Confused by the current credit crisis? Let me help.

Discussion in 'Politics' started by D_Davy_Downspout, Oct 10, 2008.

  1. D_Davy_Downspout

    D_Davy_Downspout Account Disabled

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    I didn't write this, but it's a pretty good record of what happened.




    It’s ridiculous to blame the crisis on CRA or ACORN or whatever. The central thesis seems to be that the government forced lenders to give loans to risky customers, when in fact lenders chose to give loans to risky customers because there was a vast amount of profit to be made. (Reasonable people can differ on whether the CRA is good policy in principle and in practice, but that’s really besides the point here.)

    It works like this:

    1) The global economy was pretty good, so there’s loads of extra money sloshing around that people want to invest in something nice and safe. (It actually doubled from $36 trillion to $72 trillion between 2001 and 2007.)

    2) At the same time, house prices were going up.

    3) So, people decide to invest in mortgages.

    4) Obviously there are lots of steps from, say, an investor in Mumbai to a homeowner in Michigan, but let’s concentrate on Wall St banks with lots of money and smaller mortgage lenders operating in communities. (Not that small necessarily, Countrywide was one, for instance.)

    5) Mortgage lenders sell mortgages to wannabe homeowners. Then they sell them up the chain to Big Banks (and the investors they represent) who get the rights to the income and associated risk.

    6) As things continue going nicely, Big Banks are happy to get their hands on more and more mortgages. But lenders are almost running out of people to sell houses to.

    7) Fine, say the banks, who have plenty more investors who want to get in on the action. Give mortgages to more people, even those you’d usually turn down.

    8 ) The lenders have a field day. Usually to get a mortgage you have to prove what money you have and what your income is. No longer! Now you can just tell the lender what you earn. Sometime later, the rules are even looser and the banks don’t even ask. (The fabled NINA, No Income No Assets loan.) And to entice people in they start giving away mortgages with very low introductory rates and all kinds of exciting offers (the fabled “predatory lending practices”) to get more and more people to sign up. Don’t forget, housing prices are still going up so lots of people are figuring they can sell the house on before the higher interest kicks in.

    9) Meanwhile the banks are buying these rather dodgy mortgages by the bucketload. They mix the good and bad ones up together, whatever, who cares. Credit rating agencies reckon it’s alright, though, and give them all AAA ratings. This is partly because even if a homeowner defaults, the owners of the mortgage deal get to repossess the house and sell it at a profit. Also, who pays the credit rating agency to rate stuff? The bank with the stuff to be rated.

    10) Housing bubble bursts, because that’s what bubbles do.

    11) Homeowners hoping to flip their property before the higher interest rates kick in can’t sell it for what they paid for it. They’re screwed, and default. Dumber people who just magically hoped they could pay the higher interest rates coming down the line? They can’t, and default. People who didn’t read the small print in their mortgage, also screwed, and default.

    12) Banks start to notice all the foreclosures. They refuse to buy the dodgiest mortgages from lenders, which is bad news for lenders as they’ve just borrowed loads of money and given out some bad mortgages and now they can’t sell them up the chain. Some lenders, therefore, go bust.

    13) Obviously the fall in house prices means that the banks can’t cover their debts by selling off the property. Anyway, everyone starts to cotton on to the fact that bad stuff is going on. Investors start selling their share in the mortgages to wash their hands of them, and the price of them starts going down, so what the banks actually own in terms of capital is less and less and less.

    14) Credit rating agencies start downgrading all these dodgy mixed up mortgages.

    And then the rest is all Wall Street insider stuff. Banks and investment funds start writing-off assets, basically admitting that all these investments they have are worthless. Share prices go down so they can’t make as much money by potentially issuing more shares. Banks don’t know what dodgy-ass mortgages each other have and don’t want to loan each other money. But loaning each other money is what makes the whole system work, so institutions start falling over because they can’t operate without access to the loans.
    For instance, Lehman Brothers ended up stuck with the crappiest mortgages (possibly because they were potentially the most profitable, possibly because they couldn’t find investors for them) and ended up losing $3 billion. Washington Mutual gave out subprime mortgages directly, and lost $8 billion. Merril Lynch lost $19.2 billion in a year. IndyMac was one of the biggest “lenders” and had $10.7bn of mortgages ready to sell up the chain, but suddenly nobody want to buy them, and they had to eat the losses when large numbers of them went into foreclosure. Countrywide had to eat losses, then their share price went down so they couldn’t raise money by issuing new shares, and then they had to admit that they were essentially including delinquent unpaid mortgage installments in their accounting as “assets” when in fact the mortgage payments would never arrive. Northern Rock, in the UK, was mostly fine but nobody would lend them money because OMG THEY DO MORTGAGES, had to get a loan from the government, which made everyone panic, triggered a run on the bank and got it nationalised. Netbank, usually a lender that would resell mortgages up the chain, tried to disguise their loans as safe, but when it was revealed they weren’t, were forced to buy them all back, and couldn’t find anyone else to buy them, driving them under.

    So essentially some of the assets of some of the banks have? They’re subprime mortgages, and nobody wants to buy them or invest in them, making them worthless. If they truly are worthless, people lose confidence in the bank and the bank can’t access loans, their share prices tank, and the bank dies. (This is obviously circular in that the suspicion the bank might collapse is enough to make it collapse.) The government is planning on buying these subprime mortgages.

    So there you have it. ​
     
  2. D_Davy_Downspout

    D_Davy_Downspout Account Disabled

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    Fannie and Freddie
    Basically, Fannie Mae and Freddie Mac failing are the consequences of the fallout from the subprime mortgage crisis rather than the cause. This crisis was caused by deregulation (Gramm-Leach-Bliley) that allowed banks to have investment, commercial banking, and insurance under one roof. This led to 2 separate phenomenons. First, it allowed the banking industry to create banks that were too big to fail. The sheer amount of liquid assets controlled by these huge banks makes it impossible to allow that much money in the market do be taken down by illiquid assets such as CDOs and mortgage-backed securities suddenly losing values.
    Second, it allowed banks to lend money (in the form of mortgages specifically due to the rising value of homes) and then turn around and sell the mortgage-backed securities to other investment houses. The issue becomes more complicated when you have the smaller street-lenders taking out massive loans to offer mortgages and then turning around and selling these loans as MBS’s or CBOs to pay off their initial loans. When the value of houses dropped, borrowers who either couldn’t afford their mortgages* or who depended on the equity in their home to take out a home equity loan to stave off default ended up defaulting. The mortgages that were securitized dropped in value leading to financial institutions (and more specifically investment houses) losing a significant amount of money and consequently being unable to fulfill their debts. This is exactly what happened to Fannie Mae and Freddie Mac. That’s why, aside from the sheer amount of assets present in the market decreasing significantly, banks are so wary about lending other banks money.

    *You have to keep in mind that the reason these
    people were able to take out these mortgages they couldn’t afford is because the lenders were increasingly more competitive with each other in order to make the most profit. This led to nina and ninja loans being actual services offered. For lenders, it didn’t matter whether the borrower could pay their mortgage because once the mortgage was securitized and sold, it was out of the hands of the lender.
     
  3. D_Davy_Downspout

    D_Davy_Downspout Account Disabled

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    Mortgage defaults didn’t cause this crisis. Waves of personal bankruptcies and loan defaults aren’t anything new. The problem is that financial institutions won’t extend credit to each other, not just because some are carrying bad mortgages, but because their assets may consist principally of mortgages whose only known value was set by the company that owns the mortgage.

    Every company has to have assets equal to their operating needs. A manufacturer has to have enough assets that are liquid (can be easily converted to cash) to buy materials and pay their employees. Commercial banks hold customers deposits and must have enough liquid asses to accommodate the maximum foreseeable withdrawals.

    Financial banks provide working capital for business startups and expansions by underwriting stocks and bonds - they give the company the capital and then sell the stocks and bonds to recoup their investment. They’ve got to have liquid assets sufficient to cover stocks and bonds between their issuance and sale. Insurers who often insure stocks, bonds and business ventures have to have sufficient liquid assets to cover claims.

    When one company can do all three types of financial business, a crisis in any of them can drain off liquid assets and cause a companywide failure. When the different types of financial institutions are intermingled, a crisis in one quickly becomes a crisis in all.

    This was one of the primary causes of the bank runs that sparked the Great Depression. To insulate the different types of financial businesses, Congress passed the Glass-Steagall Act in 1933, which prohibited doing business in more then one financial arena.

    In 1999, at the behest of financial institutions that wanted a piece of every pie, Phil Gramm rammed the Gramm-Leach-Bliley Act (GLBA) through a Republican controlled Congress. This repealed the Glass-Steagall firewall and opened the door to industry wide failure, again.

    Now that he’d built the coffin, Gramm nailed down the lid. In late 2000, as the Clinton administration was becoming the Bush administration, Congress was rushing to pass the annual Omnibus Budget Reconciliation Act to move budget account surpluses to cover shortfalls. At the last minute, Gramm slipped in a 262 page amendment called the Commodity Futures Modernization Act of 2000 (CFMA). The dense and obtusely technical language was passed as part of the budget bill without debate.
    This act almost totally deregulated derivatives, aka futures. Now each company that held derivatives, like subprime mortgages, was free to determine their value when calculating the value of their liquid assets, with little or no government verification. Any company that wanted to overextend itself could simply overvalue its derivatives and hope they didn’t get caught in a cash crunch.
    They did. Companies who can’t meet their cash obligations go belly up. Normally, a company caught in a cash crunch borrows cash on short terms with its less liquid assets as collateral. But no one knows which mortgage assets are likely to fail and which ones’ value is overstated. So nobody loans and everything crashes.

    The Community Reinvestment Act (CRA) of 1977 prohibited redlining, effectively saying that, if your bank or loan company’s market is Onondaga County, you can’t just loan money in Skaneateles and Manlius and decline all applications from the city. It didn’t require lenders to issue bad loans; pure greed did that.
    CRA was passed in 1977. GLBA and CFMA were passed in 1999 and 2000. Things started to come apart in 2005. If CRA caused this, it took three decades to do it.

    The CRA isn’t responsible for the over-inflation of house prices or banks bundling mortgages and selling them, that’s from the Gramm-Leach-Bliley Act of 1999 that basically repealed Glass Steagall.

    What people who buy this shit don’t understand is that if the government was “forcing” these banks to give money to people (which doesn’t make sense but that’s what they keep saying the CRA is supposed to do) then houses would be massively UNDER-valued because banks would be fighting to give the least amount of money they could.

    Instead, the repeal of Glass-Steagall allowed banks to basically sell a mortgage to whomever, bundle it up with a bunch of other mortgages, then sell that bundle as an investment that would “mature” and be worth more than what the buyer paid for it. For example, if the bank bundled up 5 $200,000 mortgages and sold it for $750,000, the buyer of the bundle would basically be assuming to make $250,000 on it when the homeowners finished paying up, which they failed to do, devaluing all those pieces of paper they’d been trading back and forth for the last decade. The bank doesn’t care, though, because they make their money back and a tidy profit off the short-term sale, it was the long-term owners of those mortgage bundles that got fucked.
     
    #3 D_Davy_Downspout, Oct 10, 2008
    Last edited: Oct 10, 2008
  4. D_Davy_Downspout

    D_Davy_Downspout Account Disabled

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    This American Life also gives you a great overview, and may be easier for you than reading all of these words.
     
  5. B_Gravedancer

    B_Gravedancer New Member

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    Generally not true, since banks redlined low-income people for a reason, then because of politically correct reasons they were forced not to.
     
  6. D_Davy_Downspout

    D_Davy_Downspout Account Disabled

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    You're saying banks decided to make bad business decisions in order to be politically correct?

    Next time quote the part of the 3 posts I made your responding to, to avoid confusion.
     
  7. B_Gravedancer

    B_Gravedancer New Member

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    No, that's why Freddie and Fannie were government directed corporations.
     
  8. D_Davy_Downspout

    D_Davy_Downspout Account Disabled

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    What? Quote what you're talking about.
     
  9. Phil Ayesho

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    Sinwin is correct- gravedancer is deluded.


    Bush started with a recession. He de-regulated lending laws in full knowledge that this would allow loan packagers to give out credit easier.
    He did it solely to drive economic indicators UP... 100,000 houses sold makes a much bigger bump in GNP than 100,000 cars.


    The loan packagers somehow got triple A ratings for packages that were HIGHLY risky.

    They then offered these very risky loans to people- making a big deal about how "safe they were" just look at that triple A!

    The loan packagers closed the deal- took the points in cash and then GOT THEIR MONEY BACK by selling the loans to fannie or freddie- who bought them cause they were triple A.


    Thus- the loan originators made out like BANDITS on points and commission alone- raking in billions thru volume.

    They knew the loans were risky- but EACH loan officer and each loan packaging operation wanted the MONEY NOW. and they knew full well THEY were not gonna be on the hook for the default.

    The BULK of bad loans were NOT to the urban poor, but were to middle class families that REALLY wanted one of those Mini-mansions that were unaccountably priced at a million bucks.

    The loan PRODUCT was unsafe. Just as any unsafe CAR would mean the builders were liable- the loan originators and the government that enabled their greed are the real culprits.




    And, people- it AIN'T JUST HOUSES.

    As our nation LOSES real productivity our GNP becomes more and more dependent upon CREDIT. Upon BORROWING from tomorrows productivity.

    If you haven't noticed... ALL forms of credit are becoming easier and easier to get.
    In 1979 it took me 3 years of effort to qualify for a VISA card...
    Now 12 year olds can get them just by asking.



    This is a concerted effort on the part of ALL politicians to artificially raise GNP figures by getting Americans to CONSUME EVER MORE.

    Its the ONLY form of growth we have anymore.



    We need to get our poiticians to start FUNDING NEW industries and tehcnologies that will Employ US , HERE, in the STATES.

    With a stable population and fully developed markets here at home--- our ONLY hope is for new industries that we can SELL to growing foreign markets.

    The LAST THING we should be shipping overseas is our jobs.


    That- or start thinking seriously about a economic system that is NOT reliant upon limitless growth...
     
    #9 Phil Ayesho, Oct 10, 2008
    Last edited: Oct 10, 2008
  10. D_Davy_Downspout

    D_Davy_Downspout Account Disabled

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    Phil, I'm sure you and I agree on a lot of issues, but I really can't read any of your responses because you appear to be typing your posts on a graphing calculator.

    What's with your formatting?
     
  11. B_Gravedancer

    B_Gravedancer New Member

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    Wall street divided and sold toxic assets just like any other asset, and people bought them because they didn't know any better.
     
  12. SpeedoGuy

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    Step 14 should have been somewhere about step 5. Then steps 9 and 14 wouldn't have been necessary.

    In other words: Those who were supposed to be trusted to maintain oversight were asleep at the wheel or looked the other way.

    Nice

     
  13. D_Davy_Downspout

    D_Davy_Downspout Account Disabled

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    Is this in response to something, or are you just blindly posting?

    Keep in mind, the credit rating agencies claimed these securities were good investments.
     
  14. D_N Flay Table

    D_N Flay Table New Member

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    before I got into my new line of work, I worked in Real Estate and Mortgage for the last 8 years.
    I never put anyone in a bad loan.
    I could of made a lot more money doing so.
    I feel that people WERE taken advantage of by bad lenders.
    now the middle class needs the help, not the wall street fat cats.
     
  15. dreamer20

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