Good Layman's guide to the financial crisis

[Rank amateur]

We're really getting somewhere on this thread. I think that by tomorrow we will have narrowed down the culprit to one single person,

It's really not that complicated. Lenders used to make money when people paid their loans back. Then the rules changed. They started making money off commissions whether the loan was paid back or not. I suppose you could blame the people who'd played by the new rules, but no matter how much of a free marketeer you may or may not be, I can't imagine why you'd rather pay $700 million than admit that one of governments responsibilities is to ensure that lenders make their profits by getting paid back.

[Ken White]

It's really not that complicated. Lenders used to make money when people paid their loans back. Then the rules changed. They started making money off commissions whether the loan was paid back or not. I suppose you could blame the people who'd played by the new rules, but no matter how much of a free marketeer you may or may not be, I can't imagine why you'd rather pay $700 million than admit that one of governments responsibilities is to ensure that lenders make their profits by getting paid back.

Pity the shakers and movers do not...

Note the date. Quote:"''These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis,'' said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ''The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.''" Unquote. LINK.

[bourbon]

Washington Mutual: Price versus Failures-to-Deliver, September 26th, 2008 by Patrick Byrne. DeepCapture.com



Naked short selling on the largest bank failure in U.S. history. Latest FOIA data came in from the SEC, data is through June.

[reed11b]

everything we have been saying on this thread in an easy to read format found here. Funnier too!
Reed

[Schmedlap]

... I can't imagine why you'd rather pay $700 million than admit that one of governments responsibilities is to ensure that lenders make their profits by getting paid back.

I'm not sure where you are getting that impression of my opinion. I think you're confusing someone else's view for mine. I'm the one who pointed the finger at (among others), "regulators who failed to enforce regulations" and "legislators and officials who did away with sensible regulation".

[Adam L]

This mess is one of the primary reasons that I am now in law school and finishing up my MBA on the side. My money is not earning anything in the market and probably will not for the foreseeable future, so I might as well spend it on something useful rather than watch it evaporate in my portfolio and depreciate faster than it earns interest in the bank.

Don't you just miss the days when Americans invested in bonds. What ever happened to war bonds. Ken? LOL!

Adam L

[Ken White]

Don't you just miss the days when Americans invested in bonds. What ever happened to war bonds. Ken? LOL!

Adam L

What's a War Bond??? Sounds like something before my time (though I still have two books partly full of Savings Stamps ).

[jmm99]

Yup, I too have some War Bond stamps - and a couple of ration stamp booklets - and, I can't even approach Pink Bunny's longevity.

But, that retrospection got me a-thinking (a dangerous thing) about another facet of this problem.

When did I last buy a bond ? Not exactly certain, but 5 years ago probably - one left in the "portfolio". Used to like muni bonds for two reasons: (1) tax free interest, and (2) they finance things I could agree with - schools, etc.

What happened during Clinton-Bush was a steady, on-going policy of low level interest rates that makes bond buying not a great investment. Long-term low interest rates have also hit investments in savings accounts and CDs.

That has been most notable in my senior clients who used to rely on interest to supplement SS, persions, etc. E.g., a couple with 200K at 5-6% could count on $10-12K in added income.

So, while low interest rates are great for "go-go" types, they have gutted the resources of middle-class savers. What I am seeing are folks who had, say, 200K in savings 5-10 years ago, who now are lucky to have 50-100K.

[Adam L]

You hit it right on the head. It has been sureal watching Samuelson's laws of economics, and reasonable bond rates with them, all but dissapear over the last 20 years.

Adam L

[Sergeant T]

Just a thought or two. It would seem that a large contributor to the current problem is the repackaging and selling of debt (credit default swaps). Didn't a guy named Ponzi perfect this idea about 80 years ago?

I would love to see is the creation of a big gun, high caliber federal agency to go after people that skirted/broke the law at all levels of this thing. The Bureau is too busy looking for Al Qaeda under the bed and isn't real interested in the mission. FinCen has the best people in the world at following the money. Charter them to be an independent agency and let it fund itself though fines and asset seizure, like the DEA and OSHA do now. When people that handle money have something to fear they might be a little more responsible. It wouldn't remedy the stupidity aspects responsible for this but it would close some cracks.

I can't see the system getting corrected in a meaningful way until we sever the connections between lobbyists and elected/appointed officials. I think we've reached the point where the only way to see that effectively implemented is through a constitutional convention. No one at the congressional level shows any serious sign of self-correcting behavior.

One last thought. This explains the current mess better than anything I've seen.

[J Wolfsberger]

... It would seem that a large contributor to the current problem is the repackaging and selling of debt (credit default swaps). Didn't a guy named Ponzi perfect this idea about 80 years ago?

A Ponzi scheme (in 25 words or less) involves using current paid in capital to pay dividends to previous investors, while concealing the lack of operational revenue. What we're dealing with is quite different.

The market raises capital and provides liquidity to the mortgage industry by purchasing mortgages, packaging them into "mortgage backed securities," (something of a misnomer since the tangible asset, property, is available in the event of default), and reselling to investors. The packages consist of various combinations of prime, alt-a, and sub prime mortgages. A security high in prime and low in sub prime gives minimum risk and lower return. A security high in sub prime and low in prime gives maximum risk and higher return. Meantime, the original lender can write new mortgages based on the money received from selling the earlier mortgages.

Absent this "liquidity" (i.e. the ability to turn the mortgages into cash) your local bank would be limited to writing mortgages based on the Fed's reserve requirements. Your local bank, because of banking regulations and its fiduciary responsibility, was also only making loans to people who qualified as "prime" borrowers. On to part two

I would love to see is the creation of a big gun, high caliber federal agency to go after people that skirted/broke the law at all levels of this thing. ... When people that handle money have something to fear they might be a little more responsible. It wouldn't remedy the stupidity aspects responsible for this but it would close some cracks.

Enter the Community Reinvestment Act. (The link provides a generally useful summary. However, do a lot of fact checking, since there is a huge effort/debate to edit the entry and protect the guilty.) In the late 90s, the CRA required certain lenders to make a portion of their loans to sub prime borrowers. Now enter Fannie Mae and Freddie Mac, and recall the above about liquidity in the market. These two entities stepped in to provide the liquidity necessary for the sub prime market. In effect, they became middle men between the sub prime lenders and the larger capital community.

Keep in mind that 100,000 loans a year to sub prime borrowers, at say $150K per loan, works out to $150B. The capital need was actually a lot larger. And multiply that figure by 10 for the number of years this has been going on.

I'll spare every one the spider web of deregulation, re-regulation and regulation changes that allowed all that to happen. The bottom line is that, for noble intentions, a part of the mortgage industry was required to enter a high risk area. To make it work, a lot had to change, especially including lending requirements. Talk to any real estate agent you know about low-doc, no-doc, NINJA, 80-20, no down, etc. loans. And remember that interest rates are determined by risk.

The only way to get all those low income people into homes was Adjustable Rate Mortgages (ARM). Which works fine, as long as home prices continue to rise, the economy keeps growing, and the owner can find a buyer if he has to bail out. When those things don't happen, and the ARMs adjust up to a payment the borrower can't meet, foreclosures start increasing. Unfortunately, the borrowers couldn't bail because implementing CRA goals created a bubble.

The problem was that the supply of affordable low cost housing is fixed. If you're a general contractor, you don't build $100,000 homes at a small profit when you can build MacMansions at a big profit. The segment grew, but not near quickly enough to satisfy demand. Add to which, the original owner of the $150K house discovers he's got $50K+ of equity, and goes in search of a larger house in a better neighborhood with better schools. The whole structure created a housing bubble.

And I can state with 100% accurate foresight the outcome of any economic bubble: It will eventually burst.

This one has. And the way it's burst involves the liquidity of the market. A foreclosed loan still represents a tangible asset: the property the mortgage was taken out to purchase. Thus, the mortgage backed securities still have value. But a) the value is considerably less than face value, b) no one knows where the market will bottom out so no one knows how to value them, and c) as result, the market for mortgage based securities dies. They can no longer be converted into cash. No one knows when the liquidity will return, if left to the market.

Thus the "bail out," except it really isn't. The government will be obtaining securities backed by fixed assets. In return, by "making a market" for those securities, the government will restore liquidity. The final cost (loss to the taxpayer) is likely to be in the area of $200B to $300B. We, the taxpayers, won't see any profit out of this. That money was lost, permanantly, when the bubble burst.

I can't see the system getting corrected in a meaningful way until we sever the connections between lobbyists and elected/appointed officials. ... No one at the congressional level shows any serious sign of self-correcting behavior.

No. And we won't. When you hear our elected officials chant "failed economic policies," keep in mind that the current adminstration identified the problem and tried to correct it in 2003. Also notice that no one in congress, from either party is calling for hearings. (At least not that I've heard.)

[selil]

One last thought. This explains the current mess better than anything I've seen.

That was pretty good. I just wish they wouldn't talk so fast.

[J Wolfsberger]

... can be found here.

[jmm99]

thanks Wolfberger.

Well, I didn't read it - so, no comments on the bill itself.

But, here is one about those who will vote on it. Before leaving for work, I saw a brief clip of an Obama interview. Said he was satisfied that the bill included his "principles" - then said he hadn't read the words, yet.

Not picking on Obama - I expect McCain would have to give the same answer - and I support neither of them.

That reminded me of a comment many years ago by my faculty advisor Eric Stein (bio here - oldest active law professor in the country as of the bio)

http://www.lawcrossing.com/article/index.php?id=1197

who told me, in effect:

You're young and idealistic; and think if you can get to Washington, you can change things. What you will find, even if you are President, is that you are dependent on thousands of people. In effect, they make the decisions - you merely make the choices between them. Change must be institutional, not individual.

[Tom Odom]

Joe G on the "Save a Wolf"

Commentary | Trust us? In a pig's eye, I say

..."Trust us," he asked most earnestly.

I howled with laughter. "Trust you? Trust YOU? After all that's gone down in the last seven-plus years?"

He at least had the decency to begin laughing along with me at so ludicrous a suggestion falling out of his own mouth.

Now they're at it again. The Bush administration is telling Congress and the president himself is on television telling the American people: Trust us.

Trust us with a check on the national treasury for $700 billion, and that's just for starters. We don't need no stinking oversight. Trust Treasury Secretary Henry Paulson — a Wall Street critter whose last civilian paycheck was for $38 million for a year's work — to make sure the money is wisely and conservatively spent.

Maybe we should just borrow some Zimbabwe Dollars and make our 3rd world status official. After all more Zim dollars are available:

Zimbabweans fill streets to withdraw cash from banks

HARARE, Zimbabwe (AP) -- Tens of thousands of Zimbabweans lined up at banks Monday, desperate to take out their money after the government raised the limit on daily withdrawals.

Every day in Harare, Zimbabweans line up at banks. After withdrawal limits were raised, the lines blocked traffic.

New rules went into affect Monday allowing withdrawals of up to 20,000 Zimbabwe dollars. about $35 or 25 euros. The old 1,000 Zimbabwean-dollar limit was barely enough to buy a newspaper.

The limit and the fact that Zimbabwe has the highest inflation rate in the world -- officially at about 11.2 million percent, unofficially much higher -- has meant long lines at banks most days.

But Monday was extraordinary, with lines resembling crowds at a soccer match.

Tom

[slapout9]

We need some 4th Generation money

[AmericanPride]

Bailout fails to pass through the House. When should I start converting my dollars into monopoly money?

[Tom Odom]

Maybe we should just borrow some Zimbabwe Dollars and make our 3rd world status official.

Ok I was wrong--not Zim dollars

We are gonna try a reverse Nigerian transfer scam

Dearest one,

This email may come as a surprise to you, but I need the assistane of someone with trust and discretion and I know that I can rely on you. I need to ask you to support an urgent secret business relationship with a transfer of funds of great magnitude.

I am the head of the Treasury Department of the Republic of America. Due to a crisis in my country, I have the opportunity to transfer 800 billion dollars US. If you would assist me in this transfer, it would be most profitable to you. This transactin is 100% safe....

Yours Faithfully,
Henry Paulson
U.S. Secretary of the Treasury

[Schmedlap]

That was a good summary. You've got more patience than I do.

Thus the "bail out," except it really isn't. The government will be obtaining securities backed by fixed assets. In return, by "making a market" for those securities, the government will restore liquidity. The final cost (loss to the taxpayer) is likely to be in the area of $200B to $300B. We, the taxpayers, won't see any profit out of this. That money was lost, permanantly, when the bubble burst.

Kind of like a wealth transfer from the middle class to the lower class - except it comes well after the fact, when the lower class has already spent it and is well into the post-binge hangover.

Also notice that no one in congress, from either party is calling for hearings. (At least not that I've heard.)

It's kind of early for that. Even as ineffective and do-nothing as our current Congress is, not even they would be so blatantly negligent as to hold hearings before doing something - however flawed - to attempt to address the current problem. If one party has a solid majority and control of the White House after the Nov elections, then I would expect that party to hold hearings to ensure that their side writes/re-writes/edits/fabricates the history of this abortion to suit their desired narrative.

[Ron Humphrey]

Am I incorrect in my reading of this that the office which the Secretary will implement this through (Office of Domestic Finance of th Dep of the Treasury) shall be headed by an Assistant Secretary( read forward to clerical amendment to 5315 title 5 = Secretary of Housing and Urban development)?