Here goes:
Fed lowers interest rates after 9/11 economic woes.
Real estate boom begins due to cheap mortgage rates.
Shady mortgage brokers are able to sell doomed subprime mortages to unqualified borrowers due to a complete lack of oversight and regulation in the industry.
Many of the shady loans have a fixed rate for 2 years that will increase after that.
Instead of holding mortgages and collecting the interest, lenders pool them together into huge financial instruments called MBSs that pay a yield like a bond or savings account based on the income of the underlying mortgages.
The fact that they are selling the mortgages off and not keeping them makes lenders care even less about the quality of the loans they write. So they write more shady loans. A LOT more.
Real estate prices go through the roof since everyone and their homeless uncle wants to and CAN buy a house now. Demand is through the roof.
The buyers of the MBSs, huge financial institutions and investment banks like AIG and Lehman ignorantly think that real estate prices can’t go down too much because after all, it’s real estate and they ain’t making more of it.
(Cue Ominous Crisis Music HERE.)
All the low 2 year fixed mortgage rates go up and homeowners can’t afford them anymore. They start to default.
The huge financial institutions, like AIG and Lehman, are holding onto MBSs to the tune of billions of dollars, thinking of it as a safe haven for their money, the way you would think of a bond.
As the mortgages increasingly default, the value of the MBSs plummet along with the net worth of the financial institutions holding them. Word gets out to consumers and some rush to withdraw their money from consumer banks causing bank collapses.
Many financial institutions, broke and scared, panic and stop lending money to each other or anyone for that matter basically freezing the flow of money through the financial system.
Without cash flowing banks can’t carry on their normal operations and smaller businesses can’t get loans for their daily operations much less to expand or grow.
The entire economy freezes, the stock market plummets with future GDP and earnings growth prospects looking terrible.
And here we are…
SOLUTION:
- More liquidity to grease the system and get it going again.
- A restoration of confidence in the economy.
That’s a very concise and of course simplistic summary of the past 7 years but should be enough to help you understand and hopefully be a little pissed off because you probably had nothing to do with it but are certainly going to be effected by it…
READ PART II HERE
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35 comments:
If you voted for W, hang your head in shame. It's your fault. : )
Very nicely summarized. There is no way to explain this in only 400 words, but that is as good as you are going to do it. I saw it summarized in a hilarious cartoon at http://www.manausa.com/blog/30/financial-markets-mess/. Good luck with your MBA (hopefully there will be a job market for you once attained!)
Well, spurred on by movies such as Money as Debt, and Zeitgeist, I've been reading about the fractional reserve system in place in the U.S., Canada (me), and elsewhere worldwide. It seems that there can be no sustainability for this system, meaning that from its conception, it was doomed to fail. I'm not sure if that's what we're seeing now, but I'm sure it's quite closely related. Your summary reads true, but I think the very nature of our money has a large role to play.
Very true Wolvish, the more I study this the more the I realize the entire banking system is a shell game... It's a little scary.
Not Bush's fault! Clinton passed a bill that basically forced Fannie and Fredie's hands into allowing everyone to have the "American Dream" of owning a home. This forced them to lower their standards of who can buy a house. Last time I checked, the "American Dream" was making it on your own from nothing, i.e. owning a business, not owning a home. Clinton made it so every schmuck could own a home, whether they deserved to or not. So please stop blaming it on bush and propagating the Liberal agenda
How bout Bush never won the election. how bout this is a conspiracy. ahh don't get the V-chip
*affected by it.
Haha Simon... Someone caught that. I was wondering...
W did some very horrible things to the economy, but this was not a result of his administration. Due to heavy pressure by, and I hate to sound one-sided but..., primarily liberal "encouraging" of banks to offer loans to anyone who could sign there name on the dotted line, we were bound for a disasterous crash whenever the housing market became saturated. The bail out saves a lot of people, but in the end, we are removing the market idea of "you take risks, and if those risks don't work out, then you are in trouble."
o_O'
Makes me want to know more of economics but all I get was some macro & microeconomics introduction back in college.
Any way... Thanks for the post, not an american but surely affected by what is going on in your country so I feel like it is importat to know what is going on with you guys.
It would be nice if you post something about the nature of our money (as called by Wolvish) & economy because, I heard somewhere that in fact, our global economy requires to be always growing which will not always be the case.
Very succinct and accurate summary of the situation I think. I worked for Freddie Mac and Countrywide both (on the IT side) so you have hit the nail on the head.
The only thing you left out were the borrowers. They wanted to keep up with the Joneses and a lot of them lied about their income or got no document loans. I realize the guys who sold mortgages were deceptive, but what were people thinking paying 2% down on all the Mcmansions that popped up.
Good idea c-g... I'll put something together about that... It's called Growth Theory.
There is definitely an underlying assumption of growth that's based on mainly:
1) Population Growth
2)Technological/Productivity Increases
It is pretty reliable that these things will continue to increase, but if disaster of some sort stopped it, yes, the economic engine as we know it would collapse and life as we know it would be very different.
For more, read here. This is the classic model.
http://en.wikipedia.org/wiki/Endogenous_growth_theory
Hey, keep going. Why stop at the present.
You left out the part about people and hedge funds pulling their funds out of stocks causing a spiraling market crash.
You also left out the part about massive *de*flation while the governments pump trillions into the economy trying to get money flowing again.
You forgot about third world countries being kicked back into the stone age when their fragile economies completely failed.
You also missed the part about small wars starting up like brush fires because the "responsible" nations were too busy dealing with their domestic problems.
Don't mention starvation.
Very nice your post!
I´m a Brasilian and the crise is already here. Our exchange rate is increasing because of the credits canal and it´s so volatile due the especulation about the future. Our stock market is melting...
The problem effected some litle banks here, and the goverment decrease the (I don´t know how write this word in English) money that the banks need to leave at the central bank.
You left out credit default swaps. We could have handled mortgage defaults (see FSLIC S&L crisis), this whole crisis is 30 times worse because of credit default swaps.
Note that you started off with the response to the 9/11 terrorism. You might have also included the Y2K capital expenditure buildup and then letdown. That laid some groundwork for future softness.
The scary part that people don't want to address is how the World economy is now far more vulnerable to another Al Qaeda attack. Didn't they boast about how $5M "invested" led to $500B in US response?
Whoever wins the 2008 US Presidential election will inherit a cumulative nightmare, and will preside over ongoing massive deleveraging (read lower standard of living) for a populace unaccustomed to deferring gratification.
Credit default swaps magnified this tremendously... I didn't think I could keep it under 400 words and un-wonkish if I got into those. Same narrative applies, it's just magnified in a bad way.
Yeah, Loren... It will be interesting to see what happens. I think we will pull out of this in a year or two, though. Most of this is a crisis of confidence rather than actual production. When and if confidence returns, production should return to normal.
Though in the orgy of the last few years, the financial sector has made something like 40% of all corporate profits while employing 5% of the workforce... That's something that will change.
Not too bad...I'd mention the Federal Reserve cutting interest rates so after inflation we had negative rates--preceding the fall of the mortgage rates.
Student Loans
"Shady mortgage brokers are able to sell doomed subprime mortages to unqualified borrowers due to a complete lack of oversight and regulation in the industry."
Were these shady brokers using guns or other means of coercion to force borrowers to sign mortgages?
Or perhaps in an exchange between two mutually consenting adults, both members of the agreement should be accountable to the consequences.
Also, to what degree should the government be responsible for policing bad decisions? If I decide to take out a credit card loan and purchase the world's largest collection of garden gnomes, then can't pay the loan back, is that the government's fault due to "lack of oversight"?
One more question on the subject, sorry about my longwinded-ness.
If there really weren't any "oversight", meaning government intrusion into the market, what would you call the Community Reinvestment Act, and the Federal Reserve's manipulation of interest rates?
Because to me, when the government forces banks by law to lend to sub-prime borrowers, this "oversight" would seem to cause more problems than it fixes.
And when the Federal Reserve arbitrarily sets interest rates below market levels, this act of "oversight" compounds the problem by encouraging borrowing by unqualified customers who otherwise should not be able to afford a loan.
cfBauer -
Part 1 -
I 100% agree that both borrowers AND lenders are to blame. The gov't shouldn't be bailing out people who bought houses they couldn't afford. Period.
That said... I know several people who worked in the subprime lending world. They went well out of their way to lie, cheat and forge all sorts of documents to get loans through underwriting. And underwriters knew what was going on and looked the other way... It was standard practice. Both are to blame.
Part 2 -
The CRA had nothing to do with this. That's complete nonsense. The CRA has been around for 30 yrs.
The bulk of the subprime loans that are defaulting are in overpriced suburbs like the inland empire, long island and san diego. Not in the hood. The CRA doesn't have anything to do with that. It's the places that had ridiculous overinflated price bubbles. Inglewood and Chicago's South Side were not building McMansions... You are way off the mark and that's just political political propaganda to stick this on Obama somehow but in no way resembles the facts. A bunch of shitheads got greedy. Buyers and lenders.
And yes, intervention in the form of A) the Fed raising rates when things were overheating (like they are supposed to) and B) making sure the income documentation to get a loan in some way resembled the truth would have been nice.
Yes, having rules of some sort can be a good thing. Or do you like where the unhindered laissez faire policies have gotten us?
There is a middle ground.
@Kris: This is clearly Bush's fault.
Your FEARLESS leader failed to revoke the law created by Clinton even when he had congressional majority.
After all Bush had the best cabinet: Paulson, Cheney and Rice.
I mean he was your GOD!
And that GOD failed you! because either his advisors(he'll pardon them) didn't tell him the truth about the law, or they did and he ignored them.
Now, Bush is neither part of executive nor belongs to Senate. He is above everyone else, including you.
If HE can't see it coming, is clinton to be blamed for it?
Thanks for your response Scott.
"They went well out of their way to lie, cheat and forge all sorts of documents to get loans through underwriting."
If this is the case then these people should be charged with fraud. However, most calls for oversight seem to insinuate that the government should "protect" individuals from making poor decisions, and that responsibility lies with the broker and not the individual. You don't seem to agree with this approach, I was wrong when I inferred that.
"The bulk of the subprime loans that are defaulting are in overpriced suburbs like the inland empire, long island and san diego. Not in the hood."
One of the hardest hit areas by the busted bubble is Stockton, CA, which happens to be where I lived for four years during college. Stockton is a lower-class farming community in the central valley, far from an overpriced suburb.
"The CRA had nothing to do with this. That's complete nonsense. The CRA has been around for 30 yrs."
Yes the CRA has been around 30 years, but it was also greatly strengthened as a pet project of the Clinton administration. And the long term consequences of market manipulation often take some time to be seen in action, meaning it isn't unreasonable that the strengthened CRA affected the bubble just a few years later.
Though I don't think the CRA is responsible for this mess by itself. This brings me to my second point, the artificially low interest rates set by the Fed. You mentioned the raised rates creating problems for borrowers, which they did. But you also didn't mention that the lowered rates create incentives for borrowers to take big loans, and banks to issue them, a policy set by the quasi public federal reserve itself.
Here is a graph of the Federal Funds Rate. You can see the rates drops all the way to around 1%, the lowest since the 1950s. What we see after the rates drop so low is a created a busted bubble.
http://en.wikipedia.org/wiki/Image:Federal_Funds_Rate_(effective).svg
The policies of neither the Bush nor Clinton administration were conductive to the free market. These manipulations I explained are not laissez faire. They are bubbles created by a cycle of unintended consequences.
The government creates problems, then tries to fix them by creating an entirely new set of problems. All of which undoubtedly are blamed on the free market by those who don't look close enough.
There are lots of examples of very successful market based economies, but only when the market is actually allowed to function. Hong Kong and Singapore are two of them.
Thanks for the talk. I appreciate this exchange of ideas.
Here's the graph, the link I posted got messed up.
Federal Funds Rate
Agreed 100% on the interest rate issues. They dropped them to stop a mild potential recession in 01 that may have been exacerbated by 9/11.
Low ones started it and the raising of the rates only hurt the situation because of all the ARMs that were marketed. They had to raise them, and probably should have done it earlier and more to stop the real estate inflation before it got out of control.
Gov't monetary policy "intervention" from the Fed on interest rates has mostly been helpful over the long run. I think most economists would agree. This was definitely an example of unintended consequences that could have been prevented with tighter control of the kinds and quality of mortgages being sold. Not necessarily by scrapping monetary policy which has been effective and was not a "cause" of this per se...
Stockton and Riverside are both working class examples of mortgage Chernobyls but they still aren't CRA "community development" type places either.
Again, inflation is bad. In this case the inflation was complicated and confined to real estate but like any bubble it inevitably burst. They all do... But no one seems to learn that until it happens to them I guess.
This is ridiculous, our economy is shot, and is getting worse by the day. Yet there are thousands of people in college, trying to take out loans to continue in college. How are we supposed to have future generations of educated people when none of us will be able to get enough money to go to college? This started way before 9/11, the dollar has been falling for years and is about to become nothing if we don't stop talking about doing something and just do it. The dollar has lost so much to the euro, its worth only 74% of a euro. Not long ago it was 160%, what happened?
Mason...
Pretty complicated but short answer is... Huge budget deficits in the US and higher interest rates in Europe. That's changing big time as this mess moves to Europe.
Euro is at 1.36 today. Was at 1.5 two months ago.
Swedish Kroner (My girlfriend is Swedish) was 6 to 1 a month ago. Now it's 7 to 1. Dollar is gaining value fast.
The weak dollar has actually helped the economy overall in the slump because it boosts exports. Sucks for tourists like myself though... I'm not exporting jet engines any time soon and beer was real expensive in Sweden this summer... $12 beers are painful.
Hi Scott.
I've posted you into Stumbleupon. Given yo credit of course. Thanks. Very helpful.
@Freedom_India: Bush tried very hard 4 or 5 years ago to get congress to take a look at this and no one really took him seriously. They saw higher than ever stock prices and tons of people buying homes and thought nothing about what Bush was saying. How is it that he should be blamed when, as you said, he should have revoked the laws made during Clinton's years. If the law was written while CLINTON was the president, how in the hell can you blame Bush?
I'm not trying to bring out partisan issues here, I'm just defending a man who doesn't deserve the blame for this. When the problem finally showed up, he was the first one with a plan, and that plan was one that doesn't fit into Republican planning by a long shot.
Good break down. I think the CDS market played as large a role as any in this collapse as well.
I do a breakdown on my blog as well (much longer w/ sources so you might need a minute)
http://anotherdamnblog.com/index.php/why-are-we-in-a-the-financial-crisis/
Would love to know your thoughts.
-ep
Nicholas Finn wrote. 'defend a man who doesn't deserve the blame for this.'.... He (his admin) did not catch this major mistake for 8 years, made it worse with their actions, and you want to give him a pass. I want you as a boss...
Cfbauer, I'm all for free markets but you can't pin the CDS nightmare on oversight. Those are all Wall Street's babies and out match the damage done by bad loans by trillions of dollars (the true cost is yet to be seen). There's nothing worse than watching an insurance company pay up after a hurricane it doesn't have the money to pay for.
Scott, I'm with you. Prudent confirmation that business is being done with the greater good in mind is always appreciated. Were talking about oversight (with authority) not regulate.
In the end we are all animals, left to our own devises...even Rome fell...
So... right. I think I'm a fan of switching economic systems now.
Excellent - thanks to all.
As a homeowner who drank of that "Kool Aid", I've not heard any comment on how many mortgages in trouble are re-fis.
The most obvious reason for a re-fi in that period was to get out of crazy high credit card interest rates.
I also want to point out that promoting home ownership, as public ploicy, was and continues to be a very good idea.
We all get to share in the responsibility for this one. Some more than others, but it is inherent in a fear-greed cycle. And the example set by our leaders is no better, as we run up a federal deficit over ten trillion with questionable underlying equity. In the political landscape we have be come a digital culture of 0's and 1's. Republicans love to cut taxes but spending continues to rise with no apparent regard for financial health of country. Dems are painted as big spending liberals in efforts to promote social justice, yet deficits go down when they are in office. So, many citizens follow suit and continue spending even when income cannot cover it. There are limits and corrections when no artificial limits (as in regulations) are in place. No single source of financial problems when a culture veers this far off course int he fear/greed cycle.
I’m with Kris on this one. It wasn't lack of regulation, but government interference that caused the crisis. Obama was involved in suing banks that didn’t offer enough sub-prime loans. Watch the video at http://www.earthfrisk.com/blog//?p=100. They spell it out better than I can, and its going to get a lot worse. His Cap and Trade plan is going to raise the price of natural gas, coal, gasoline. Read the article at http://www.usnews.com/blogs/capital-commerce/2009/03/03/what-obamas-cap-and-trade-plan-will-cost-you.html, increasing costs will mean less jobs. If you voted for Obama hang you head. It's your fault. :(
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