Financial Meltdown Simplified
I have already explained the involvement of our past, present and future Presidents in this crisis. A lot of people still don’t understand how it started and why it is still escalating. I am going to simplify the entire crisis in this blog post in an easy to understand fashion, so you can brag to your associates and be able to explain it to anyone you know. Here goes:
It started with the CRA (Community Reinvestment Act) that forced lenders, through lawsuits from left-wing groups, to give out high risk mortgages to people that normally wouldn’t qualify for one; I.E. have a good credit score and be able to put down 20%.
The banks knew that it was a big risk in this forced involvement with toxic mortgages, so they wanted to insure these loans; the same way you buy insurance for your car. So banks that gave out these mortgages like CITI, Wachovia and PNC went to major insurance companies like AIG and said I would like to insure these mortgages for five years; so if these homes lose value you will pay me what I lost on this bad mortgage.
So companies like AIG insured these mortgages in exchange for banks paying a yearly premium, same as you pay on your car. For instance, if CITI wanted to insure $10 million in mortgages they paid about $200,000 a year for this policy. If the homes never lost value, this would be a profit to AIG and they would never have to pay for the policy. The same way your healthcare and auto insurance companies make money.
The only difference is that banks wanted AIG to guarantee they will be able to pay on their policy so they asked them to put down a “security deposit” of lets say one million. If everything goes according to plan and the homes keep their value, AIG would just take the deposit back at the end of the five year contract. But if AIG goes under, they already put funds into this deposit and the banks would get the cost of their premiums back.
The problems started when these high risk mortgages started defaulting and people couldn’t afford their payments anymore. Financial analyst companies realized that AIG would have to start paying the billions of dollars in insurance contracts they signed with these banks. So AIG was downgraded from a triple A rated company to a triple B rated company.
What this meant was that banks who bought insurance from AIG realized they are not the super stable company they were when these banks purchased these insurance policies, so banks demanded that AIG increase their “security deposit” from one million to three million.
Now AIG has Billions sitting in “security deposits,” money that they can’t touch and homes are continuing to foreclose, so analysts downgrade AIG even more and they have to increase their “security deposits” even more now.
By the time AIG had to start paying all the banks for the insurance policies they sold to them, they had so much money in these deposits they couldn’t afford to make good on their policies. This is why the Insurance companies like Lehman and AIG fell first.
Then the banks realized they are not getting any money on their insurance policies for these mortgages, so all these mortgages they have are losing value like crazy. And since the banks had insurance policies on these mortgages they didn’t write them on their books as losses, but once the financial firms went under all of the banks assets instantly turned worthless. This is when the Banks started collapsing.
The rest of the industries are a trickle down effect from the above, including the automobile industry, since a lot of states and companies invested heavily in these banks and financial institutions.
I hope this was simple enough for everyone to understand what happened. This financial crisis was a government created problem and it was an embarrassment for John Mccain to blame this on Wall Street greed. The greed came from lenders who used the CRA to give out as many sub-prime mortgages as possible and sell them to bigger banks. AIG was a victim of horrible government intervention into the private sector and not because of free-market principles.
Pretty good write-up Stan, but I need to add a step between your 2nd and 3rd paragraphs. The banks did not want these toxic loans on their balance sheet. They sold them off keeping a small percentage for “servicing” the loan. The investment banking firms and Fannie Mae & Freddie Mac did the securitization by bundling many of these loans and then craving them up and re-selling them (CDO-collateralized Debt Obligation). They collected a fee for this work. Many large investors balked at buying these risky assets so the investment banks then turned to AIG to insure these investments (CDS-Credit Default Swaps).
With interest rates low, the investing public wanted higher returns so they, either directly or indirectly, purchased these instruments. Once the defaults reached a critical mass, no one wanted to own these any more. Assets on balance sheets became nearly worthless and the credit crisis ensued.
FYI…Lehman Brothers was an investment bank not an insurance company. Their problem was that they were too leveraged and could not sustain such a large setback. AIG screwed themselves by mis-pricing the CDS and not collecting enough premium for the risks they were taking on. The problems at Fannie Mae and Freddie Mac were completely the fault of Congress.
Your premise is 100% accurate. By government trying to do a good thing, it interfered in the marketplace. Businesses (financial firms) will play the hand that is dealt them as best as they can in order to make a profit.
I know you were trying to keep it simple. I hope i did not complicate it too much.
November 25th, 2008 at 12:05 pmExcellent post. The part about the CRA – essentially over-regulation by the government – is easy to understand. But when these ‘mortgage backed securities’ were being sold, was there not a lack of regulation there, too? I have talked to someone I know who has worked with the FDIC and other financial institutions and this is what he told me.
November 25th, 2008 at 12:58 pmThe hell with Newark and Camden! Let the people that live there rot in their own filth. They don’t contribute anything to society anyway. And they stink to high hell. I wouldn’t eat a hamburger that they touched with their minimum-wage earning hands. In fact, the minimum wage is already too high for them. Screw them if they weren’t born into white protestant families. Their parents should have thought of that before they had children. What were these left-wing assholes thinking when they enacted the Community Reinvestment Act in the first place? Everybody knows the only way to stop a cancer is to kill it! Why should the banks have to take chances? All they should ever have to do is take take take. They shouldn’t have to give anything back! That’s not the American way! And as for good old AIG, they saw an opportunity to exploit the situation and they did! That’s America fer ya! “The only difference is that banks wanted AIG to guarantee they will be able to pay on their policy” HUH??? Imagine that, asking your insurance provider for something! AIG should have just rammed a few cartons of cigarettes down the bank’s throat and charged them EXTRA!!! Go USA! You see what happens when you let the left-wing losers have their way! Spread a little money among the poorer communities and the great old Capitalist Machine will be there to exploit the situation! They should have seen it coming. Assholes!
November 25th, 2008 at 1:03 pm“What were these left-wing assholes thinking when they enacted the Community Reinvestment Act in the first place?”
You mean owning a home is a right? You shouldn’t have to earn enough money to buy a home?
“And as for good old AIG, they saw an opportunity to exploit the situation and they did!”
How did they exploit the situation? They didn’t is how.
“Spread a little money among the poorer communities and the great old Capitalist Machine”
The people who got mortgages they couldn’t afford, took out reverse mortgages and spent the worth of their homes on new cars and electronics.
Now we should bailout these bums who didn’t care to be responsible? Your socialist rhetoric has led to places like Detroit, Newark and Camden; where money from hard working Americans is squandered by corrupt politicians and Pastors like Racist Wright.
November 25th, 2008 at 1:16 pm“The people who got mortgages they couldn’t afford, took out reverse mortgages and spent the worth of their homes on new cars and electronics”
November 25th, 2008 at 1:29 pmCareful Stan, you may be going out on a limb here. And you miss the point of the proceeding post entirely. What “Friedman” was trying to point out was money from hard working Americans meant to revitalize these urban centers was squandered instead by expensive insurance policies. But you couldn’t expect the banks to invest in the communities where they did business, after all its bad enough they had to lend these people money against their will…
“The people who got mortgages they couldn’t afford, took out reverse mortgages and spent the worth of their homes on new cars and electronics”. You my friend are a bigot. At least you could tell that “Friedman” was joking (well, he was, you know, just in case you were wondering, nitwit…)
Yes the $700 million or so going to Newark every year is squandered by insurance policies and greedy bankers. No your right, that is exactly what happens.
The banks were forced into extremely high risk investments, not because they were bigots, like you liberals call everyone.
Those forced high risk loans turned into economic meltdown of 2008. Congratulations keep promoting these disastrous policies.
November 25th, 2008 at 1:34 pmYou may believe what you wish to believe but nobody ever claimed the banks were “bigots”. I believe that it was Stan Gendlin that was accused of being a “bigot”. Slow down partner!
November 25th, 2008 at 1:40 pmRacism has become Liberal Party’s bread and butter
November 25th, 2008 at 1:45 pmCare to get back to my question now?
Yikes! 8-|
November 25th, 2008 at 2:09 pmMike:
This is similar to the argument Obama made about the surge. Who cares if its working or not, he voted not to go into Iraq in the first place.
There would be no need for regulation if this poorly devised program wasn’t created in the first place. Instead of giving people better ways to advance themselves economically, they were given homes at rates they couldn’t afford in the long run when their salaries were not going to match the increasing rate of their mortgage.
But you are right, I did point out that the Bush administration did nothing to fix the problems associated with sub-prime lending and securities and instead in 2007 wanted to increase the amount of loans given out.
November 25th, 2008 at 2:16 pmThe Community Reinvestment Act dates back to 1977, forty years ago! The notion that poor people are the cause of the current financial situation has already been discredited. Stan should be ashamed of himself. If you drive anywhere in New Jersey you will see the vacant million dollar McMansions. Were these homes built for the former inhabitants of Newark and Camden? I don’t think so. They were built for the fiscally irresponsible greedy people that just had to have a newer and bigger home. These people were bamboozled by the criminal banks offering adjustable rate mortgages. And nobody forced these banks to loan money to them! Shame on you Stan! What kind of people buy things they can’t afford with money they don’t have? Poor people are smarter than that!
November 25th, 2008 at 2:47 pmPlease read my posts about CRA reforms in the 90’s. Lets not try to spin this in unrealistic directions.
November 25th, 2008 at 2:52 pmBy the way, no one has blamed this on poor people at all. The blame is going to irresponsible people, not saying specifically poor people, unless you are implying poor people are irresponsible?
The country as a whole is making the notion of responsibility a thing of the past. Including CEO’s who make bad financial decisions that lead to bankruptcy and get to continue as top management. I.E. big three top execs.
November 25th, 2008 at 3:01 pmMike,
I’ll try to address your regulation question but it will come down to when businesses are forced to buy lemons they will make lemonade.
Freddie, Fannie, and the investment banks could not sell the CDOs without insurance. Insurance is heavily regulated. So, in order to get around those regulations, they created credit default swaps (CDS). These financial firms have a number of PhDs in Mathematics. Those math geniuses created models to show how to value these CDS. Many people could bring themselves to say that they did not understand the models and bought into their argument.
As was the case with Long Term Capital in the late ’90s, just because a bunch of really smart guys says it is so, does not make it so.
November 25th, 2008 at 3:15 pmBy the way….a reverse mortgage is when someone who has equity built-up in their home (usually fully paid up), will borrow against that equity and collect monthly payments FROM the bank. The bank then collects when the house is eventually sold (hopefully at a much higher price).
Reverse mortgages were a virtual non-existent cause in the financial crisis. However, home equity loans (where people treated their home as an ATM to purchase “lifestyle” items), did have a significant impact. this was especially true for those that borrowed more than the equity in their home.
November 25th, 2008 at 3:25 pmThat is what I was referring to, thank you for correcting me.
November 25th, 2008 at 3:28 pmHere is a link to one of the best and most accurate accounts of this financial crisis:
http://www.youtube.com/watch?v=3EyKiOE78yU
There is a lot of information that goes by very quickly. I suggest you keep a finger on the pause button. For you doubters, you may want to have additional browsers open to confirm the information.
November 25th, 2008 at 3:35 pm“What “Friedman” was trying to point out was money from hard working Americans meant to revitalize these urban centers was squandered instead by expensive insurance policies. ”
I think you both missed the point. It is a shameful attempt to incite class warfare and shift blame to ‘the bankers’, but this has little to do with the problem.
Congress put “hard working Amercians” money at risk, but then lied about the risk. Congress (and Acorn lawsuits) forced banks to make risky loans without charging higher interest to cover known higher default rates. The Government (Fannie and Freddie) hid the credit risk of these mortgages by bundling them into Mortgage Backed Security Pools. Investors bought shares of these MBS, but then realized the Mortgage default insurance was worthless, and therefore the MBS had unknowable (risky) value.
Of course, It was Congress that created and manipulated the market, removing the protections put into place after the great depression. I agree that home ownership is part of the American Dream, but giving mortgages to illegal aliens and people on unemployment is risky.
Hiding that risk set up the market place for failure that hurts all involved, regardless of their role!!
One way to get the markets functioning again is to document the credit rating on every Mortgage, and rate every MBS Investment Pool. This would allow investors to begin trading these securities. Congress should reinstate personal and banking responsibility and the moral hazard by closing Fannie and Freddie.
November 25th, 2008 at 3:39 pmMike of GSP Blog –
“But when these ‘mortgage backed securities’ were being sold, was there not a lack of regulation there, too?”
Yes, its called Investor Fraud by Fannie and Freddie. They bundled a mixed bag of mortgages into huge pools, then sold shares of this pool to investors. They also sold ‘derivatives’ based on the cash flow streams such as “Interest only” parts or “Principle Only” parts. These bonds behave differently from normal corporate bonds because the principle outstanding changes every month based on individual decisions to refinance, make additional payments, or default rates.
I’m curious why “PMI” seems to have failed completely. Thats the “Primary Mortgage Insurance” required if you have less than 20% down payment. Was this just a scam?
November 25th, 2008 at 3:49 pmOne suggestion that I have is that the loan originator must keep some portion of the loan on their books. I suggest 20%. This would be like a deductible on an insurance policy. Nobody they sell the mortgage to would incur a loss until they lost their stake. With this process in place, they would take greater care with whom they underwrote for a loan.
Of course, it would make financial institutions less profitable because they would have less money to loan out and could not leverage their capital as much. In the end, we would all benefit because our financial system would based on sound principles.
November 25th, 2008 at 3:58 pmDi Marco:
November 25th, 2008 at 4:00 pmThat was an interesting compilation of what happened, good link!
I am glad you liked it but surprised you had not seen it before.
November 25th, 2008 at 4:02 pmAppreciate the responses. Excellent discussion.
Of course, my fear moving forward is the Dem Congress will not hold open and honest hearings on this matter. If that happens, we will only be setting ourselves up for more problems in the future.
November 25th, 2008 at 5:07 pm[...] With Attitude’s! Stan Gendlin has a terrific post up today regarding this very question. His post started an interesting discussion among Stan, myself [...]
November 25th, 2008 at 6:06 pmWhy do you suppose the Community Reinvestment Act was enacted in the first place?
November 25th, 2008 at 7:24 pmDavid, do you have a crush on Stan or is there some other reason you like to impersonate him?
November 25th, 2008 at 11:12 pmDavid,
Look up Community Reinvestment Act in Wikipedia.
November 26th, 2008 at 9:27 amI’ll tell you why the Community Reinvestment Act was enacted. But you had better get your dictionaries out because I’m going to use a word that you haven’t heard before. With practice you may be able to spell it or even pronounce it, but as Republicans you will never be able to wrap your heads around its meaning. Trying to grapple with the concept will probably send you screaming to nut house (where you belong). Ready? Take a deep breath and hold on! The reason the Community Reinvestment Act was enacted in the first place: HUMANITARIANISM
November 26th, 2008 at 10:17 amCRA was enacted by a big Humanitarian, Jimmy Carter, who recently met with fellow Humanitarians known as Hamas. The move shunned by both parties, emboldened Hamas with no positive turnout for anyone.
November 26th, 2008 at 10:26 amStan, I’m glad we finally agree. Jimmy Carter IS a great humanitarian. For this reason alone I believe he was the best president in my lifetime (I was born in 1960). And I‘m sorry I don’t use my real name. Quite frankly, you republicans scare me to death. All I need to see is some blue elephant in a Speedo and I’m outta here…
November 26th, 2008 at 10:47 amHAPPY THANKSGIVING & Ciao!
Being a good Humanitarian and a good President are two different things. Jimmy Carter does seem to genuinely care to help poor people, but his economic and foreign policy stances were horrible.
In regards to Israel, there are definitely injustices on both sides, but sitting down with Hamas with no pre-conditions led to emboldment of Hamas and that is it.
A good Humanitarian doesn’t make someone a good politician.
November 26th, 2008 at 11:24 amYou might argue that Hitler was a brilliant politician. There are no good politicians, only good humanitarians. Pray for peace!
November 26th, 2008 at 11:35 amToo bad Carter wasn’t more of a humanitarian when it came to the people of Iran. If he had been maybe they wouldn’t be under the thumb of radical mullahs and Ahmadenijad. Maybe he could have prevented a vicious regime from taking power and spreading death and terror around the globe.
BTW, it’s easy to be a ‘humanitarian’ with other people’s money, isn’t it David/Charles/Liberal Nutcase?
Oh, and perhaps you ought to have your facts before you imply that liberals have some sort of monopoly on compassion and philanthropy over conservatives. After all, conservatives are more charitable than liberals.
That’s a fact, Jack. As they say, you can look it up. Like here:
http://www.realclearpolitics.com/articles/2008/03/conservatives_more_liberal_giv.html
But we appreciate your posts. Considering that tomorrow is Thanksgiving, it makes sense to have a turkey trolling around on our blogs.
Have a great holiday!
November 26th, 2008 at 11:47 amHumanitarian? Even if he was what the heck does that have to do with CRA? CRA was to create a civil right out of owning a home, instead of the opportunity?
If Carter was a Humanitarian he would of had government subsidized Rentals or more homeless shelters. But what does owning a home have anything to do with being a humanitarian?
What a awful pitch for the CRA really. CRA had nothing to do with Humanitarianism.
November 26th, 2008 at 11:51 amBoy, Hasn’t this discussion veered off its original topic!
I will add one comment about “humanitarianism”. For hundreds of years and long before the founding of our great nation, people of all races, creeds, religions, and financial status, have sought to make a new life in America. They came because America offered OPPORTUNITY. They knew that if they worked hard and sacrificed, success would come. Maybe not for them, but maybe in one, two, or three generations hence.
One thing everyone must remember, the government cannot give anything unless it takes something. The government cannot make everyone rich, but it can make everyone poor. There are many cases of poor becoming rich and rich becoming poor. This is proof that the free markets work and OPPORTUNITY is available to everyone. When government intercedes on someone’s behalf, they upset the balance and, inevitably, harm someone else.
Humanitarianism works when helper and helpee know one another. The more institutionalized, the less effective and more wasteful it becomes.
On this day before Thanksgiving, I call on all of us, regardless of political viewpoint, to give thanks to those that came before us. Because if not for their struggles and sacrifices, we would not live in the greatest nation on Earth.
November 26th, 2008 at 12:40 pmDi Marco:
Unfortunately, as you have seen in California, Liberals want to get rid of Thanksgiving. I doubt they will be giving thanks to anyone on that day, instead discussing how horrible America is.
November 26th, 2008 at 12:50 pmI truly feel sorry for those that cannot realize that they have much to be thankful for. What a sad existance they must live!
November 26th, 2008 at 12:56 pmTry to “wrap your head around it”. The CRA did in fact make it easier to own a home. But, and please try to stay with me here, WHY would anybody want to make it easier to own a home??? Because it is the HUMANITARIAN thing to do!!! The CRA has EVERYTHING to do with humanitarianism.
November 26th, 2008 at 1:05 pmAnd Happy Holidays to you Mike, our esteemed host. Humanitarianism doesn’t come from the wallet, it comes from the heart.
And finally, thank you Di Marco for your kind wishes. I don’t know anything about liberals in California trying to get rid of Thanksgiving. I’m a liberal and they don’t speak for me! It’s not a black and white world. Now be thankful.
Humanitarianism is providing homeless shelters, affordable housing and rent controlled apartments.
You still have not explained how CRA is humanitarianism you just keep repeating that it is without a single valid point or fact.
November 26th, 2008 at 1:27 pm“Affordable” housing??? Rent controlled apartments??? You mean like the one Charlie Rangel lives in? Rent control is another distortion of the marketplace. There is little difference between rent control and the COAH rules being pushed by Trenton. Stan, you were supposed to stay on the road, not swerve left down the slippery slope.
Anything of value is worth saving and sacrificing for. Only something temporary should be provided help overcome an unexpected situation. How is it that an illegal immigrant that cannot speak english is able to live here without receiving these handouts?
November 26th, 2008 at 2:06 pmDi Marco:
I am not advocating any of those, but simply saying they make sense when arguing Humanitarianism unlike CRA.
November 26th, 2008 at 2:18 pmI think these say it all…
http://www.groundbreaking.com/Good_Sam/Rhyme002.htm
November 27th, 2008 at 4:47 amAgain, the liberals mistake Humanitarianism with Tyranny.
It is far better to use government regulation to provide a safe and secure banking system and financial markets in which all people can build their savings with confidence than to use government force and taxation to take from one house in order to give it to another.
It is easy for a tyrant to defraud the public, steal from them, and incarcerate the unwilling, but then appear benevolent when dishing out the spoils to the poor.
George Washington said it best: “Government is not reason, it is not eloquence. It is force, and like fire, it is a dangerous servant and a fearful master.”
December 1st, 2008 at 12:44 pmStan…your explanation of the financial crisis was downright hillarious…
Looking back on this from a historical perspective it’s amazing the lack of knowledge for what was occuring. A scary time in America indeed.
Let me summarize this whole huge mess:
1) The government enacted legislation encouraging subprime lending.
June 18th, 2009 at 2:52 pm2) Irresponsible people took out huge mortgages and loans
3) Banks hedged their exposure to these loans going into default by employing the mentality that:
a) If the borrower defaulted, they would reclaim the house and sell it for more than the loan’s principle – based on the theory of appreciation of housing values on a year by year basis
b) Bundling up these loans in highly illiquid Mortgage Backed Securities that they sold mainly to AIG, Fannie Mae, and Freddie Mac and other companies. The government endorsed this for the most part because it put money back in the bank reserves and allowed banks to continue lending
4) The problems started when the housing bubble burst, sending housing values plummeting. This lowered the equity that people had in their homes (theoretical value). As a result, adjustable rate mortgage rates increased, causing people to default on their loans. This signicantly decreased the value of the mortgage backed securities, and forced whatever credit default swaps were purchased against the loans to be paid out. Additionally, repossesion of the property would not even cover the original loan agreement because much of the time the mortgage was more valuable than the home. As a result, everyone lost a tremendous amount of money and now we’re becoming a socialist country. Amen.
“Too bad Carter wasn’t more of a humanitarian when it came to the people of Iran. If he had been maybe they wouldn’t be under the thumb of radical mullahs and Ahmadenijad. ”
Hahahahaha! Ever heard of the Shah and SAVAK (trained and equipped by the CIA)?
June 18th, 2009 at 3:58 pmyour site is very great!!!
September 11th, 2009 at 4:21 am