Economic Crisis of 2008/2009

[Realist_Classic]

Oh wow. The House (mainly the Republicans) rejects the Paulson Plan. The Dow taking a hit (down some 700 points at one point). Looks like it's back to the drawing table for Paulson, Bernanke and Congress.

[solomon]

Im not an Econ head, so most of the nitty gritty of this fiasco is beyond me.

All I know is that we can't drag out this deliberative process too long, I hear that was a factor of the fallout in the 1930s.

[Realist_Classic]

^^^

Agreed, and it looks like the markets are still trying to read the entrails of what remains of the failed Paulson Plan. My impression was that most pundits and market players were almost certain that the bailout would go through.

Although Bernanke's a scholar of the Great Depression (and by implication he would most likely try to avoid a repeat of history), getting a skeptical Congress to agree with a bailout for excesses caused by the financial services industry is a different matter altogether.

[Aquillion]

I am getting the sense that a lot of people here don't understand what the bailout plan really is; they just hear 'a trillion dollars', then lock up and start screaming, imagining a trillion dollars being randomly given away to wealthy fat-cat bankers.

That isn't what it is at all. A post by an economist I know explains it better than I could. It is long but please please please read it, this is very important; it could easily be more important than the Presidential election. Understand that for the past few years, the Bush administration has been desperately struggling to salvage its economic conservative legacy; they instantly tossed it in the fire just now. They did not do this lightly. Nearly half the Republican party turned their back on economic conservative principals. They did not do this because lol they wants the monies.

The corrupt and self-serving politicians are many of the ones who voted against this; they put politics over the country and pandered to voters who barely understood what was being discussed.

Now, you don't have to agree, but at least read. This is the best explanation for what went wrong and how this plan aims to fix it that I've seen:

A DISCUSSION ON MARK TO MARKET ACCOUNTING

1. HOW TO MAKE A MORTGAGE BACKED SECURITY

first, read Liar's Poker. Mortgage Back Securities (henceforth, MBS's) were invented at Solomon Brothers back in the eighties. Previously, mortgages were held by banks. this was for a few reasons: a) each individual mortgage was, well, unique, it is very hard to make them fungible, or easily exchangeable for other mortgages; b) the biggest risk, for your standard investor/bond holder, with buying a mortgage, is prepay risk. if interest rates go down, your mortgage holder refinances, and then you have all your money back, and now interest rates are lower so you re-invest it at a lower rate.

Mortgages being held by banks is also inefficient because the bank would sure like to have that money to lend out to other people. (this, by the by, explains the growth of Fannie/Freddie, because they bought mortgages from banks and then repackaged them out to the system. Fannie/Freddie took only high quality mortgages and also insured them against deafult, but that is another story).

Along come some crazy fat leveraged bastards at Solomon, and they invent the MBS. In short: take 1000 mortgages of similar credit quality/repayment risk etc. Now, create a bunch of tranches. Your first tranch gets the first portion of all the interest and principle payments. this tranch, because the vast majority (99%) will repay or refinance, is rated AAA and probably has a maturity of 5 years. your second tranch is next in line, and is probably rated AA with a maturity of 7 years, etc. etc. etc. until you are down to an equity tranch, which has no credit rating and lets hope you get your cash back (hence equity). All of the tranches are sold off to the market. now, you have a bond (also referred to as paper) that you can judge on credit risk, have a predictable stream of income with little to no repayment risk. This paper is now completely fungible, as the first portion of a basket of mortgages has the same characteristics as the first portion of another basket of mortgages.

A CDO is merely taking a series of BBB rated MBSs and using the same alchemy to turn them into a series of AAA, AA, A, BBB, BB, B, and junk paper.

make sense?

2. CUE TWO YEARS OF 1% INTEREST RATES

i think we know this part of the story: home prices never go down, every body gets a mortgage, lending standards go out the window.

3. THE SEC UPS THE LEVERAGE LIMIT.

if you are an investment bank, you are, basically, a highly leveraged. You take $1 in assets, and then you go out, borrow $12 with it, and then buy more shit with it. (you also do things like mergers and acquisitions, debt funding, etc., but every ibank has its own "book" which it trades for). Most ibanks are limited to 12-1 leverage. the SEC, in 2004, allowed the leverage limit for certain banks to go to 30-1. Which is fine, as, during the boom period, this meant that the 5 investment banks who were allowed to raise their leverage to 30-1 or 50-1 printed money.

Now, in order to fund all this leverage, ibanks borrow a lot on a short term basis (all banks borrow short and lend long. your bank borrows your deposits from you and lends them to the homeowner). thus, their credit rating is critical to their access to cheap short term capital. Everyone was okay with the 5 investment banks who were allowed to raise their leverage because they were printing money and that meant their ability to repay (i.e. credit rating) was still bueno.

4. A BRIEF DISCUSSION ON MARK TO MARKET ACCOUNTING

Now, these days, we live in a "mark to market" world. Basically, the SEC decided back in 2000/2001 that you have to "mark to market" the current value of all the assets on your books as though you were going to sell them "in an arms length transaction". This makes sense in orderly markets as everything has a price, and you can't hide dead assets on your books (see also: Japan's banks in the 90s; Greenlight versus Allied Capital).

In practical terms, this means that whatever the last trade was in the security that you have on your books is the value that you have to mark it at (or, at a similar price to similar securities recently traded).

5. THINGS FALL APART

Well, your MBS and CDOs are built with specific assumptions on default rates etc (historically 1%). Well, default and foreclosure rates are now 3% (per NPR on monday, Banal Intercourse). This FUCKS YOUR WHOLE CALCULATION. This means that your AAA paper is actually AA, your AA paper A, your A paper is now BBB, and your BBB paper is now JUNK JUNK JUNK JUNK JUNK BB paper. Your CDO manager, doesn't believe this:

6. WHAT MARKET DO WE MARK IT TO?

Remember how an MBS chops up a mortgage into different pieces (some of your mortgage is in the AAA tranch, the AA tranch, etc?), well, now NO ONE KNOWS WHICH MORTGAGES WERE WRITTEN BY CRAZED FUCKERS TO WAITERS WITH NO INCOME.

So, you try to sell. Well, everybody else is trying to sell to, which means that there are no buyers. (well, this isn't exactly true, as "distressed asset funds" will attempt to buy these assets at a discount with the idea that if they lose on one piece of paper they bought at $.25, they'll buy two others at $.25 that will mature at $1.00 and they'll make a killing. Elliot Spitzer became one of these). But, compared to the number of sellers, there are effectively no buyers.

So, right now there are two "Values" for these MBS and CDOs. First there is the Market. The market, though, is extremely thin, if not non-existant. no one wants to buy a piece of paper that could be worthless or be worth less tomorrow.

Second is what gentle Ben called the "hold to maturity" value. in reality, the market is drastically undervaluing what these assets will be worth at the end of the day. I forget the specific stats, but MBS are "pricing in" a default rate of something %20 on the american homeowner, whereas we are currently at %3. So, even if defaults climb to %10, MBS will still provide positive value at the end of the day. Still, no buyers. However, the market has dried up, and the mark to market rules require that the ibanks mark these assets to their books at last trade. Thing is, most ibanks aren't strictly marking these asset to market, because that would mean that their $1 in their 30-1 leverage was actually worth $.20, which would make that x - 1 ratio a lot worse.

See Also: Lehman.

7. WHY DO WE NEED THE CHECKBOOK THEN?

Well, ibanks (actually, most comercial banks out there as well) are basically pouring ALL AVAILABLE revenue from other business lines to write off MBS assets. yeah, yeah, fuckers should be punished for letting their risk tolerance go out the window, but the problem is, their ability to lend to the wider economy has stopped.

So, simply, what Paulson and Bernanke want to do is buy these assets somewhere between the $.20 "last trade" and $.80 "hold to maturity" value. They want to buy out the banks at an asset price above where it is now (because that means insolvency), but below the value of the asset class as a whole. Because the US Treasury can afford to have a long time frame on these assets. Because if we buy $700 billion of MBS at an average of $.40 and we net on average $.80 on each security, we've cleared $700 billion on the transaction.

They want to turn the US Treasury into the largest distressed asset fund in the world.

and saved the banking system.

and thusly the economy.

make sense?

[TigerII]

Ouch, 777.68. Largest point drop in NYSE history, though not the largest percent wise.

Several people are know are panicking really bad. One pulled three fourths of his money out of his bank account. Another is terrified that in a decade the Chinese will buy America because of the debts the US owes. Another is upset that inflation will get so bad he won't be able to afford TV, computers, internet, etc(Lol, a little selfish, no?). A fourth thinks this is hilarious because he hates major corporations and wants them all to fail.

[Sazelyt]

Originally Posted by Realist_Classic

Although Bernanke's a scholar of the Great Depression (and by implication he would most likely try to avoid a repeat of history), getting a skeptical Congress to agree with a bailout for excesses caused by the financial services industry is a different matter altogether.

Nothing can be done about what happened. Right now, they need to look at the future, and choose the best method to minimize the ongoing problems, regardless of who gets the most out of it. If they don't do anything, it will still be the poor who may get affected the most. It is sad that those hands approving hundreds of billions of dollars to kill people from other countries (even though they may not actually be willingful to say yes to that) cannot do the same when it comes to saving their own people.

Another sad thing is, for the Democrats, they might have lost the argument they have to put all the blame on Bush. Now, they will need to do some sharing.

[mg1942]

Damn Pelosi and her partisan speech...

[Ithekro]

It partialy makes sense.

Though I did hear a suggestion on instead of doing what has been proposed, turn that money over (equally) to all American Taxpayers as income (which can thus be taxed). $700,000,000,000 U.S. Dollars spread out amoung something like 138,000,000 people (estimated). About $5,072 each before taxes. Not much if you look at it like that...but what would you do with an extra few thousand dollars?

[cors8]

Originally Posted by mg1942

Damn Pelosi and her partisan speech...

One of the most ridiculous excuses I've heard from the Congress.

[Anh_Minh]

Originally Posted by Aquillion

I am getting the sense that a lot of people here don't understand what the bailout plan really is; they just hear 'a trillion dollars', then lock up and start screaming, imagining a trillion dollars being randomly given away to wealthy fat-cat bankers.

That isn't what it is at all. A post by an economist I know explains it better than I could. It is long but please please please read it, this is very important; it could easily be more important than the Presidential election. Understand that for the past few years, the Bush administration has been desperately struggling to salvage its economic conservative legacy; they instantly tossed it in the fire just now. They did not do this lightly. Nearly half the Republican party turned their back on economic conservative principals. They did not do this because lol they wants the monies.

The corrupt and self-serving politicians are many of the ones who voted against this; they put politics over the country and pandered to voters who barely understood what was being discussed.

Now, you don't have to agree, but at least read. This is the best explanation for what went wrong and how this plan aims to fix it that I've seen:

For those who go "TL;DR", I'll sum it up: "<explanations on the "how" of the crisis>. Banks are in trouble, and thus, so is everyone." I accept that banks are in trouble. I even accept that something has to be done. But what that post didn't explain is why that "something" has to be giving the people who got us (and I say "us" even though I'm European) in trouble in the first place unchecked authority over a trillion dollars so they can practically give it away with no counterpart.

[TinyRedLeaf]

Originally Posted by Aquillion

That isn't what it is at all. A post by an economist I know explains it better than I could. It is long but please please please read it, this is very important; it could easily be more important than the Presidential election. Understand that for the past few years, the Bush administration has been desperately struggling to salvage its economic conservative legacy; they instantly tossed it in the fire just now. They did not do this lightly. Nearly half the Republican party turned their back on economic conservative principals. They did not do this because lol they wants the monies.

Actually, to get straight to the point, you only need to highlight this specific sentence:

"Mortgages being held by banks are also inefficient because the bank would sure like to have that money to lend out to other people."

This, was where all our immediate problems began. The key question to ask being: Why should banks be allowed to lend more money than they actually have? Or, more sensibly perhaps, just how much liquidity should a bank be allowed to generate?

Bear in mind that one man's notion of fiscal prudence is another man's nightmare of total recklessness. Then, we begin to understand that the problem isn't as straightforward as many people claim it is, that is, amoral fat cats conniving to steal Honest Joe's pension.

In truth, I suspect that most Wall Street operators were clueless. Some were just plain stupid. Others were greedy. And a small handful were criminally deceitful. Unfortunately, it takes only one rotten apple to spoil the whole barrel. In the end, it remains true that greed has blinded most people to obvious problems that would have exploded in everyone's faces, sooner or later.

========

As for the vote-down on the bailout package, I feel that the market is over-reacting to the news. Hopefully, wiser heads will eventually prevail. Hopefully.

To put it very simply, the US has two options: To either deflate or inflate its stricken financial system. Both options have their pros and cons. Now that the House of Representatives have voted against the "inflate" option, we'll soon see whether deflation would achieve the desired effect of cutting away the fiscal gangrene immediately. Either way, it's going to be very, very painful.

[Sazelyt]

Originally Posted by TinyRedLeaf

In truth, I suspect that most Wall Street operators were clueless.

The system has been there for a long time, and they have been part of the system. Being a player of that system, if they didn't have the clue on what is going on in reality, they must really be stupid. But, I doubt they are.

[Vexx]

Originally Posted by Anh_Minh

Questions:
- how much influence do you and the other millions of other middle-class voters have over whether Paulson get another trillion of your dollars or not? Isn't it in the hands of the congress and government anyway?
- how many of those millions are in agreement that Paulson shouldn't get that money? (And are willing, say, to write to their congressmen and swear to never again vote for them is Paulson gets the money?)

I think you just saw today how much influence those voters have .... now comes the attempt to "punish the public" for saying no to the "no oversight and ya'll should pay for our diddling" proposal. That's rather how I view the market drop.... It was a flagrant over-reaction mostly pushed by a combination of institutional investors ("the big boys") who are all the things TinyRedLeaf calls them: clueless, stupid, greedy, and a few criminally deceitful. They mistake large testicles and luck for brains rather like the guy who keeps betting on a lucky streak and thinks it is skill.

Now, you don't have to agree, but at least read. This is the best explanation for what went wrong and how this plan aims to fix it that I've seen:

I *have* been reading... yes, we need a risk-mitigating plan. Not a "bail out" plan. Not a "get of jail free" plan. Not a "no oversight and no accountability" plan.

Ouch, 777.68. Largest point drop in NYSE history, though not the largest percent wise.

The key part of that is "not the largest percent value" ... 777/11000 = ehhhhhh, round up to 8%.
Wonder which players will snap up all the SALE stocks that have suddenly become great deals.

[TinyRedLeaf]

Originally Posted by Fipskuul

The system has been there for a long time, and they have been part of the system. Being a player of that system, if they didn't have the clue on what is going on in reality, they must really be stupid. But, I doubt they are.

It's not that "simple" at all. It's easy for us now, with the benefit of hindsight, to howl over the apparent "stupidity" of Wall Street. But really, it's down to a matter how you'd expect any rational person to evaluate risk. The mortgage-based instruments, such as the CDOs and MBSes quoted by Aquillion, did sound like very good ideas at one time. It's easy to forget that sub-prime mortgage loans did benefit some genuine borrowers who had temporarily fallen between cracks, and were therefore unable to get prime loans at more competitive interest rates.

Now, we say the whole idea is stupid and shouldn't have been implemented in the first place. Hindsight, unfortunately, is 20-20. Was it always a question of greed? Or was it more a systematic problem? I feel it's the latter, not the former. A problem this huge couldn't have been caused by any grand plan, no matter how "intelligent" Wall Street operators think they are.

[TigerII]

Originally Posted by Vexx

The key part of that is "not the largest percent value" ... 777/11000 = ehhhhhh, round up to 8%.
Wonder which players will snap up all the SALE stocks that have suddenly become great deals.

Seriously, now is the time to buy.

[FLCL]

im thinking of buying before the next resolution comes through, they just have to pass something

good thing i moved my cash into HSBC and bank of china

[Xellos-_^]

well at least the drop wasn't 666 or you would also have the religious loonies running around as well.

[TinyRedLeaf]

But really, it's down to a matter how you'd expect any rational person to evaluate risk.

Thinking further about the above point I brought up, I hope an analogy would better illustrate the market psychology that caused the credit crunch.

We've heard the analogy about banks passing the cookie jar between one another until someone is eventually caught with an empty jar. That's an apt description for what happened to Lehman Brothers, Bear Sterns and Northern Rock. But it doesn't fully explain how they got to that point.

On the matter of risk evaluation, it's perhaps useful to think of a poker game. Suppose you have one player who holds a full house, another who only has a pair, and someone who has nothing at all, among other players at the table.

Nobody actually "knows" what hand each player is holding, that is, no one was really sure how much risk each bank was carrying. You can only gauge the probabilities by the audacity of each player's bet (similarly, to evaluate the banks' risks, we went with market sentiment, and the markets loved the mortgage-based instruments).

In effect, over the last several years, we've had a scenario where the player with only a pair gambled as though he held a straight flush that trumps the full house (the soundly-financed loan). We may even have had a situation where the guy with nothing at all gambled as though he held a royal flush.

Well, now's the time where we finally get to see everyone's cards, and it turns out we've all been played for fools. But we know this only because the game's over. During the game, even decently intelligent people could have been fooled. Who can you believe? Who's bluffing? Who's holding the full house? When all you have are guesses, to what extent can we fully blame everyone at Wall Street for what has happened today?

Or do we blame the game instead? I would. I've always regarded poker as a stupid game that's more about gamesmanship than true skill, for example.

=========

On to another matter, I continue to have difficulty understanding America's deep-seated aversion to "socialism", seeing as how this was one of the leading factors that caused the collapse of the bailout plan.

Why are Americans so afraid of socialism? Socialism works, to the extent that it can often create a more equitable society for all citizens. It seems bizarre to me that, at a time of colossal corporate failure, there are still people who want to leave it to the private sector to settle the problem, rather than the government.

I just don't get it at all. Where does this fear of socialism come from?

As for the calls for more government oversight, it's not as though such concessions weren't included in the plan, but perhaps not as tough as many would have liked. What further controls do Americans expect to see in its financial system that the Bill didn't address? Just curious to know. Also curious to know how such controls may or may not conflict against this fear of having too much government intervention in business.

[TigerII]

The government has told Americans that socialism is bad since they were young. Brainwashing.

[Neki Ecko]

Originally Posted by cors8

One of the most ridiculous excuses I've heard from the Congress.

Ditto, everybody in Congress should get a mirror and point at it, then you will see who fault is it. At the end, the American people is one who is going to suffer the most.