I believe that banking institutions are more dangerous to our liberties than standing armies. (Thomas Jefferson, US President; 1743 - 1826)
The only time Bush got it right was what he said about the economy. Everyone Got Drunk.
Granted he said it to a friend, off camera, when no one was supposed
to sneak a recording device into the room.
I have read at least 50 articles, spanning the world wide web about the economy, credit default swapps, mortgage backed securities, hedging, money market acount, the bond market, the paper market, etc. And while i wrote two pieces on the economy already those were wrote during my learning process, this shall be my final paper.
Everything was great until home prices fell.
Than the house of cards fell.(no pun intended)
(ok yes it was)
Starting with foreclosures, leading into the drop in stock prices in the mortgage
backed securities sector, than into a rush to cash in insurance policies, When one couldnt pay they all couldnt, ending in (for now) the falling of giants, Bear, Lehman, AIG.
The story as i have read it, probably started 300 hundred years ago with the
origins of the banking system of this nation and how its built on leverage.
The crash of 2008 grew out of leverage.
If you ask me to borrow money today but promise to pay it back tommorrow with
interest knowing that my bills are due two days from now, I am leveraging.
I am betting my bills that you will pay me back. If you dont pay me
back i am screwed.
Today America is screwed.
Or most of us are, because someone is making out on this whole mess. Just like the Iraq Colonial Expedition (a line from michael hudson)(dont tell him bc i didnt ask to borrow it). While most of us suffer with the expense of blood and gold someone is getting rich off the expedition.
The basic idea of how banks work is that banks takes in savings
deposits and hand out loans. Savings accounts get 1% today, loans pay the
bank 5-10%. But regulation says the bank can lend out
than they have in stock. I think the rate is 30-1. For every dollar in the vault, they can loan out 30 dollars. This creates a problem if all loans stopped being paid than your savings account is finished. This is called a run on the banks and it happened during the 29' crash and the 87' savings and loan. People ran for there savings account, and it was gone.
A Government body the
is supposed to insure deposits so fear and panic wont lead to another bank run. But from what i read, when one bank, the Savings And Loans bank, crashed in 87' the FDIC spent over 50% of its reserves to replenish empty savings account. So what would
if more than one bank crashed?
This is the world of banking leverage. The bank needs to lend to make money. The riskier the loan the more money. Now take it up one notch and you have the world of stock market leverage. Today when you buy stocks or bonds you can invest in a swapp. A fancy word for insurance. So that if your gamble loses you can cash
in your insurance policy and you still win.
Being a swapp and not insurance it does not get regulated. Meaning two things.
1.No one overseas the trading in these markets to look out for dangerous trends.
2. Anyone and Everyone selling this swapp/insurance has no obligation by law to keep stock piles of money on hand in case large numbers of people lose on there bet and seek
cash in their swapp/insurance. My first question is who was the smart guy at lehman brother and AIG who said we dont need no stinking financeial reserves in case people actually want to cash in their insurance. Secondly how come there has not been any prosecutions. If i sold insurance from my porch but never paid out i would be in jail.
This is one of the parts of the Economic trouble. With these types of rules(none) who would not want to get in on the racket. The housing market had increased in value for decades so anyone selling insurance/swapps on anything
mortgage related would have made a
killing for years. Premiums in and no one putting in insurance claims.
Imagine how Gieco would succeed under this model. So Sales of insurance boomed, CEO's raked in the free money. Wall stree bonuses were huge. Remember when the head of the New York Stock Exchanged retired with a 150 million dollars payout package. Time were good.
You could even buy insurance on stock you didnt own. HUH?
Thats right. I know it sounds weird. I mean how much of a killing would i make if i walked into a hospital and began to purchase life insurance on
patients in ICU. I would be betting against the patient. And my bet would be sound.
Well on wall street they are allowed to bet a stock will crash, making money
when the stock crashes. But too many people bet(bought swapps). And every one on wall street was selling them but not putting away funds to pay them off.
And No one in government was regulating. (they used to be but the law was changed)
But many had mentioned this to former Fed chairman Alan Greenspan. Who's job it was to watch over the economy of the country. Yet when he was told about the dangers of an unregulated credit default swapp market, that is estimated to be 50 trillion dollars in a 5 trillion dolar bond industry. That means while only 5 trillion bonds were sold, 50 trillion bets were made on the bond for its success or failure.
(yes trillion i did not make a mistake)
Greenspan said regulating this 50 trillion dolalr market was not needed. But this is not a Republican issue becuase the treasurey secratary under Bill Clinton, Robert Rubin also refused to regulate the market.
Mr. Rubin is now the economic adviser to current presidential hopefull Barack Obama.
Another aspect of this credit default swapp market
(buying insurance on a stock)
is how companies leveraged against each other by buying insurance from one company than selling insurance to another company.
Anything to make a buck.
Why would you want to buy and sell insurance on the same item, if you ever need to cash in the
insurance you have simply have to pay out the check you get, making no money right?
As risk increases so does insurance premiums. If i bought my premium for 10 dollars, but risk has increased current premiums to 200 hundred dollars, than it pays for me to hedge(buy cheap insurance and sell expensive).(remember there are no rules saying i cant buy and sell the same insurance coverage,and none saying who can sell insurance)
The Problem with this type of leverage is when many banks are interconnected, say if AIG cant pay Lehman, than Lehman can pay Bear, than Bear cant pay Wackovia and on and on. Until they all cry bankrupcy uncle. I have seen it a million times.(ok only once)
So now you have these banks linked together in a daisy chain, and you have this industry that is unregulated so no one has to report anything. So much of how each firm acts is secret. This means that if a bank failed in japan it could be linked to any chain and no one knows who is affected by what. And this not knowing,this uncertainty about what banks are sound, who placed what bets, who lied on their balance sheets, this has caused banks to freeze up their lending. No one knows how much risk is saturating each bank.
For example Wachovia was just bought by Wells Fargo for 14.8 billion dollars, yet one month ago Wachovia listed on its balance sheets its net worth was 50 billion dollars. So either Wachovia lost 35 billion dollars in a few days or Wells Fargo is getting 35 billion dollars in free stuff. Or the third option. That Wachovia is lying on its balance sheet.
But lets back up a minute and talk about selling the stock because what good is it to know the swapp story if you dont know the stock story.
Everyone knows what stocks are. Buy low sell high, lets make some money.
Well according to my research there is an estimated 71 trillion dollars of total world savings. This is money that wants to make money and not sit in the bank. The safest bet
over the years has been US Treasury bonds. But Greenspan in the 2000's lowered rates to 1%. Someone who i read, who can read the market says there was a hidden message
in Greenspans actions at keeping the rate very very low. Basically he was telling the 71 trillion dollars
worth of world wealth to not buy US Government bonds.
Go somewhere else.
So searching for somewhere, anywhere to earn more than a measly 1% wall street tried something out that eventually grew into a monster.
Mortgage Backed Securities.
Which are home morgages that wall street banks buy in bulk and package into stock.
It began innocent.
One banker bought a thousand mortgages. This is 2000, 2001. And like clockwork he recieved a check every month from one thousand home owners who paid there morgage to this wall street banker. So instead of earning 1% from government bonds, this banker earned 7%, the morgage interest rate. It was so lucrative that he began to package up more and more mortgages to sell them to this 71 trillion dollar pool of money that was desperately seeking an avenue of investment that would earn more than 1%.
The thing was the these mortgage backed securities peformed so well, because remember the housing market had risen in value for decades. It was a given that my grandma bought her house cheap and would sell it for profit. And because
of their high performance they sold out like wildfire. Eventually wall street called the mortgage firms one day and said guys we need more mortgages our investors are hungry, but the mortgage lenders said sorry, we tried it all, but we have given out every mortgage we possibly could to prime customers(customers that could prove they had a job, downpayment, good credit). Wall street said these things are so hot and we need more so why dont you lower your standarsd, and we will reward you. Do whatever it takes to get us more mortgages.
So the game began.
But first to lower standards we have to have a federal government that would like lower standards and pushed for it. And they did.
So mortgage outfits all over the country, big and small began to lower standards. They wanted to cash in on the feeding frenzy going on on wall street. Greed was an issue but so was competition.
If one street is lined with companies selling mortgages and your firm has the strictest criteria most likely you would do the least business. So not only did the owners
of these companies race to the bottom to survive, but workers in these companies
would constantly push there superiors to lower standard. They didnt want to lose out on a sale.
Standards grew so laxs that 23 dead people in Chicago were given mortgages. And living people were able to get mortgages by not even showing w2 forms. Just answer two questions do you have a job and do you get a paycheck? yes ? ok here is your mortgage. And dont forget the story i broke in my first economic meltdown blog, that some companies were established with the sole purpose of temporarily parking money in a persons bank account so when they went through the mortgage application process they would pass. And when the mortgage was approved the funds were removed, and for this you paid a fee. Some Mortgage firms would recommend this type of service.
Now in the old days when banks would give you a mortgage they would make sure it was sound because the banks plan was to keep your mortgage on its books for the life time of the loan. Not anymore. With the intense feeding frenzy on wall street for as many mortgages as possible, each mortgage firm knew they would be giving a mortgage to a home owner than selling it right away to a wall street bank only to be sold again to an investor in say
china. There was no intimate connection to do the right thing. The mortgage firm had no interest in seeing the mortgage payed off. They got there fee and washed there hands.
And remember no one in the government was watching.
Now the theory was to get as many mortgage loans out as possible, so they gave low or no initial interest rates to make the american dream of owning a home seem within reach. And prices were rising at such a rate, that many sellers of mortgage told their clients that in 3 years when your higher interest rates kick in you would have accumulated so much equity that you will be able to renegotiate your mortgage at a lower rate. This did happen, for years, as long as home prices rose. But could they rise forever? And what would happen if they didnt? Well no and we are living the what happened question.
So you have many parts to the story. The Investor on wall street trying to feed the intense desire of his clients to buy more mortgage backed securities. You have the married couple who is told you can you can now afford your dream. You have the entry level seller at the mortgage firm begging his boss to lower standards and cash in on the rush or he is quitting to join the firm down the block. You have the billionaires in the middle east looking for safe areas to park there money. And you have the Stock Ratings agencies Standard and Poor giving these risky stocks AAA rating when they knew how risky they were.
This is another damning piece to the puzzle. The rating agency happens to be paid, handsomely to rate stocks by the same firms that sell the stock. Stocks that people buy based mostly on there rating. Rating relates risk.
How could they not know the risk in mortgages given out to risky clients would not be a riskier investment as a stock.
The answer is they knew.
Thus another party that should be in jail.
In emails uncovered by the federal goverment there are two quotes from employees at the ratings agencies that gave these risky stocks a safe rating that prove their guilt.
"If a cow asked us to rate a stock we would do it"
"I hope we are rich and retired by the time this house of cards crashes".
This is corrupt and illegal, buttom line.
It became a game to unload risk, knowing that the rating agency would polish up any turd you tried to sell with a perfect, safe, AAA rating.
In fact it became so popular to unload RISK as a stock for an investor to buy that firms began looking at any risk they had on their balance sheet to slice up and dump as a security. And the laws were so lax that
even after the security was bundled and sold, the investment bank that bundled it was able to go in and swap in riskier items, and take out items.
And the man that will save America is the Treasury Secretary Paulson. He was ceo of Goldman Sachs investment firm. Surprisingly, a firm that was left untouched by this mess, yet also a firm that did its share of selling this risky stock but getting out in time. It seems like that was the plan all along, from the small mortgage firm to the big wall street banks, get in , make money, get out. But the house of cards fell so fast that hardly anyone got out. All the wall street giants like Bear Sterns and Lehman brothers that sold the stock were stock with billions of dollars worth of shares on their desk ready to sell them when the people buying them smelled something fishy and stopped buying. These big banks were now sitting on billions worth of garbage, much of the money used to by the stock was taken out as loans.
The mortgage firms all around the country were also left holding a bag of garbage that they took out loans to buy with the expectation of selling the next day. At the height of popularity for these risky mortgages stocks being sold, wall street was calling up mortgage
firms daily telling them we need more mortgages. So the mortgage firms began to borrow huge sums of money to buy mortgages, but they were going to sell them tommorrow to wall street.
But when investors stopped buying from wall street wall street stopped buying
from mortgage firms, and many were left with 100 million
dollar+ loans they could not pay back. Fannie Mae and Freddie Mac chose this death.
Another interesting piece of the puzzle that only one man
i read of talked about was speculators. While prices in the real estate
market rose at dramatic
levels it paid for speculators to begin to buy houses, hold them for 6 months and sell for a profit. Some estimates show that 25-40% of the real estate sales in the 2000's was of a speculative nature. Now the mindset of a speculator does not care about adjustable rate mortgage loans or no interest teaser rates because they will use their loan for 6 months tops.
Once again life was great as long as
home prices rose. when they stopped rising there was no
money in speculating and many got out or faced foreclosure. This paper that i am summarizing argued that the high foreclosure rate cannot be blamed solely on the sub-prime market. His statistics show just as many prime market foreclosures as sub-prime.
Which expels the republican myth that this problem
has to do with people who took out mortgages
who could not
afford to and who should have known better. And I hope this blog entry shows that that idea is only 1/1o of the story.