How mortgage-derviatives tanked the economy
Writing in the NYT, David Leonhardt has a good primer explaining the exotic, sleazy economic shenanigans that turned some bum mortgage loans into a multi-hundreds-of-trillions-of-dollars toxic bubble that threatens the planetary economy:
Investors then goosed their returns through leverage, the oldest strategy around. They made $100 million bets with only $1 million of their own money and $99 million in debt. If the value of the investment rose to just $101 million, the investors would double their money. Home buyers did the same thing, by putting little money down on new houses, notes Mark Zandi of Moody’s Economy.com. The Fed under Alan Greenspan helped make it all possible, sharply reducing interest rates, to prevent a double-dip recession after the technology bust of 2000, and then keeping them low for several years...Link (via The ConsumeristMany of these bets were not huge, but were so highly leveraged that any losses became magnified. If that $100 million investment I described above were to lose just $1 million of its value, the investor who put up only $1 million would lose everything.
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To really understand the economic system that leads to cyclical booms and busts of which the subprime meltdown is only the latest, readers would do better to read "The Creature From Jekyll Island" by G. Edward Griffin.
Normally when investing you have to accept both the upside and the downside. What the real estate players did was find ways to get the upside while shifting the downside to someone else up the food chain. E.g. the small investor who gets a 110% mortgage and then walks away if the property doesn't appreciate. Everyone up and down the food chain did this, setting themselves so that if things went bad the person above them took the fall. This is why small problems turned into big problems.
What makes me a bad business person: The way I see it, if you are 99 million dollars in the hole, you don't 'have' 1 million. So when the overall investment of 100 million increases to 101, you haven't made anything.
@ #3 -- What you have to remember is many of the people who work in finance are grunts straight out of college who can be hired and fired at the drop of a hat. Each day is potentially their last, so they're in it for the short term only, this quarters figures, this years bonus.
It's in everyones interests to engineer things so that the perception is "we're meet the (short-term) targets" - increase sales by offering mortgages that have low interest for the first three years - and employ other people to allay fears by projecting out unrealistic financial models into the future.
They operate secure in the knowledge that it's not their money anyway, it might work out according to the models - (so it's not out and out fraud) and in any case they'll have changed job / department before the sh#t hits the fan if it was wrong.
...and so it carries on until the situation becomes manifestly untennable, to the point where if the banks were to fail it would be a political disaster as well as a tragedy for the small investors who had bought into the scheme. This compels the government to bail out the banks and cover their bad decisions.
Remember a year ago or so when ALL the big financial firms were handing out billions of dollars of bonuses. IIRC, top level managers got $10-25 million at the end of 2006. Even secretaries were getting the equivalent of their base pay in bonuses.
If you are top management, who cares whether the whole thing goes bust? You can blame it on somebody else and you already collected.
If you are the secretary, you collected a little, but now you are unemployed in a tough job market.
I think there should be a way to revisit those bonuses, especially in a case where the government is bailing out a company.
... I think the telegraph (UK newspaper) had an astute observation in a cartoon it runs, along the lines that many of the people who fled after setting up this house-of-cards system are now re-employed at different banks calculating "risk exposure", being the only ones who actually understand the muddle.
If you haven't already, watch Paul Grignon's 47-minute animated presentation of "Money as Debt", available on Google video.
Some thought after understanding the system will help you to realize why fiat currency is necessary and also why it should be managed directly by the government and why no one should be allowed to practice fractional reserve lending.
It's explained here quite well also.
http://www.youtube.com/watch?v=SJ_qK4g6ntM
http://news.bbc.co.uk/1/hi/business/7073131.stm
It all seems like they found ways to cash in, and leave the mess for someone else, even Greenspan the supposed economic genius was essentially betting that the house of cards he had (inadvertently maybe?) helped build would stay up long enough for it to stabilize itself.
There was a quote in a G.K. Chesterton novel that this reminds me of, about how (I paraphrase from memory) "the poor are always more patriotic than the rich, if things get rough the rich can just pack up and go abroad with their wealth, whereas the poor are tied to the land and so are more concerned about the well being of their country." When the market tanks the multimillionaires lose millions, but often STILL have millions in reserve, whereas the family buying its first home ends up living out of their car.
I advised lots of people to not buy into the internet bubble a while back. But greed won out and lots of money was lost. Millions and millions down the drain. You can't save people from themselves. I've tried and it doesn't work.
#10 Amen brother I have been late to that space and have suffered from the , I Can, I Can , I Can save them syndrome way beyond it's usefulness. My bad. However, as a proponent of humans being allowed to live here I still can't help myself from pointing out that parasitic economics kills the host. It may take a while longer than it should have to become disgusted with the economics of War and illusion fostered by the parasites, but I am still alive and can maybe pay back some debts to our planet. None of my personnel debts are monetary. I am parasite free. Getting free takes work. Worth doing. It is really easy to die stupid. Very hard to die awake. That is the gold.
Before Spinobot posts here about how we need more "regulations for the common good", I'll briefly reiterate what I've said in other threads about the foreclosure and collapsing dollar: The greedy shady lenders were an effect, not a cause. They are the consequence of piss-poor monetary policy that makes credit artificially cheap (under the premise of "stimulating" the economy), in concert with a central banking system that uses regulations to protect itself from failure (and externalize the problems to everyone else).
I don't mean to start a battle of ideologies, but as far as I can tell, the problem is the regulations we already have. It's a problem of "Who will watch the watchmen?". The government wants to cheat (principally to fund warfare), so it delegates that authority to others, who use that same power to cheat for themselves as well, and down the ladder it goes.
The root cause is fiat currency and the Federal Reserve setting interest rates. With a gold standard no one can cheat, and governments can't afford wars without a war tax, so citizens would really have to believe in the cause to sacrifice for funding the war.
Blaming the lenders is almost as short-sighted as blaming the borrowers. (Although the lenders certainly know the system is rigged; most borrowers do not.) Treat the disease, not the symptoms.