Today was that day, perhaps the one you're asked about many years from now, questions from your kids forced to study economics and realizing something huge happened when they were still children. The best answer I'll conjure up is something like "man, I dunno – it was complicated."
As best I can tell, this is what happened (and please, if I'm getting this wrong, please correct me):
1. People without any real money bought houses they couldn't afford.
2. They could do so because banks were lending them money with no downpayment and crazy low interest rates and no stringent credit checks.
3. The banks figured they could do this, because housing prices always go up.
4. Now the banks have shitty loans, which they sell to investment banks on Wall Street who figure they can make a buck off them too – because housing prices always go up.
5. The banks then sell these shitty loan mortgages to everyone else looking for a safe investment, rating them misleadingly, and using offshore accounts so nobody could see what they were up to. Who cares? Housing prices always go up!
6. Housing prices don't go up. In fact, the bottom kinda falls out.
7. People who ultimately bought these "safe investments" wonder where the money is, but all the ORIGINAL homeowners (from number 1 above) have foreclosed. The banks say to their disgruntled customers, "well, we never promised you a rose garden."
8. The truth comes out, and all these banks – and everyone associated with them – lose stock value so rapidly that the shareholders revolt.
9. Now there's no more money and no more credit being given. Without credit, the entire financial sector loses their oxygen, and the whole fucker slams to a halt.
10. The Government ponders a bailout plan to shore these banks back up and get credit flowing again.
12. The bailout plan fails because some Republicans believe it goes against their small-government philosophy, and some Democrats believe it wouldn't actually change the way these banks behave, it would reward the people who fucked up, and the taxpayer wouldn't share enough in future earnings.
Then the Dow falls off a cliff. Is that basically what all of you believe happened? If not, what is your take? And what happens now?
Posted by Ian Williams at September 29, 2008 11:31 PM
To break it down further:
1) 1999: Congress votes to deregulate the financial services industry, removing the separation between retail banks, investment banks and insurance companies. McCain votes FOR it. Biden votes AGAINST.
2) Financial institutions take advantage of the situation, creating new kinds of mortgages. The results are good (expanded home ownership) and bad (high risks). A chorus of voices warning of disaster should home prices fall (Warren Buffett among them) goes unheeded amidst a feeding frenzy of unprecedented profits.
3) Housing prices fall and the house of cards collapses. Congressional Republicans block passage of a desperately-needed bailout package. The stock market crashes; the US and global economies teeter on the brink of collapse.
The rest is still to be written....
Seemingly, either Congress passes a bailout bill, or it's welcome to the jungle, baby.
You missed the Kredit Krunch (TM) part:
5a. Some banks borrowed tremendous sums in the short term interbank market to buy mortgages. (When they bought the mortgages they are basically lending money. They borrowed the money to do this at lower interest rates than they were lending at. Voila, printing money!)
5b. As the value of homes dropped, the value of the mortgages on the banks' balance sheets dropped. Suddenly they had less "assets" and could therefore lend 12 fewer dollars for every dollar they lost on mortgages. If you add up the amount of "write downs" the banks it runs into the hundreds of billions.
5c. Huge companies previously thought unsinkable sunk.
5d. Everyone furiously recalls short and medium term loans. Either because of balance sheet effects or fear of 5c.
5e. Everyone sells assets to get cash to repay loans. Some assets being liquidated are stocks, by the way.
5f. Asset values go down, reducing balance sheets. Go to step 5b.
Paulson & Bernanke are scared because we are currently stuck in a death spiral of step 5.
Thanks Dean for coming up with some stretchers to spread the blame.
The fact is, the problem was caused by financial instruments that were illegal before Gramm-Leach-Bliley. Bill Clinton signed it, and a bunch of Democrats voted for it. That was in 1999.
Then Bush became President, and made a complete joke out of oversight and regulation. Now we see the result.
Sure there are Democrats who voted for GLB, and greed is non-partisan. But the root problem is a bankrupt economic philosophy, one that Republicans still cling to after they've done their level best to ruin the entire world economy.
Maybe while we try and solve this shitstorm we could think about the other Republican economic crime -- repealing anti-usury laws so that credit card companies and banks could charge loan-shark interest rates.
Just a few tweaks:
On #1, this wasn't just "people without any real money buying houses they couldn't afford" - it was poor underwriting by banks that knew they could sell the risk to someone else. A big chunk of the foreclosure problem is in subprime, sure, but another big piece is in the Alt-A market.
On 2, 3, and 5, the banks loosened their underwriting standards because the high demand for high-yield asset backed securities meant they could sell as many loans as they could make without anyone taking a hard look at their underwriting. Rating agency criteria focus more on the structure, not the terms of each particular loan, as anyone that paid attention knew, so the rating problem is a red herring meant to distract from the real problem, which was banks/funds/etc. buying stuff that they didn't understand from investment banks that were happy to take advantage of their ignorance, part of their basic business model.
Anon is right, CRA has nothing to do with this. That's another red herring meant to pin the blame on poor folks and minorities.
On #s 10 and 12 (and what happened to #11?), the bailout failed because it was ill-conceived and poorly understood, because the Republicans have spent the last 30 years teaching their supporters that the government cannot be trusted while gerrymandering their districts to make them highly polarized politically and thus safe for ever more conservative politicians, and because the current president used up so much trust and credibility that he was unable to deliver his own party, at the same time that the House Republican leadership was too weak to ensure the support of more than a third of their own.
Blaming this on Nancy Pelosi (who gave what was in fact a very mild rebuke of deregulation) would be pure comedy, if the situation weren't so serious. That was the best Boehner could come up with to feed the rubes to cover his own weakness. Pelosi delivered 60% of her party, twice what Boehner provided. It probably didn't help any that Republican strategists were openly suggesting that Republicans oppose the plan to score political points.
The upside, if there is one, is that this may ultimately mean a better plan, one that addresses the underlying problems rather than just the credit aspect.
I am having a hard time understanding a lot of this. Mostly because for the first time, I, the most liberal guy I know, disagree with Democrats. Not all, but I agree with more Republicans (the ones up for re-election, anyways).
I was very happy that the bailout failed. Quick decisions are often bad ones. I do not want to save a failed system in this way, especially with urging from Premier Bush. I think of the bailout as just another straw on the camel's back. Maybe what should die, should die.
I hear you Paul G. Does sort of feel like we're bailing that trouble making teenager out of jail for a DUI again and then giving him the BMW back. How about some tough love?
However, to stick with the analogy,in this case, if we do nothing it's like we're getting back in the car with him and handing him the 6 pack.
Or maybe I'm wrong, I hope so.
Not to harp on my usual topic but this financial crisis is not too far from the health care crisis as I see it. Bunch of greedy people trying to make as much money as possible. Many people in the health care industry are getting really rich (yes, including some doctors, and definitely including some insurance companies) while needy people go without. We should all be ashamed.
Of course, with this financial fiasco we'll never have the money to fund health care reform now.
Bin Laden must be laughing in his cave. Those greedy Americans are taking themselves down without any help from terrorists.
I definitely think they were in it for the money and now they will pay the price for their overzealous lending habits.
I just hate to see $700 billion dollars go to save 4 poorly run institutions.
I think of world hunger, illiteracy, disease, the homeless, etc. and can only imagine what we could accomplish if we put that money to work to solve these problems.
I believe the Citigroup purchase of Wachovia greatly influenced the votes of many of our representatives as it should have. (Wachovia was started over 100 years ago in my hometown of Winston-Salem and was a FANTASTICALLY RUN BANK before the First Union merger. You think you have problems- think again. People are dying on the vine in NC with their worthless Wachovia stock).
The market is up today. Financial armageddon will have to wait another day.
I don't see any mention of HELOC's - Home Equity Line of Credit. People took out millions of dollars in phantom equity, and when the house of cards came tumbling down, they are suddenly underwater. (They owe more than their house is worth.) In California, HELOC's are non-recourse loans. So if you spent it all, and then end up walking away, you get to keep the money! Or at least the assets you bought with the money.
The HELOC phenomenon allowed people who actually put down money to extract their down payment and spend it. How crazy is that?
Here's an interesting blog by a guy in my town which details some of the stupidity here in Orange County. www.irvinehousingblog.com
Fannie and Freddie are subject to SOX.
And the bailout would help more than 4 companies. It was for any company who wanted to sell their bad mortgage=backed securities to the gov't.
My husband is an Evil MBA and he rocks. He should take over Paulson's job ASAP.
I think so much of the problem is that 'Main St.' doesn't get how Wall St. affects them and the economy, in general. No one has done a very good job of explaining it, it my opinion.
Suze Orman, who I am not normally a fan of, was on Oprah the other day and she glossed over some complicated facts but did a pretty good job.
Ian, your 'splanation was pretty good. Like Suze, it glossed over some stuff, but you've got a handle on it.
> We forgot about those people that were living
> BEYOND THEIR MEANS. For the majority of
> Americans car loans and credit cards are
> NOT necessary.
There are two parties to any loan -- the lender and the lendee. The fact of the matter is that in America right now, getting in over your head in debt is way too easy, and its because banks encourage you to spend money you don't have. It's wrong that anyone who holds down a job and lives in one place long enough to get on the mailing lists can get 20-30 credit cards, plus an ARM Mortgage, plus a home equity line of credit.
It's a major act of will and judgement NOT to get in over your head.
Back in the day, it was HARD to get a credit card, and your bank held your mortage in house. If you were bad with money, you might get into hock for rent and bills, and get your utilities cut off or get evicted, but there was a limit to how far in debt you could go. Now it seems like anyone making $30K a year can be a half million dollars in debt before any red flags go up.
If financial institutions just get back to exercising due diligence, then this won't happen again. But don't expect the Republicans to bring this about.
"It's a major act of will and judgement NOT to get in over your head."
Do you really believe this? It is called common sense in my book - not a major act of will and judgement. What compells a person to fill out these credit card applications? Greed. Sense of some off-base entitlement. Looking for identity/fulfillment in ALL the wrong places.
I would like for each person with eyeball level debt to say...I am responsible. Yeah, I bought what some schmuck at abc lending was selling me, because he assured me it would be fine. But, I am responsible for my finances. I am responsible for signing this piece of paper. I am responsible for not reading the fine print, for not heeding the advice of every financial guru who says your mortgage should not exceed 25-30% of your income. I am responsible for going to Starbucks (insert any store) while I am behind on my bills and creditors are calling. I am responsible for getting myself into this mess and I will work hard to get myself OUT of it. I will take my lunch to work, I will shop at thrift stores, I will (gasp!) make my own coffee for the drive to work. I will sell that new car and buy one that is several years old and paid for! I will make a budget and stick to it!
Oh, but that is right. I can just claim bankruptcy and get right back into the game.
There are only a couple of things I can add to this. Obviously, the market was run yesterday by scared investors and today the money flowed back on "bargains" and you will watch the money flow out again tomorrow as people take their "run ups" out of the market. This tide will eventually settle out (and lower than before) becuase the economy is heading south. You hit the issue on the simplistic head, Ian. The one thing I'd add to your info is that everyone had a flawed idea that a house somehow was an investment and the price should act like their stock portfolio. Well, the prices have gone down and will likely go down further, just like stocks. If you think about it, the way people made money on their houses in the past was by growing the equity by PAYING OFF THEIR MORTGAGES!!!! When did we lose this concept? My kids can't afford a house in the future if the starter homes start at 1 million dollars and keep going up. That is the reality in many parts of California and in Florida. It happened because again, some bozos came up with the bright investment strategy that a home could be a like a stock and shoot up based on speculative buying. Crazy and unsustainable, but we all liked it while the home equity ATMs were flowing. Now, the time of reconing is here.
I for one am against this whole bail-out thing from the get go. I know that it has worked in some cases in the past, but I say let the banks fail, let things go crashing down and pay the piper. There will be much pain, but the bailout just seems to be a salve to avoid the pain and pass it on to future generations. I think we can survive and will be the better for it in the long run.
Randy, I admire the principle of your stand.
I take it that you are willing to bear the costs of your stand, even if those costs include losing your job, your kids not being able to go to college, or homelessness?
It's not often that one sees that kind of personal courage today and I salute you for it. You're a better man than I, Gunga Din.
You are willing to bear those costs, aren't you Randy? Or to see your friends, family or neighbors bear them?
If not, you need to hold your nose like the rest of us are doing and support a rescue effort while there's still time.
Buying bad debt is not a rescue for the rescuers.
Would you be willing to loan or give money to your friends, family or neighbors? Probably.
Would you be willing to pay off their credit cards for purchases of salad shooters, their gambling debts or their missed payments on their vacation home? Probably not.
If they asked you for the loan without explanation you may inadvertently be paying for their bad debt. If they told you up front that it was bad debt, then you probably wouldn't.
We are being told up front that the bailout is for the most toxic debt that exists. It currently will not be purchased by any private investor in the world, at any price.
I favor an equity position in any rescued financial organization. It is normal collateral for any loan, stock purchase or reasonable transaction conducted anywhere in the world, at any time in history. The value of the product or stake is always open to negotiation and is always open to scrutiny. Only through deception, stupidity, gullibility or ignorance is this rule broken.
Do you think people are not buying SUV's because they can't get a loan? Are GM employees losing their jobs because of GM's credit?
Is steel more expensive because Rio Tinto can't get a credit line to develop a new mine?
Is McDonald's credit line cut off with BOA for daily operating reasons, or was the credit line to allow franchises to expand their stores into the "premiere coffee" market the actual credit line that was rebuked? Given the fortunes of Starbucks recently, I'd say it was the expansion plans.
It's plain to see that the era of stupid debt is winding down. Even though the bailout comes with tighter regulations, the regulations should be coming regardless of whether money is involved, and indictments.
I don't have a particular political stance on the bailout but I do know down deep that I have had a great time over the past 15 years. About half of it was brains, timing and talent and the other half was blatant speculation, unheard of gobs of free money, extension of outrageous amounts of credit and tax breaks that would break a normal government (these are personal, I'm not commenting about society at large). Given my take on the situation above I believe the bailout will not actually fix the situation and yes, I totally expect hard times, stress and my personal situation to decrease in quality...maybe a lot of quality.
We will bear the costs in the same way, one way or another.
I am willing to bear those costs. I do not have anything, moreover, I was not stupid enough to pretend or think I should have something. My parents do not have much, but what they do have is paid for.
Sorry to you, your friends, and neighbors, but pumping 700 billion into a dead horse is still gonna leave you with a dead horse. And another unfathomable debt.
I have ZERO sympathy for those that got themselves into this. I wish nothing bad on them, but I do not believe they should be helped in any way.
I think we need to act, to act fast and most importantly to act correctly.
Bud and Kent correctly lay the blame for this mess on Gramm-Leach-Bliley. Repealing the usury laws didn't help much either.
Greg (grumphreys) provides a link to a reasonable, proven model for a solution. We're not the first country to have to deal with this. There's no reason to re-invent wheels - or to give away the store to the people whose greed got us into this.
Sweden came out of their mess somewhere between 2% down or slightly up, depending on whom you ask. The key ingredient, as Jody points out is providing rescue only in exchange for equity.
But Admiring Citizen has a point, too. Fail to act at all - and quickly - and we're in for a long, cold lonely winter.
Perhaps we'd be better off to reset this thing now rather than trying to prop it up. It may not be fun to live with in the short-term, but the markets do have a way of correcting themselves.
As to blame - believe the NY Times - which in 1999 published a story that the Clinton Administration was pushing Fannie to accept more risky loans and people with poor credit to get people in houses (that they shouldn't be). Now, being a conservative, it may have started there, but the Bush administration (which has been admittedly terrible) has done noting to change that - in fact, they probably profited from it as well. The article went on to predict that in financial hard times this would result in the mess we've been living with over the last year.
Can it get worse? Yes. and I believe it will (bailout or not). But I also believe the businesses in this economy, while struggling, are not doing as bad as the financial section and we'll weather the storm (or depression or recession or whatever you want to call it). The one thing I can't stand are these financial "experts" showing up on commentary shows scaring the common man with ideas of a depression when they don't know what the impact of this will be. It should have been voted down the first time - nobody deserves a blank check. They all seem like a bunch of crackheads looking for their next fix and $700 billion seems like it ought to do it.