Whats Really going on with Our Economy? Try this…

So if you’re having trouble knowing exaclty what has been going on with the economy, what the bailout means and how it affects the likes of the US citizens, well you’re not alone! Everyone has been wondering and with hundreds of opinions, countless sources of media, it’s hard to form a formal though on the matter. Well take a look at this, a time line of the most relevant events which lead to our current position.

Here’s a rough timeline of some of the most directly relevant mechanisms:
1) In the late 1930’s or so, the government created an organization to buy mortgages from people with good credit, in order to help out in the American Dream. In the 1970’s, the organization — Fannie Mae — is setup as a private company. In total, they operated for 70 years or so, increasing the number of mortgages that banks would give out and not having any huge problems.

2) McCain’s economic advisor wrote a law freeing up banks from a lot of the protections that were put into place because of the problems banks caused to contribute to the Great Depression. Clinton signed this GLB Act into law in 1999.
http://en.wikipedia.org/wiki/Gramm-Leach-Bliley_Act

3) Consumer banks started selling their mortgages to other big banks for a tidy profit, and then were not responsible for the loans anymore.

4) Big banks took the mortgages and bundled a bunch of them together. This way if a few people defaulted, then you’ve still got all of the rest of the package to generate a profit.

5) Big banks started letting people invest into these packages and share in the profits.

6) People didn’t bite as well as hoped for these investments.

7) Big banks found a form of shady insurance to help cover any mortgages that defaulted (credit default swaps). These insurances were never called “insurance” to avoid insurance laws.

Ratings companies now gave these mortgage packages the highest ratings.

9) People jumped all over them to invest, since they were so highly rated.

10) Big banks wanted to buy up these mortgages.

11) Consumer banks start caring a lot less about how credit-worthy people were, since they weren’t going to be responsible for collecting the money after they sold the deal off to one of the big banks.

12) Officials warn about subprime problems as early as 2001.
http://www.nytimes.com/2007/12/18/bu…8subprime.html

13) Greenspan eventually lowered the interest rate to 1%.

14) Banks had plenty of opportunities to make money, so they started giving out mortagages willy-nilly.

15) People saw the low interest rates and super-lax credit requirements, so they started getting mortgages and flipping houses (even if they couldn’t really afford the loans). They were only approved for subprime rates, but interest rates were still pretty low, and banks were happy to give them out,s o that the banks could sell the deal off.

16) Large numbers of people start failing to pay their mortgages. No one other than bankers are surprised, since it was obvious that a large portion of them weren’t very creditworthy in the first place.

17) Banks started tightening up their loan requirements. This cut down on the number of home buyers available.

18) The housing market was stuck at a point with a large number of sellers, and buyers dropping off.

19) People started having to sell houses much cheaper than expected …. so house values started dropping.

20) Banks really tightened up their loan requirement leading to the credit crunch.

21) As the value of the things that banks owned started dropping, they began to fail since they stretch themselves rather thinly and people with money held at such banks get antsy — hypothetically, would YOU keep your money at Bank of America if you heard they were having money problems?

22) When banks fail, they take a large amount of money with them, which could spread to other banks.

23) It was believed that Bear Stearns was a bank whose destruction of money would carry over into other banks, so the Fed helped them out.

24) A failure of Fannie Mae and Freddie Mac would clearly carry over into other banks, so the government took them back over.

25) Merrill Lynch and Lehman reached a point where they needed more money than they would be able to get for themselves.

26) People are wondering how bad things are at other banks leading to trouble in the stock market.

It is a form of “financial derivative” … which is the fancy Wall Street term for a bet.

A credit default swap, in particular, is a bet between two parties … one side betting that some third party will default on their loan payments, and the other side betting that they will not default on their loan payments. Banks can use this as a sort of insurance.

… except the market for it was unregulated by some misleading legislation in 1999. So, it’s the craziest insurance you’ve ever seen.

So, imagine that a guy named Andy is approved for a subprime mortgage by BankOne. BankOne doesn’t want to hold onto this mortgage, because they know it is risky. They might even have fudged a number or two in order to get it through the loan process. They just want to collect the commissions and then resell it to a big investment bank. So, BankOne sells the subprime mortgage to Citibank. Citibank now does some fancy stuff with the mortgage, and then offers part of the interest profits to investors. Investors say, “hey man … that loan is too risky!”
So, Citibank goes to Dumbo Insurance Corp, and sees if they are willing to bet that Andy will make his payments on time. Citibank bets against Andy, and pays a monthly fee to Dumbo insurance everytime Andy makes his payments. On the other hand, if Andy misses too many payments, then Dumbo Insurance would have to buy that subprime mortgage from Citibank as their part of failing the bet.

So, now Citibank offers pieces of the subprime profits to investors again …. but this time with insurance. Investors put their money in, and thus reduce the liability that Citibank alone would hold for the loans.

We already know that the subprime market melted down. Now the problem is that the credit default swap “insurance” might melt down as well.

The problem with these (completely unregulated!) default swaps is that something like this could happen. Dumbo Insurance might find someone who is willing to make an even riskier bet that Andy will make his payments. So, Dumbo Insurance sets up this bet, in effect making pure profit. As an analogy … imagine that you buy a car insurance policy for $1000 from Dumbo Insurance. Then (unknown to you), Dumbo Insurance finds someone (SafeAuto) who offers the exact same coverage for $900, and passes the coverage onto that company — pocketing the $100 difference … free money. SafeAuto finds a company (SleazeCo. Hedge Fund) that will actually offer the same coverage for only $50! SafeAuto can hardly setup your policy to SleazeCo fast enough, since they get to pocket $850 for free!

The company officials are thinking that the market is way too strong for SleazeCo to ever have to pay for more than a few defaults at a time … so, they’re racking up these $50 bets!

Then, wouldn’t you know it … the bottom falls out of the housing market and Andy can’t make his payments. Citibank forecloses on Andy, kicking him out onto the streets. Now, they’ve got a house and a bad loan that they have to write off … which is money that they have to make up from somewhere. Oh yeah… the insurance policy! So, they call up Dumbo Insurance and find out that Dumbo isn’t willing to pay …. eventually Citibank finds out that their hopes are riding on a company like SleazeCo.

Now if Andy were the only one, there wouldn’t be much of a problem. However, as this is a nationwide crisis, quite a few banks are already lining up and screaming for their money from SleazeCo.

…. and this is the point that our economy is at now. Wondering if all of the SleazeCo’s can really pay. Probably not … so another bank meltdown is in our near future.
http://seekingalpha.com/article/7121…he-bottom-zero

Did you happen to catch the failure points for this whole crazy system? In particular, you’ll notice how BankOne is the one that even gave out the shitty loan in the first place, and yet they ended up with profit on it … no loss on their part at all. Also, you might notice that the insurance tended to roll downhill to the company offering the riskiest propositions. (Maybe this is what they mean by “trickle-down economics”….)

Worst of all is that this isn’t the first time that the Fed has had to bail out “banks” because of problems with derivatives. They just don’t learn their lessons, it seems.