance sheets -- assuming banks are levered around 10 to 1 -- of around $4 trillion to $6 trillion in in lending and asset sales.

For example, the bankruptcy of Lehman Bros. meant about $600 billion of debt was eliminated. This inflicted losses on holders of Lehman debt, and that flows through the chain of capital. The destruction of Lehman Bros.' capital (around $20 billion) also permanently diminishes the capacity for further credit creation in the future.

The second phase of the cure is the higher cost and lower availability of credit. This forces corporations to sell assets, reduce investment and raise equity -- for example, as General Electric has done. It also forces consumers to cut debt by reducing consumption or selling assets.

Read more on The Washington Independent