FTR:

At the risk of sounding somewhat ridiculous, let me say , "Solvency is an accounting fiction."

You have two very nice ties. I like one of them and would like to wear it. I offer you one million dollars for the one I like, financing the transaction with a no doc loan with zero down, secured by a trust deed on the tie. This loan is bundled, sliced diced, and some of the best resulting tranches are placed in a SIV.

You take the million dollars in proceeds and realizing that your remaining tie, similar in all respects, is also now worth a million dollars, feel you can spend the million from the first transaction. You do so and benefit the economy.

Unfortunately, I experience difficulty making the payments on my million dollar tie when the teaser rate expires and my payments go from $2 per month to $6000 per month. Ouch. Plus, they are selling similar ties down the street for $50. All, in all, I decide to place the tie in the mail and sent it to the bank who is servicing my tie-purchase loan. Even Steven.

The marketplace of high-quality inexpensive ties is causing many people who also overpaid for their tie to do the same. The SIV investors get wiped out, and maybe the purchasers of the commercial paper issued by the SIVs also loose money.

But what difference does it make? Except that I now no longer own a million dollar tie, and you realize your remaining tie is only worth $50 not 1M. We feel poorer, but in reality nothing has changed except that you got to spend some of the money that formerly belonged to some poor schlubs who invested in a hedge fund that invested in an SIV. Their loss, your gain.

The real economy did not contract or expand as a result at all.

Moral of the story: a lot of people in these pages talk about how our economic system is founded on debt and that without ever expanding debt it will all collapse. I don't think that is true. The only thing that allows society to consume more is an improvement in productivity. Consumer debt is in virtually all cases nonproductive (compare: the vehicle that allows a worker to get to a factory). As a result, lending just transfers consumption in the present from one person to another at a price, and with a certain risk of default.

Of course, we Westerners have as a society taken debt financing to unsustainable levels and our lenders (China, Saudi Arabia) are about to cut us off. We will inevitably default. But what we don't consume in the future, they will.

PO is a problem, because it causes a dramatic decline in our productivity as a global economic system as what was once produced easily becomes difficult and expensive to obtain. That and we may end up nuking one another, which would result in a rather significant decline in productivity as well.