After all that typing, I figured it best to move this up front:
Huck notes Dr. Paul's riposte: "Consumer prices are going up, no matter what your CPI says."
The CPI is an index designed to remove evidence of inflation from consumer prices. It is absolutely incredible how one can measure the price of anything specific from apples to gasoline to laundromats, with the single - and temporary - exception of consumer electronics, and one will find they rise, year after year, at a double-digit rate. Yet once they are aggregated, they come out at about 1.5%/yr. It's freaking criminal.
As of now there are few - either in government or the financial press - who don't take the CPI numbers as gospel. When it becomes widely accepted that they are almost completely unrelated to the thing that they claim to measure, all hell is going to break loose.
The biggest problem in Subprime* is not that some people can't pay their mortgages, but that no one knows what the debts, sliced and diced and packaged as they are, are worth. No one knows what's in them, so they can't price them. And when you can't price something, and when no one wants it, the value is zero.
Now, fast forward to the day it becomes widely accepted that CPI is worthless, that inflation is far higher, maybe 5x higher, but no one really knows.
How do you price government bonds? Sure, there will be a market and it will be far more liquid than subprime ever was. But the price will also be far, far lower than today** because without reliable information upon which to make financial decisions, people will err on the side of safety, they will simply not accept 5% for 30 years when they fear that inflation is twice that or more. The buyers, as they say, will go on strike until they are confident that they have honest numbers upon which to make financial decisions.
These banks think the writeoffs they are taking today are bad***, but they have not seen anything yet.
* It's bigger than just subprime but that moniker will have to serve for now.
** Meaning interest rates will be far higher than today.
*** And they are correct.