What Happens When Everyone gets a Margin Call at the Same Time?

Paul Krugman had a great op-ed piece today in the NYT appropriately named the "Face-Slap Theory." Here's a taste:

One consequence of the crisis is that while the Fed has been cutting the interest rate it controls — the so-called Fed funds rate — the rates that matter most directly to the economy, including rates on mortgages and corporate bonds, have been rising. And that’s sure to worsen the economic downturn.

What’s going on? Mr. Geithner described a vicious circle in which banks and other market players who took on too much risk are all trying to get out of unsafe investments at the same time, causing “significant collateral damage to market functioning.”

A report released last Friday by JPMorgan Chase was even blunter. It described what’s happening as a “systemic margin call,” in which the whole financial system is facing demands to come up with cash it doesn’t have. (A financial joke making the rounds, via the blog Calculated Risk: “Who is this guy Margin that keeps calling me?”)

You'll have to check out the article for yourself to read on.