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OT:good explanation of where we're headed without

Discussion in 'Off Topic Threads' started by wireguy, Oct 1, 2008.

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  1. wireguy

    wireguy TS Member

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    I was forwarded this by a friend. Is this about correct?

    Let's make this simple, because I don't have a lot of time today. For political reasons, the government supported Freddie and Fannie making home loans to people for whom The Market wouldn't otherwise provide financing. (When I capitalize The Market, I'm referring to the whole financial system versus the NY Stock Exchange.) Historically, the most reliable loans are home loans, because people need a place to live so they make their payments. What happens is Freddie and Fannie then package these loans up into bonds, which rating agency rate based on their risk, and sell the bonds. This is important because it frees up more money for Freddie and Fannie to lend back out. Easy math, you loan $100 then sell a portion of the payments on that loan for $80 so you only need another $20 to make another $100 loan. Done properly this is a massively good thing, and there's nothing inherently wrong with this. It provides a good safe investment for pension funds, etc. and reduces the interest rates lenders have to charge borrowers. In fact this model is largely responsible for the massive increase in wealth our economy has experienced since the early 90's – including the tech boom, but that gets complicated.



    So where's the problem? It's on either side in the lending and the rating. Remember Freddie and Fannie are being pushed by politicians to make loans The Market wouldn't otherwise make. In order to keep up, private groups doing similar business. Ideally, the lower rating of these riskier bonds would drive up the interest rates being charged and lower the price lenders could get for their bonds – thus decreasing the volume of these transactions. Problem is the government is backing Freddie and Fannie because cheap home loans are good for votes. The rating agency then get pushed to improve their ratings for Freddie and Fannie, and of course the private guys start pushing for similar ratings… This is the origin of the problem. Criminal negligence by rating agencies, some mortgage originators, and of course fraud by some borrowers. Part of the problem was the mindset that residential real estate would just keep going up. It lulled borrowers into bad loans. OK, so how does this lead to a market meltdown and bailout.



    Remember the high quality bonds. Well in addition to the pension funds and mutual funds that make up middle class America's 401k's, many banks held these bonds. They were supposed to be the low risk investments they could sell in times of trouble. Remember, banks can't just sit on money. They have to pay interest on their savings accounts, and they have to generate profits to make loans. So instead of cash they hold high quality bonds like Residential Mortgage Backed Securities (RMBS), which provide a low but stable return. Why is this so critically important? Without banks making loans the economy grinds to a halt. Literally. Most businesses don't pay for things with cash, they use a credit line that enables them to finance for a short period of time a percentage their purchase. Let's use AT&T as an example. They're constantly buying wire and switching equipment ahead of people paying their phone bills. It's a short term loan, but it enables them to do things like increase the coverage of money making services like DSL. AT&T needs banks to keep their business afloat. Without these credit facilities they would have to contract back to what they could do with cash, which would mean laying off THOUSANDS of people.



    So what's happened today is that people have lost faith in these RMBS, and they've also lost faith in a bunch of other similarly high quality products like Commercial Mortgage Back Securities (CMBS). It doesn't mean these bonds are failing, but the value of them in the market has dropped to under 20 cents on the dollar. This means the banks' ability to cover their loans has collapsed – remember this stuff is like their cash! So the banks are having to sell off everything they can, but the problem is everyone is in the same boat. So there's hardly any money to buy things. So banks are taking long term losses and selling good assets at a discount now for immediate cash. We're caught in a self-propagating cycle, and it's worse than anything anyone has seen before. It has nothing to do with greed or bank presidents' salaries or trickledown economics, in fact, it doesn't have anything to do with bad loans anymore. The cycle is running on its own, and it's wiping out one financial institution after the next.



    The Bailout is a very savvy attempt to break the cycle. By buying the RMBS, which no one else will buy, from the banks it will shore up their balance sheet and in effect set a floor value for these bonds. The interesting thing is, this will likely be hugely profitable for the government. Remember, these bonds are the payments of Americans all over the country who don't want to lose their house. If 25% of these loans go bad, it would be unprecedented. And the government will likely pay less than 50 cents on the dollar for these bonds. So in fact, the banks are going to take huge losses to the benefit of the American tax payer. So yes, $700 billion seems like a big number, but Monday America's retirement account, the New York Stock Exchange, lost $1.5 trillion dollars. Trust me the fat cats will always be OK, but working class people on fixed incomes like our grandparents are getting screwed. Why, because of greedy, ignorant America crying foul. "Hey, banks is who gots all the money. Why we give'n them rich bastards more?" But when the mechanic needs a loan to buy more tools, or a farmer to buy a tractor, or a trucker to buy a new fuel efficient truck, or a retailer to buy goods for their shelves where do they turn? The banks. So this isn't a bailout of Wall Street. They're losing BILLIONS. This is a bailout of Main Street.



    Don't believe me? McDonalds and AT&T announced this week they're going to start laying employees off because they can't get financing. This last Friday a dozen local banks announced they were halting all commercial lending. If your loan was coming due with WAMU of Wachovia this week, you're not getting a renewal. Even B of A customers are suffering, because they're running out of money to lend. Wells Fargo is still lending, but they're having to charge such high rates that most business can't afford to take the loan. The biggest problem is, as Paulson tried to explain to the ignorant bastards in Congress, this won't fix itself overnight. You've got to climb back out of the hole, and, in effect, the deeper you get the slipperier the walls get.



    I love you Eric, and I know your passionate about this because you feel like there's so much injustice in the world – economically and politically. I agree. But justice comes through opportunity, and opportunity comes through a job and the credit to take a risk. This crisis is about the loss of both of those for the common man, and discussions of "the wall street guys" are a near criminal distraction from the real issues. Twenty years from now, anyone who has spoken out against this bail out will be ashamed of themselves, because we are entering a depression the likes of which we have not seen in our life time. Batten down the hatches boys, because this ride has only just begun.
     
  2. crusha

    crusha TS Member

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    Doesn't this illustrate - just how DESPERATELY Congressmen want to hold onto their jobs?
     
  3. tad houston

    tad houston TS Member

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    I agree with much of what was passed on to you, however I am sure you realize it has been simplified significantly.

    I do however disagree with the reasons given in the fourth paragraph for the drastic reduction in the value of these assets.

    The link above is to an article written a few days ago that sheds significant light on this facet, and offers what I believe is a munch more prudent answer to this situation.

    It is far to long to copy and past here but I strongly suggest it is worth the read. And after you review it, I suggest you use the links at the top of the main page and let you representative in the House know what you think, the Senate will have already passed their version by now.
     
  4. halfmile

    halfmile Well-Known Member

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    I believe the millions of dollars kicked back to Washington in the form of political contributions and also lobbying money (more millions) may have just had a teensy bit to do with it.


    HM
     
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