But...but...they told us the subprime crisis was contained...that means...[sniff]...they weren't being 100% honest?

I have a very naive question about money, especially the electronic kind.

So we have a number of mortgages that were set up based on inflated house prices that have rates too high for the borrower. These loans are not being paid back causing a liquidity crunch to the institutions that created the money for the loan.

So in my simple mind, as these properties go into default and devalue, some of the money just evaporated. This is just the reverse of how the money was created in the first place, it was blinked into existence via the mortgage loan process.

The fall out of this is that the currency that was created on paper is not being paid back in reality, or at least not enough of it is getting back to the bank to maintain a positive cash flow. Ultimately this means the properties will lose value and not all of the money created will get back to the lender.

My question is this. Why can't the Fed and other central banks bail this out by giving enough cash directly to the lenders to cover their shortfalls of defaulting payments and allow them to rework their long term income stream back to a positive cash flow?

Some percentage of that mortgage created money is gone for good but the Fed can just create some new money to take its place that can be used for something other than originating mortgages.

I don't see it as a requirement that the Fed has to cover the entire defaulted value in 2007 (many of the loans must be 15 years or longer with interest accruing all the time), just keep the cash flow close to what was planned. Over time the housing stock will be revalued (but still retain value above $0) and allow everyone involved to cope with much lower profits than expected. My thinking is that all the new houses built did add assets to the economy just not nearly as much as the loan valuations projected.

I would think the goal of the Fed and Central banks is to get cash into the hands of these big originators but prevent them from using it to originate new risky loans going forward. This keeps the money circulating but gradually shrinks the risky debt back to a manageable small percentage. What's missing in my assessment of why this won't work?

Hopefully there are competing posts addressing this so I get a better scope of how the money supply works.