?

Log in

No account? Create an account

The financial crisis. Let me show you it

« previous entry | next entry »
Sep. 30th, 2008 | 09:40 am

This American Life did a marvelous job of explaining the subprime mortgage meltdown, and they're working on a followup to explain the current crisis. I think that followup airs at the end of this week.



1) The US government, by various means and measures, encouraged a higher and higher percentage of home ownership (the highest in US history).

2) Eventually, all of the "good" mortgage borrowers were used up, in a macroeconomic sense. They didn't need or couldn't be persuaded to refinance or to borrow more.

3) A huge pool of money became available internationally for investing, right after Enron and several other high profile corporate failures. This pool of money sought safe, consistent returns on investments, and mortgages were considered quite safe and conservative.

4) Government policy and this investment money collided, creating a huge market to lend to less and less qualified borrowers. Mortgage banks, investment banks, retirement funds, and various other investors offered and bought up more and more risky loans, on the principle that a certain, well understood percentage of them could fail, but no less than that.

5) To serve calls for more from these investors, big financial institutions created financial instruments that "sliced and diced" large pools of mortgages, and sold them like shares of stock or mutual funds. Banks, retirement funds, and other investors held these shares as part of their assets.

6) Within the last year or so, far more of those mortgages failed and went into foreclosure than the principle, above, allowed. The investors stopped buying them. Investors who held them (and still hold them), now have billions of dollars worth of mortgages (and parts of mortgages) that can't be valued with any certainty. They're probably assets and worth something, but when no one will buy them, it's hard to tell.

7) When your assets have an uncertain value, you can't borrow against them, and you can't make loans backed by them. Banks and other financial institutions stop lending to each other. The inter-bank lending rate goes through the roof for what little funds are still available. This is what has been happening for the last 2 weeks, and part of what has Paulson and Bernanke so scared.

8) The easy flow of money between banks and institutions that we take for granted stops. You can't buy anything at the store this week (even on a debit card), because your employer has to pay payroll out of cash on hand; it can't use a short term loan as usual. But that doesn't matter, because the stores can't afford the cash to maintain a full inventory. But that doesn't matter, because the trucks can't afford the cash to buy diesel to ship goods. But that doesn't matter, because the factories can't afford the cash for raw materials. And on and on. It ripples into the service economy, the entertainment industry, utilities, and (eventually) taxes and government services.

That's what really has Paulson and Bernanke so scared. And they're right to be, but I disagree with a $700,000,000,000 bailout that buys up all those mortgage papers --especially since insiders at the Treasury admit that they pulled that number out of the air, because it just sounded good.

Other good explanations:
NY Times: Diamond and Kashyap on the Recent Financial Upheavals
This American Life #355: The Giant Pool of Money
Kiplinger: 10 Things That Will Change
WashingtonPost.com: Bailout Could Deepen Crisis, CBO Chief Says

Link | Leave a comment |

Comments {26}

(Deleted comment)

Clayfoot

The bailout as an old car

from: clayfoot
date: Sep. 30th, 2008 02:49 pm (UTC)
Link

Here's one explanation I heard recently:

Say you have an old car you want to sell, so you can get a new one. Maybe it's a priceless antique, but maybe it's just a junker. I want to help you get rid of it, so you have the money to get the car you need.

One thing I could do is buy the car from you, at some price I think is fair, and for less than I think I could sell the car later. Problem solved, right? The thing is, I'm now stuck with the problem, and you're free to go on your merry way. That's what the current financial bailout proposes to do.

I could also loan you the money for another car, or otherwise invest in you in some helpful way. The junker car is still your problem, and you have to figure out what to do with it, but at least you have the money for another car, now. That's another way of solving the current financial crisis: Instead of buying up the subprime mortgage securities, the government could buy shares in the banks that hold them, providing enough cash for the banks to operate while they figure out what to do with the securities.

Reply | Parent | Thread

Tender Shredder Betty

Re: The bailout as an old car

from: thekerriproject
date: Sep. 30th, 2008 04:16 pm (UTC)
Link

But... but... but... the government buying shares in banks is the anti-thesis of our beloved Capitalism. Government-owned banks? Isn't that Socialism?

Reply | Parent | Thread

Clayfoot

Re: The bailout as an old car

from: clayfoot
date: Sep. 30th, 2008 04:21 pm (UTC)
Link

Yes. Yes, it is. Buying hundreds of billions of dollars of mortgages? Also Socialism. Communism, really, since it's about managing the economy for the common good. Even China seems to think this is less and less of a good idea. It just never seems to work out as well as the government intends.

Reply | Parent | Thread

(Deleted comment)

Clayfoot

Re: The bailout as an old car

from: clayfoot
date: Oct. 1st, 2008 01:31 am (UTC)
Link

I knew I thought of it somewhere!

Reply | Parent | Thread

Tender Shredder Betty

(no subject)

from: thekerriproject
date: Sep. 30th, 2008 02:29 pm (UTC)
Link

The house mulls over other bills for years but they think they can push this one through in a weekend.


I read a lot of house members simply voted the sucker down (after being offended by that horrible woman Pelosi for one) and because it didn't address bankruptcy in any detailed way.


I'd call it a first draft. Something will get approved and hopefully we all have enough fuel, heating oil, canned goods in our pantries until they write a bill that can fly.

Hopefully!

Reply | Thread

Clayfoot

(no subject)

from: clayfoot
date: Sep. 30th, 2008 03:30 pm (UTC)
Link

Hopefully so! I don't mind if the House takes a little while to figure out something better. It wouldn't have passed as is in the Senate either; apparently, the Senate already had some changes in its version.

Reply | Parent | Thread

T_Rex

(no subject)

from: t_rex
date: Sep. 30th, 2008 02:29 pm (UTC)
Link

Thanks! I understood pieces of the problem, but couldn't quite string all the pieces together.

So, what I want to know is this. Would it be better to let the market correct itself, over time, rather than do this bailout thing to get the economy going again? It would hurt worse, perhaps, but in theory the economy would be stronger than before once it recovered. Seems like a bailout would get things moving again, but the underlying issues would remain in large part.

This isn't a question for you, necessarily, but it would be nice to hear your opinion if you have one. Maybe NPR will explain that part, too.

Reply | Thread

Clayfoot

(no subject)

from: clayfoot
date: Sep. 30th, 2008 03:27 pm (UTC)
Link

The honest answer even from the experts: Nobody knows. Temporary government measures (like the stimulus package earlier this year) usually don't work. They create a temporary "bump" in the overall trend, and then the economy continues the trend as before. This bailout, as proposed, is so big that it might actually prevent a collapse. Then again, there may be no collapse, package or no package. If we do bailout these big financial firms, then we accept that some private institutions are essentially too big to be allowed to fail, and we enter a new era of American politics and economics. I, too, am looking for expert opinions on what to expect.

Reply | Parent | Thread

T_Rex

(no subject)

from: t_rex
date: Sep. 30th, 2008 03:38 pm (UTC)
Link

>If we do bailout these big financial firms, then we accept that some private institutions are essentially too big to be allowed to fail

I'm not comfortable with the precedent that would set. If you are "big enough", it doesn't matter what you do, or how lousy your business practices may be. The government will always bail you out.

Reply | Parent | Thread

Clayfoot

(no subject)

from: clayfoot
date: Sep. 30th, 2008 03:43 pm (UTC)
Link

--Even worse: As soon as you attain that status, the government won't even allow you to get close to failure. It will intercede before you're actually in trouble. This is something like how we treat public utility monopolies, now, only it will be for companies that ostensibly have competitors that could do business just as well or better.

Reply | Parent | Thread

Ozy_y2k

(no subject)

from: ozy_y2k
date: Sep. 30th, 2008 03:43 pm (UTC)
Link

The precedent's already been set, though. It was set decades ago, when the government under Reagan bailed out Continental Illinois under the theory that the bank's failure would be too big for the overall economy to absorb.

That precedent was reiterated just earlier this very month when the government bailed out AIG.

Reply | Parent | Thread

Clayfoot

(no subject)

from: clayfoot
date: Sep. 30th, 2008 03:59 pm (UTC)
Link

Continental Illinois is a better example than AIG. At least AIG got a loan, and was left in possession of its "illiquid assets." With the current package, the government proposes to buy up those assets, and transfer the problem of what to do with them to the government. Since we have some institutions that were bailed out with loans (like AIG) and some which were allowed to fail (like Bear Stearns), we still have an opportunity to let the investors keep their bad investments, and perhaps allow the market to choose a new set of big players who won't bank on the federal government to bail them out for taking their own foolish risks.

Reply | Parent | Thread

Ozy_y2k

(no subject)

from: ozy_y2k
date: Sep. 30th, 2008 04:07 pm (UTC)
Link

Well, yeah, it was a loan, but it was a loan which was repaid, in part, by warrants for almost 80% of AIG stock which were issued to the Federal Reserve. So that makes it look a lot more like an equity buyout. Granted, the Fed may never EXERCISE those warrants (and probably won't), but functionally it basically bought the right to own a huge stake in a private company, which to me smells like a bailout-of-sorts.

Reply | Parent | Thread

Clayfoot

(no subject)

from: clayfoot
date: Sep. 30th, 2008 04:27 pm (UTC)
Link

Absolutely right. Quite out of order in a free market economy. But... even a loan backed by (potentially useless) stock is better than buying up (potentially worthless) securities, and turning the government into the world's biggest mortgage holder. Somebody has figure out what these mortgage securities are really worth, and these big financial institutions are the best equipped to do that. At least, they have a financial incentive to figure it out and get it right.

I realize the risk: With banks loaded down with securities they can't value and can't sell, they still won't be able to get liquid enough. We'll face ten years of stagnant growth, just like Japan, because nobody can borrow or lend enough money to grease the economy. We're so much bigger than Japan, and so much more rich in land and in natural resources, and so much more service oriented, that I don't know if it's as great a risk for us, but I see it, I see it...

Reply | Parent | Thread

Clayfoot

(no subject)

from: clayfoot
date: Sep. 30th, 2008 05:12 pm (UTC)
Link

I caught part of this explanation at the end of last week. I guess I kinda track with his reasoning on opposing the bailout, at least as currently drafted.

Bailout Could Deepen Crisis, CBO Chief Says
Asset Sales May Lead to Write-Downs, Insolvencies, Orszag Tells Congress

Reply | Parent | Thread

 David is my name

(no subject)

from: idav5d
date: Sep. 30th, 2008 04:05 pm (UTC)
Link

Hey clay, I'd like to show some folks this post, would you consider unlocking it?

Reply | Thread

Clayfoot

(no subject)

from: clayfoot
date: Sep. 30th, 2008 04:07 pm (UTC)
Link

As you wish.

Reply | Parent | Thread

 David is my name

(no subject)

from: idav5d
date: Sep. 30th, 2008 05:07 pm (UTC)
Link

thanks!

Reply | Parent | Thread

Cirrus Strafe

(no subject)

from: cirrusstrafe
date: Sep. 30th, 2008 04:32 pm (UTC)
Link

Awesome, I had no idea what was going on aside from "DOOM DOOM DOOM" in the newspaper headlines, this is very helpful.

I've got no clue about real world economics (I'm a monopolizing economic whore in WoW though, I redesign and rebuild the Auction House economy and game market on my server like it was my personal set of legos) but there's nothing that we, as consumers, can do, right?

I mean a theoretical solution that I consider would be that every consumer and layman simply doesn't freak out and never buy anything again, to hold onto their money like it was their firstborn, and helps spur the economy's frozen gears by spending (intelligently, not impulsivly) and eventually the money will feed lifeblood into where it needs to be to keep the economy's heart alive.

Not like it's gonna happen, but it's just a theory I came up with and I was wondering if it held any ground, and why or why not (since I'm crazy interested in all this stuff, I just don't have the ability to learn about it very well =/ )

Reply | Thread

Clayfoot

(no subject)

from: clayfoot
date: Sep. 30th, 2008 05:33 pm (UTC)
Link

Being a wise, careful consumer is always good advice. You have exactly the right idea, if the public can be so persuaded. For individuals, assuming the bailout goes through:

1) Save up to buy your first or next house or car. You'll need a much bigger down payment than before. If you can pay cash for a big purchase, you'll be in an even better position to bargain for a deal. (Incidentally, your savings will also help make your bank safer from high short-term lending rates).

2) If you've got the time and some cash you won't need for awhile, there is (or will be) some very good investment values. They'll just take awhile to bear fruit.

3) Expect higher taxes and reduced services at the federal, state, and local level for years. This bailout won't come cheap.

Reply | Parent | Thread

Clayfoot

(no subject)

from: clayfoot
date: Sep. 30th, 2008 05:35 pm (UTC)
Link

Also: robogriff just got me started on a WoW 10 day trial. Where can I learn more about your WoW work?

Reply | Parent | Thread

Cirrus Strafe

(no subject)

from: cirrusstrafe
date: Oct. 1st, 2008 05:59 am (UTC)
Link

I have a Horde Druid, level 70, crapton of gold, rather good gear (nonraid, mostly arena) blah blah blah, on DragonMaw with Tsuki, FugitiveSoldier, Izequo, Rendonsmug, Marco, and Zorplex.

Also, I have a far less well off 70 druid on Alliance, over on Dark Iron, and my roommate is on it with his Tier 6 (max gear) hunter in the 2nd best guild on the server which has recently broken apart, and all the really good players formed a smaller guild which is priming for bullrushing Wrath of the Lich King when it comes out, which is meh for you, but having roots in t3h OMG guild is always good.

D-Maw is where us Halogoblins are, at least the clique I'm a part of.

Reply | Parent | Thread

Cirrus Strafe

(no subject)

from: cirrusstrafe
date: Oct. 1st, 2008 06:03 am (UTC)
Link

By the way, my AIM is KitAresSephiroth

You've always been really awesome at clearing stuff up for me and your posts tend to be brimming with intellect and reason, I wish to talk to you more and subscribe to your newsletter.

Reply | Parent | Thread

Clayfoot

(no subject)

from: clayfoot
date: Oct. 1st, 2008 12:35 pm (UTC)
Link

Sure. The IMs are all in my profile, since you're on my friends list. I'll add your AIM to my AIM when I get home.

Reply | Parent | Thread

Clayfoot

(no subject)

from: clayfoot
date: Oct. 1st, 2008 12:36 pm (UTC)
Link

I have, like, a level 6 or 7 hunter with no guild and 3 days left on the free trial.

Reply | Parent | Thread

Cirrus Strafe

(no subject)

from: cirrusstrafe
date: Oct. 1st, 2008 01:01 pm (UTC)
Link

XD, well we can't do much with that, then =P

Reply | Parent | Thread