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Why the Financial Meltdown.

Discussion in 'Uncategorized Threads' started by JBrooks, Sep 20, 2008.

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  1. JBrooks

    JBrooks TS Member

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    Ok, this is a long read and if you would rather just get your information from one of your ignorant buddies at the gun club you can stop reading now because you will get to about the third paragraph and you will stop reading then anyway.

    The writer knows Wall Street inside and out. It was originally posted at RedState.com:

    "The Root Causes of the Financial Crisis
    Leverage and the Shadow Banking System

    Posted by: Blackhedd

    Saturday, September 20, 2008 at 09:18AM

    Let me tell you a story about mortgage-backed securities purchased with borrowed money ("leverage").

    An MBS is basically a package of individual home mortgages pooled together so that it can be priced and analyzed like a bond. (And usually the pool is also divided horizontally into credit-quality tranches too.)

    MBS are a big hit with institutional investors, because their bond-like analytics made it possible to do something they’ve been wanting to do for decades, which is to gain exposure to the US mortgage market. (Compared to almost any other kind of asset, a mortgage has higher credit quality. Most people, when they get squeezed, will pay their taxes and their mortgage and let their other bills slide.)

    And Wall Street firms were thrilled with this piece of financial engineering because the bundling and marketing of MBS generated enormous fee income. And like the drug dealer who uses his own product, Wall Streeters often bought the higher tranches of MBS for their own accounts too. (Bear Stearns and Merrill Lynch were particularly guilty of this.)

    So how do you make a good thing better? You buy it with borrowed money. All over the world these last few years, there’s been a tremendous amount of buying of MBS by banks, Wall Street firms, insurance companies like AIG, hedge funds, even money market funds and small towns in Norway.

    No less than Fannie Mae and Freddie Mac bought acres and acres of this paper.

    And many of these players used funds borrowed from banks and from the overnight money-markets to buy it. If you want one single root cause, one thing to blame for the financial crisis out of all the rest, this is it.

    Here's how it happens...

    Let’s say you can borrow money overnight at five percent. (The numbers in this example are not necessarily representative of any specific point in time. Overnight rates today are far lower than they were during the MBS craze.) And you can use the money to buy an MBS that is expected to pay a yield of 5.75% over its five-year term. And the MBS has a triple-A, investment-grade credit-quality rating.

    Wouldn’t you want to do this trade as large as anyone will let you? Let’s say that you’re a hedge fund with a billion dollars in capital. Let’s say you levered up 30-to-1 (which is not unrealistic). Conceivably you could construct a $30 billion portfolio of MBS off the $1 billion in capital. Your raw annual investment return (without counting a handful of external costs like insurance) would theoretically be 30 times 75 basis points. WOW! That’s far, far, far above the “normal” risk-adjusted investment yield of 8 to 10 percent that institutional investors have targeted as a benchmark for decades.

    Now do you see where the whole problem came from? Ok, what happened next?

    As soon as the housing bubble burst, the values of all the MBS had to be reduced because default rates on the underlying mortgages started rising. You saw an increase in the amount of risk that any given mortgage would default, and that in turn would increase the risk of the MBS that the mortgage had been packaged into.

    You always have to receive a higher yield on a riskier investment. (That’s why Treasury securities, which are risk-free, normally have the lowest interest rates.) But if the MBS has already been cut, packaged, and sold, the income that it generates is fixed permanently. In that case, the MBS will behave just like any other fixed-income security: its value will decline, which effectively raises the yield.

    But what if you bought the MBS at a certain price to obtain a certain interest rate? You now have an unrealized capital loss, because the MBS in your portfolio is worth less than you paid for it.

    Ah, but you say it doesn’t matter. Just hold the darned thing until it matures. It will keep paying the same amount of interest (which doesn’t change). A small number of them will default, and you’ll take those losses in stride.

    Good point. But here’s the problem: what if you borrowed the money to buy the MBS?

    If you borrow money to buy something, the guy you borrowed from wants to make sure you’ll pay him back. And since your ability to pay him back depends on whether the MBS will default, your lender will enforce your capital position at all times. (He’s managing his so-called “counterparty risk.” He wants to be sure you have enough capital to withstand losses without passing them on to him.)

    Simply put, if your leveraged MBS portfolio declines in value by even a small amount, you lender will demand that you add to your capital (“margin call”) in order to protect him. If you don’t, he can and will seize your assets and put you out of business.

    In two sentences, that’s what been happening all over Wall Street for over a year now.

    So there’s a huge amount of MBS paper out there that was purchased for more than it’s worth now. When you’ve lost that much money, you can’t buy anything new. (In the jargon, you don’t have enough balance sheet.) But you’re still stuck holding the distressed assets until they mature.

    Multiply that by thousands of institutions across the country, and you’ll see why we have a credit crisis. Any bank that’s forced to take big losses in an MBS portfolio doesn’t have enough capital to make any new loans. It’s the biggest systemic margin call in history.

    THIS IS WHY THE ECONOMY SLOWED DOWN, BEGINNING LATE IN 2007. And I’d been saying that in this space a whole quarter before it even happened. This is also why economic stimulus plans like the one we got this year from George Bush and will get from Obama if he’s elected President, only make the problem worse, not better. And it’s also why the economy can not recover until the bad paper all runs off.

    This is the root cause of all the failures by one investment bank, commercial bank, hedge fund and insurance company after another. It’s why the world’s “official” investors (foreign central banks and sovereign wealth funds) quietly insisted that the Treasury explicitly guarantee Fannie Mae and Freddie Mac’s securities. It’s why private equity has come to a halt and the stock market has stopped growing.

    And it’s the problem that Hank Paulson and Ben Bernanke have stepped up to solve.

    Now why on earth would you suppose anyone would let people use 30-1 leverage, or even more, to buy risky paper?

    This is another extremely important point for you to grasp: The leveraged purchases were not considered risky at the time. People make investments expecting to make money. They don’t go in expecting to lose money and get bailed out by the taxpayers.

    The combination of securitization and faulty credit-quality ratings made many MBS look like some of the safest investments out there. Because of their perceived safety, which nearly everyone accepted, lenders had no problem giving hedge funds and Wall Street firms the money to buy MBS on 30-1 capital ratios.

    In fact, 30-1 would have seemed conservative, implying as it did a raw default rate of something like 3%. Even today, in the middle of the mortgage maelstrom, default rates haven’t gotten that high. And people with access to really cheap capital can readily buy Treasury bonds (which have no default risk at all) on 100-1 leverage.

    But at high leverage ratios (or conversely, low capital ratios), your lenders will keep you on a much shorter leash. The less capital you have compared to your assets, the less skin you have in the game. The lender perceives his risk to be far higher than yours. So you’ll get a margin call at the first sign of trouble.

    And when the MBS bet turned bad and the margin calls started coming, a lot of bad things happened (which I’ve written about in past posts as they were happening), and we got to the point we’re at now.

    But think about this a bit more carefully. If a hedge fund or structured investment vehicle borrows short-term money in order to buy somewhat longer-term MBS (and make a profit on the interest-rate differential), what exactly is it doing?

    It’s creating credit. That fund has made the money available for someone to get a mortgage and buy a house. If that’s not clear to you, keep thinking about it until it is.

    The only difference between what that fund has done, and what a normal commercial bank does every day, is the source of money. The bank gets the money it uses to make loans from deposits that it takes from the public.

    And depositary institutions are regulated heavily. Among other things, they will generally avoid being leveraged any more than 10-1. The regulation is part of the price they pay for the FDIC deposit-guarantee.

    So a hedge fund that invests in MBS isn’t functionally different from a bank, but it escapes the banking regulations because it doesn’t take deposits from the public. It’s part of a vast “shadow banking system” that creates credit in an unregulated way. So why the hell are they allowed to run 30-1 leverage ratios, even to buy assets considered safe?

    That’s something we will need to change.

    -Francis Cianfrocca"
     
  2. Tripod

    Tripod Well-Known Member

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    It's all Clintons fault. He lessened the requirements to allow neer-do-wells to buy homes when they couldn't afford it. ha ha
     
  3. nspktr1

    nspktr1 TS Member

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    No doubt there were plenty of mistakes made on both sides of the fence. It was and is the great American dream to own your own home, some lenders made it way too easy for some to own more home than they could afford. The ARM was initially designed for young people just entering the job market to purchase a home, with the knowledge that their salaries would increase to meet the adjustments and normal life would go on. However, greedy lenders made this available to middle aged buyers that were at plateus in their earnings and no way to meet the loan adjustments unless the economy stayed booming. Who's at fault, the lenders or stupid borrowers trying to keep up with the Jones' on Smith's salary.
    The economy has seen these types of adjustments since the 1876 stock market plunge when Railroads defaulted on their bonds and banks folded. There just wasn't a structure to bail them out in place at the time. I'm sure if there had been there would have been bailouts, nobody wants to lose everything they have. The country's financial makerts rebounded and we survived until the next one in the late 1890's, then the '20s, the '70s, the '90s and now.
    We are still one of the most capable countries in the world. We just need more good people running industry and less self serving jerks in charge.
     
  4. fearlessfain

    fearlessfain TS Member

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    caused by people wanting to make money without working for it.
     
  5. Dahaub

    Dahaub Active Member

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    Nothing but greed created this mess and Grahams leading the bill thru congress to deregulate the banking and loan industries a few years ago lead the way. There are so many here that bitch about socialism and communistic governments and where are they now? They are all backing "Dubbya" on his communistic way to save the banks. Hell his own family owns ?What percentage of Chase Manhattan Bank? How much did they get to borrow to buy Bear Sterns? I'll betcha that those big executives will still have their outlandish salaries and perks while some poor kid who has worked his way up thru government to get to be a G8 or G9 will be telling someone who makes several millions a year how to account for the billions that we as a country have to put up for the piss poor management bailout of the super rich. I think it's bullshit. Someone who likes to Googgle can come back and tell me what the projections of the increase of the Bush familys wealth will be after the government gave Chase the first 29? billion to start this fiasco. Lets see if any of the legislatures we have now have any balls and insist that the management that got those banks in this mess become tellers at teller salaries if they want to stay in banking. I'll bet that doesn't happen. Where are the communist haters now? How come they aren't bitching about the communist bailout of the banks by the rest of us? Come on republicans lets here it. I know you have all the answers, come on Brooks let me know how the Democrats did this to America. Oh by the way I didn't see the word "Greed" in any part of your cut and paste explanation. Dan
     
  6. halfmile

    halfmile Well-Known Member

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    I beg to differ. Bernanke and Paulson did not "step up" to solve the problem. They came up with a solution that protects the big boys and will create an unbearable tax burden for years.

    There should never have been any bailouts of any sort. Once the vault door was open via the Bear Stearns debacle, the rats started lining up for their share of the cheese.

    The one facet of this wretched scenario is going to be the ultimate collapse of the dollar to unbearable levels.

    Because, you see, the government is creating money that will not be backed by anything except debt.

    More money covering the same GDP = money with a lower value.

    Last year I predicted this and was flamed by many here.

    Now let's see what happens with the soon to explode credit card bubble, coming soon to a bank near you.

    Will the mighty Gov step in and help the little guy? Now, He will cough up some more dollars( becoming more worthless by the day) and give it to the rest of the rats, who haven't gotten their cheese yet.

    I'm going to buy powder and bullets while I can still afford it. Things are going to get pretty darn tough in Amerika.

    HM
     
  7. Paladin

    Paladin Well-Known Member

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    Dahaub said; "Nothing but greed created this mess and Grahams leading the bill thru congress to deregulate the banking and loan industries a few years ago lead the way."


    You are wildly mistaken about the Gramm-Leach-Bliley Act. This act had nothing, if anything to do with the laws allowing sub prime mortgages, and eventual meltdown.


    "The Gramm-Leach-Bliley Act, also known as the Gramm-Leach-Bliley Financial Services Modernization Act, Pub. L. No. 106-102, 113 Stat. 1338 (November 12, 1999), is an Act of the United States Congress which repealed part of the Glass-Steagall Act, opening up competition among banks, securities companies and insurance companies. The Glass-Steagall Act prohibited a bank from offering investment, commercial banking, and insurance services.

    The Gramm-Leach-Bliley Act (GLBA) allowed commercial and investment banks to consolidate. For example, Citibank merged with Travelers Group, an insurance company, and in 1998 formed the conglomerate Citigroup, a corporation combining banking and insurance underwriting services. Other major mergers in the financial sector had already taken place such as the Smith-Barney, Shearson, Primerica and Travelers Insurance Corporation combination in the mid-1990s. This combination, announced in 1993 and finalized in 1994, would have violated the Glass-Steagall Act and the Bank Holding Acts by combining insurance and securities companies, if not for a temporary waiver process [1]. The law was passed to legalize these mergers on a permanent basis. Historically, the combined industry has been known as the financial services industry."


    Mash on the link for the rest of the story.
     
  8. JBrooks

    JBrooks TS Member

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    You are right Paladin.

    The Government really had no choice in the Fannie Mae/Freddie Mac and AIG situations.

    If AIG had failed, the vast majority of construction projects larger than a room addition would have come to a halt because of the lack of completion bonds.
     
  9. Tripod

    Tripod Well-Known Member

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    Iowa man!!
    If you are going to "meddle" when times are good, you are going to have to "meddle" when they are bad. Thats why the government should stay the hell out in the first place and let the people who don't want to bust their butt a little harder to get the things everyone wants just live below the standards of those who do bust their butt. Let em live like dogs if they want to. Its their choice what they want out of life.
     
  10. R.Kipling

    R.Kipling Well-Known Member

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    Don't believe anyone, look it up for yourself! You can do the search, just like the rest of us then, you'll know for certain. Remember, two questions: What's so wonderful - What's so wrong, with this information.

    Notice that the Act was signed by Clinton, in '99, long before his swan song. What is really interesting is that the bill was contested in the Senate (not so in the House)until the banking industry spent a year, and 200 million Lobby dollars wooing the Democrats, who had held it up in conference committee. Do I detect some GREED in the Liberal party, say it isn't so.......

    Since then, Franks (D) has had a strangle hold on the Banking Committee (Wall St. is NObama's biggest supporter), and Chris Dodd, Chair of the Mae/Mac committee, has manipulated 70% of the bad-Mortgage industry. Again, the two biggest beneficiaries - Dodd and NObama.

    Former Presidential Candidate, John Edwards also spent a year working in a Hedge Fund, and never made it an issue in his campaign. I'm not defending Bush with this information, he'll have to defend himself. However, I can't stand by and let all the BDS wave a fat finger, and wag a forked tongue.

    Kip
     
  11. bigdogtx

    bigdogtx Well-Known Member

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    did you forget who used to control congress?
     
  12. Paladin

    Paladin Well-Known Member

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    What has your 8% congress improved or fixed, 2stupid,,anything, all?? They certainly dropped the ball here,,just like you've done!!
     
  13. halfmile

    halfmile Well-Known Member

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    2st8t, Clinton signed the bill in 1999 repealing the legislation that had kept commercial and financial banking separate.

    This link will give some of the basics, but blaming Bush for the Clinton-approved deregulation is somewhat disengenuous.

    Lobbyists put 300 million dollars into washington on just this one issue.

    This is a serious issue, and putting petty High school "we-they" connotations on the mess is juvenile and counterproductive.

    Money talks and BS walks. The 300 million spent got the rats a lot more than just a little cheese.

    Do your research before you pull the trigger, please.

    HM
     
  14. jim brown

    jim brown Well-Known Member

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    The government stayed out of in in 1929. That sure worked well didn't it?

    jim brown
     
  15. halfmile

    halfmile Well-Known Member

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    The topic is why the meltdown.

    the above link gis some of the reasons.

    I have to say the misstate the role of the S&L industry. S&L's were ripe for a group of thieves, Keating, Bush brothers, et al, who got them to issue huge loans which almost immediately defaulted.

    The proceeds of the loan were split under the table, and only a few of the players went to jail. Neal Bush should have gone, and possibly Jeb also.

    I saw in Phoenix the headquarters of a construction company, recipient of a 3.5 million dollar loan, (defaulted immediately) whose headquarters was a 2 stall garage with a curtain on the door window.

    When the camera crew came, the door was closed and the curtains drawn.

    the S&L industry had been a thjorn in the side of the big banks for years, and also one of the few means for working class people to enjoy home ownership.

    Taking it down was a means to an end.

    The present problems are the result of the greedheads not stopping when they had enough.

    A lot of people involved here belong in jail for wrecking the american economy.

    The bailout money is going to come from US Bond issues, which will increase the money supply so drastically that widespread hyperinflation is almost unavoidable.

    The only good part is that a lot of Chinese bondholders are going to get boned severely

    HM.
     
  16. ou.3200

    ou.3200 Well-Known Member

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    In 2003 the Bush Administration proposed a new agency to oversee regulatory reforms of Fannie Mae and Freddie Mac. This required action by Congress. Guess who shot it down? The Democrats who were using Fannie/Freddie as their own cash cow resisted regulation and resisted losing Senate oversight to an Executive Branch agency.

    Here is an excerpt from an article dated 9/11/03:

    "The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago.

    Under the plan, disclosed at a Congressional hearing today, a new agency would be created within the Treasury Department to assume supervision of Fannie Mae and Freddie Mac, the government-sponsored companies that are the two largest players in the mortgage lending industry.

    The new agency would have the authority, which now rests with Congress, to set one of the two capital-reserve requirements for the companies. It would exercise authority over any new lines of business. And it would determine whether the two are adequately managing the risks of their ballooning portfolios.

    The plan is an acknowledgment by the administration that oversight of Fannie Mae and Freddie Mac — which together have issued more than $1.5 trillion in outstanding debt — is broken. A report by outside investigators in July concluded that Freddie Mac manipulated its accounting to mislead investors, and critics have said Fannie Mae does not adequately hedge against rising interest rates."

    In 2005 John McCain co-sponsored the Federal Housing Enterprise Regulatory Reform Act of 2005 which was also killed by the Democrats. At the time he said:

    "I join as a cosponsor of the Federal Housing Enterprise Regulatory Reform Act of 2005, S. 190, to underscore my support for quick passage of GSE regulatory reform legislation. If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole.

    I urge my colleagues to support swift action on this GSE reform legislation."

    So all you who are laying this at the door of the Bush Administration are dreaming. The oversight was the responsibility of Congress, they got their Democrat buddies appointed to run Fannie and Freddie and according to the outside investigators they manipulated the accounting to mislead investors. Substantial contributions were made to Senators Dodd, Obama, et al to avoid any meaningful oversight. Democrats were in place running Fannie/Freddie, Democrats got the lion's share of contributions, Democrats and a few Republicans blocked reform. Now the Dems don't want any Congressional investigations that will disclose their little charade. They know where the chips will fall.
     
  17. ou.3200

    ou.3200 Well-Known Member

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    First, the Democrats who were running Fannie/Freddie got those positions before the Republicans gained control of the Senate. Secondly, it made no difference who was in control of the Senate when the margins were small as they were in 2003. Senate rules require 60 votes to bring cloture so the Democrats could and did block anything they wanted. I think you are guessing about a lot of things.
     
  18. Husky44

    Husky44 Active Member

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    All debt is a reflection of our own shortsightedness. If you look at debt growth overall vs GDP...I am talking ALL debt (FED, State/Muni, Mortgage, Corp,Consumer)...you will see that the explosion really started in 1992. That is the beginning of the debt binge.

    Encouraging your citizens to take on debt in the private sector (via monetary policy and legistlation) is really not much different, economically, that the government borrowing. Government debt is less productive, but it also carries a much lower cost (interest rate), so call it a wash there.

    The story of the 90's is that the start of the debt binge set in place a self reinforcing upward credit spiral where asset prices were inflated, and the industries that grew up around the passing back and forth of these assets created phantom economic growth. This created a fairly robust economy that negated the need for the Federal government to run big deficits. As such, Clinton's ability to be 'fiscally responsible' was a result of the private sector being fiscally irresponsible, and setting in motion an economic boom that was ultimately going to fall like a house of cards.

    By the time Bush got in office, the asset spiral was coming to an end, and we should have fallen into a huge recession, if not for Alan Greenspans near treasonous policies. Instead of allowing us to have a major recession that would clean out the excesses, we cheapened money to the point that real interest rates were negative, and the party started all over again.

    You want someone to blame...look to Alan Greenspan. He should be hung for treason. He is the man that destroyed America. The Presidents are merely along for the ride. Even Congress' actions carry less weight than the Federal Reserve.
     
  19. halfmile

    halfmile Well-Known Member

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    2str8t, read 3200's posts again. They tell it like it is.

    Defending or bashing one or another administration is not the topic here.

    The real culprit was a system that allows 300 million dollars in lobbying money to create the opportunity for predatory moneylenders to screw working Americans even more.

    This is what happens when you let the fox take care of the hen house. It has been going on since the creation of the Federal Reserve.

    The agenda reaches beyond a single person's lifespan, and ends in the New World Order.

    And I don't give a shit if anyone believes me or not.

    HM
     
  20. Setterman

    Setterman Well-Known Member

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    After reading this thread, I think I'll buy some property before the the dollar is not worth the paper it's printed on. And, we should demand new laws on lobbying. No politician should pocket dollars from other interests. That's not what their elected for. Neither should anyone of their direct relation, business associates, or any other direct contact. This is also McCains stance. It's go to be cleaned up, and now.
     
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