We all know by now–because it’s been repeated to us by our news­pa­pers and inter­nets and tele­vi­sions ad nau­seam–that the fun­da­men­tal prob­lem at the heart of this whole eco­nomic crisis is the so-​called “toxic assets” held by banks, many (but not all) of which have the form of mortgage-​backed securities.

But if you’re like me you may be won­der­ing what the scale of that tox­i­c­ity is. How bad are things really?

Now we have a number. Here’s com­menter Dan from Yves Smith’s Naked Cap­i­tal­ism blog. (For my fellow human­ists: the OIS spread is, among other things, an indi­ca­tor of how much credit is avail­able out in the world, the bigger the number, the less credit is avail­able, hence an “explosion” is not good; LEH is, or was, Lehman Bros.):

I under­stand that the explo­sion in the OIS spread is a reflec­tion of the fear banks have for each others sol­vency. And it makes sense that it exploded right after the bank­ruptcy of LEH–it was not the bank­ruptcy per se, IMO, but the that $110b of senior LEH debt went from trad­ing .95 to .12 in a matter of days that con­cen­trated the market’s atten­tion. If you include the less senior debt that is trad­ing at essen­tially zero, LEH had $110b hole in its bal­ance sheet….

Now is there a prece­dent in this his­tory of bank­ruptcy–exclud­ing cases of account­ing fraud–where bonds col­lapsed like this once a bank­ruptcy court opened up the books? I’m think­ing the answer is ‘no.’ Which then makes you re-​evaluate the premise that there wasn’t fraud at LEH in mark­ing the value of their assets.

Now extrap­o­late this rea­son­ing across the entire bank­ing system and, voila, you have the seizure of the inter­bank lend­ing market.

And the really bad news is that the bailout, even if it were to pass, wouldn’t fix this problem:

Now this leads me to the ques­tion: if the OIS spread rep­re­sents emi­nently legit­i­mate fears of inac­cu­rate marks on banks books, how is a com­mit­ment from the trea­sury to buy hun­dreds of bil­lions of dis­tressed assets from the banks any assur­ance to a coun­ter­party that that bank will not still become insol­vent. Obvi­ously it helps on the margin, but the stag­ger­ing hole in LEH’s bal­ance sheet that was revealed after bank­ruptcy cre­ates pro­found fears about the true sol­vency of C or UBS. Until the market is con­vinced they are sol­vent–and TARP does not do this–the OIS spread will remain ele­vated and lend­ing will remain frozen.

Scary stuff.

And on that note, I really can’t rec­om­mend Naked Cap­i­tal­ism highly enough as the place to go if you want to try to keep a handle on what’s hap­pen­ing these days in the econ­omy. If you haven’t been tuning in there lately, the short ver­sion is that Smith believes we are in for a pretty mas­sive shrink­age of the econ­omy (on the order of 4-5% of GDP) no matter what anyone does or does not do in terms of bailouts. He’s a critic of the Paulson-​Dodd plan, not because of the pre­pos­ter­ous rea­sons adduced yes­ter­day by House Repub­li­cans, but because he’s con­vinced that the Paul­son plan will lead us down the (unsuc­cess­ful, and very painful) path of the Japan­ese crisis of the 1990s rather than the (suc­cess­ful, though still painful) path that Sweden took to handle its crisis in the 1990s. What’s more, Smith argues that the scale of the finan­cial mess is simply too big for the U.S. gov­ern­ment to try to prop up. The other day he posted an esti­mate by Ken Ohmae that it would take $5 tril­lion to really set things straight–money, need­less to say, that the US doesn’t have and can’t get.