Financial Crisis Woes?

Question

No matter what I do, what I watch, I still don't understand why this country is doing so bad financially. Can someone tell me the situation as to why we are broke, what's happening with the banks, and what Obama is doing to fix it (in terms normal people can understand)? Thanks.

Answer 1

Bernie Madoff is one example of punching a hole in the financial services sector. He has been found guilty of a Ponzi scheme. A Ponzi scheme is when you provide money to be invested and given the promise to invest money into a certified investment instrument, but instead Madoff then gives your money to others as if they made a return on their investment that was never done. This motion goes back and forth, like a pyramid. This one example caused billions of dollars to evaporate in the financial market when Mr. Madoff could no longer rob Peter to pay Paul, then pay himself and everyone else. This damages the credibility of the financial service sector, specifically in book keeping and accounting.



The AIG debacle. AIG is an insurance company that knitted risky deals together as one. If one link collapses they all fall in. AIG is a single entity that is global and all monies run through it like a clearing house. It is the proverbial hub and related banks and insurance companies are spindles to the wheel. The hub became wobbly and almost collapsed completely. The government steps in to shore up the wobbly hub of banking and insurance. Another failed sector of the economy that required government intervention because the business could not save itself. During the Bush Administration bailout monies were provided with no strings attached with government tax payer monies. No earthly person can account for the monies spent to save AIG and it needs billions more. This damages the banking and insurance sector of the economy as well as U.S. government standing in the world community.



Government oversight. The Senate and House Banking Committees are suppose to provide oversight to protect the pensioners, investors, savings accounts etc. For six years the Republicans where in the majority in Congress. For two years the Democrats were in the majority of the House of Representatives. Whatever comes out of the Congress must pass the upper house, the Republican controlled Senate. Their was no oversight, therefore the government protection was more like molestation to the you and I in banking, finance and insurance. Government failed to do its part.



The Fed Chairman. Former Fed Chair Alan Greenspan believed that the market will correct itself. He articulated that government should not have a heavy hand in free markets. What is good for business is good for people, hence the Republican mantra smaller government, less regulation.



Mr. President. The Executive branch of government is constitutionally duty bound with enforcement of rules and regulations in banking, insurance, and financial services just to name a few. The Bush Administration did not enforce the regulations on the books. This signaled to the marketplace greed was acceptable, so they had a free for all. The Office of President is sworn to uphold the constitution so help me God. We are now at the so help me God part.



And then the G20. Monied countries blame the United States for bringing down the world economy since we were leading the world with our economy. The U.S. has a credibility problem in the areas of banking, insurance and financial services. U.S. Government now has to come in and print money it cannot back just to keep life as we know it, going. Other countries like China want to lead the world market because they profess to have better financial discipline and decency than to let the global economy meltdown like the Americans allowed to happen on their watch.



President Obama. His administration has released taxpayer monies that is borrowed from the Chinese to stimulate sectors of the economy. In my state between the months of June to December $38 million must be spent for job training, businesses related hiring, loans for worker related credentialing to become a plumber, electrician etc.

The signature accomplishment for the President from the G20 meeting is the document from 20 other countries to commit $1 trillion from government coffers to avoid a worldwide depression and to meet again soon.

On the Administration's plate is what to do with AIG, Chrysler, GM and the banks. Do we let AIG fail? If Chrysler does not ink a deal with Fiat do we let them fail? Will GM have a plan within 60 days to revive itself or will their be a structured bankruptcy? If so, pensions will be lost. What then? In any scenario investments can tank. No guarantees. It is for this reason everyone needs to work in unison.



I will leave with this nursery rhyme that is an exact analogy to the U.S. marketplace; but we have to come up with a different ending. "Humpty Dumpty sat on the wall, Humpty Dumpty had a great fall, all of the Kings horses and all of the Kings men, couldn't put Humpty back together again." This is where we stand today, in laymen terms, putting it back together again.

Answer 2

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Answer 3

In response to Mark above:

Bernie Madoff has nothing to do w/ the financial collapse. He was a crook exposed when it collapsed...nothing to do with it.



"The AIG debacle. AIG is an insurance company that knitted risky deals together as one. If one link collapses they all fall in."



Not quite -- insurance companies bank on the probabilities...and nobody saw ALL of the banks coming for insurance at once.



For example, if there was to be a major catastrophe where millions of people needed health care (call it a bomb dropped that affected the whole west coast) -- the health care companies would go broke. Just like the Ponzi scheme above, insurance takes money from one to pay for another. If everyone comes at once, there's nobody left at the table to pay.



"During the Bush Administration bailout monies were provided with no strings attached with government tax payer monies. No earthly person can account for the monies spent to save AIG and it needs billions more. This damages the banking and insurance sector of the economy as well as U.S. government standing in the world community."



True -- but what's the alternative? Let all of the banks collapse? I'm all for the free-market, but I don't see any other alternative that'd allow banks to survive -- taking consumer accounts with them, savings, checking, investment accounts, mortgages, car loans, etc. etc..



"Government oversight. The Senate and House Banking Committees are suppose to provide oversight to protect the pensioners, investors, savings accounts etc. For six years the Republicans where in the majority in Congress. For two years the Democrats were in the majority of the House of Representatives. Whatever comes out of the Congress must pass the upper house, the Republican controlled Senate. Their was no oversight, therefore the government protection was more like molestation to the you and I in banking, finance and insurance. Government failed to do its part."



Nobody in Congress had a super-majority which means w/o Dems, nothing gets passed in the Senate. With an entrenched hatred for Bush by Democratic constituencies, it was career suicide to cross the party line...Pelosi and Frank ruled the roost.



Government did fail to do its part -- is it a coincidence that the four largest recipients of TARP money were those most heavily involved by government before the collapse? Citi, AIG, Fannie, Freddy.



"The Fed Chairman. Former Fed Chair Alan Greenspan believed that the market will correct itself. He articulated that government should not have a heavy hand in free markets. What is good for business is good for people, hence the Republican mantra smaller government, less regulation."



Greenspan regulated the markets by manipulating interest rates. He's since come out and said he probably did more harm to the markets than he's done any good. The Fed caused the collapse of the Great Depression and they've got a hand in this one too. Check the New Yorker Magazine for Bernake's interview about 2 months ago -- Greenspan talks about how he messed up.



"Mr. President. The Executive branch of government is constitutionally duty bound with enforcement of rules and regulations in banking, insurance, and financial services just to name a few. The Bush Administration did not enforce the regulations on the books. This signaled to the marketplace greed was acceptable, so they had a free for all. The Office of President is sworn to uphold the constitution so help me God. We are now at the so help me God part."



haha -- agree, however, those charged w/ the job issued by the President are the ones that messed up...G-dubs can't get a sentence out let alone monitor all of these guys?



"And then the G20. Monied countries blame the United States for bringing down the world economy since we were leading the world with our economy. The U.S. has a credibility problem in the areas of banking, insurance and financial services. U.S. Government now has to come in and print money it cannot back just to keep life as we know it, going. Other countries like China want to lead the world market because they profess to have better financial discipline and decency than to let the global economy meltdown like the Americans allowed to happen on their watch."



'tis true, but I will point out the UK was hit the hardest, not the U.S.. Everyone one was riding the high-horse...



"President Obama. His administration has released taxpayer monies that is borrowed from the Chinese to stimulate sectors of the economy...."



At some point we have to let the market take over...we can't just keep pumping money into these businesses, especially when the CBO says it'll cost trillions in backlash. www. cbo. gov



"Humpty Dumpty sat on the wall, Humpty Dumpty had a great fall, all of the Kings horses and all of the Kings men, couldn't put Humpty back together again." This is where we stand today, in laymen terms, putting it back together again."



Except Humpty won't be an egg when he emerges...he'll be a marshmallow to protect him from himself. Bad policies being proposed...CBO makes no mystery about it.

"Figures never lie, but liars always figure"

Answer 4

It is giong down the toilet because people got greedy and figured a way to sell homes to people who couldn't afford them and make it look legit...

Answer 5

1. Supply and Demand: If you've taken basic economics, you know there's an equilibrium point in every market where supply meets demand. At that point, there is a certain price and quantity that people are willing to buy and willing to sell a product or service.

2. The Housing Market: Back when Carter was in office, the Community Reinvestment Act was put into place which allowed lower income individuals to purchase a house on special terms. Normally, they'd be disqualified for a loan to get a house, but this legislation brought those standards down. The legislation remained on the back burner through Reagan's years, through Bush Sr.'s years and when it reached Clinton, he increased the program's size by approx. 15%, allowing that many more people to access loans. George Bush Jr. raised it again by another 3% when the housing sector began it's exponential climb.

3. Increased Demand: When a market has more people looking to buy (as CRA allowed), the value of the products within that market have to increase in price. Same supply -- increased demand, price goes up. For example, if you have 10 ipods and 10 people who will buy at $100, you likely sell each for $100. What happens the next week when all of their friends come to buy the only 10 ipods you have for sale? Assume there are 20 people looking to buy now...the value of the ipods has increased and you'd likely find 10 of those 20 willing to pay $110 per ipod.

It's the same concept in all markets. There was an injection of home buyers in the market and the builders (suppliers) couldn't keep up -- so you had a higher growing demand than supply being offered...price goes up.

4. Liars Loans:

Ninja Loans (No Income, No Asset), Sub-Prime loans:

Because many banks saw prices increasing with no end in sight, they decided to offer loans that only required not much more than a signature on the loan documents. The Ninja required very little confirmation they home owner had money to pay the monthly payment and the sub-prime attracted those that needed a smaller monthly payment in the first year (which reset to the normal rates later making the payment increase as well). They did this for 2 reasons:

A. The housing sector was strong -- and many thought "prices can only go up!" A dumb assertion for any investment.

B. The process of Securitization.

5. Securitization: Banks have to have a certain ratio of capital to debt, called solvency, in order to maintain their banking status. When a bank makes a loan, they take on a certain amount of debt which makes the number of loans they make finite as the capital they own is also finite...it's a balancing act b/n capital and debt. Securitization is the process of selling off that mortgage to a third party to reset the bank's solvency and make a small profit up front, rather than holding the loan for 360 months (30 years). If solvency is reset, the bank can turn around and make another loan and maintain the capital/debt ratio required of them. Their loaning ability becomes infinite...loan, securitize, loan, securitize, etc. etc..

6. Fannie/Freddy: Before Fannie Mae and Freddy Mac, "government run" mortgage firms, banks could securitize loans, but it was difficult. The market for them was relatively small so banks just kept the loans on their books. As Demand skyrocketed, banks needed to get a part of the action...so they needed a place to dump the loans (securitize). Enter Fannie and Freddy.

Fannie/Freddy would buy these mortgages from bank allowing them to reset their solvency and then re-rating them in their favor (an unethical move by any standard...basically calling a Walkman an Ipod) and selling them bundled w/ other mortgages on yet another market -- the paper market for credit-default swaps. Investors would buy the packages mortgages as a way to diversify their portfolio (not get caught holding 100% of 1 investment, like stock in Apple Corp.). Fannie/Freddy were also cooking the books, falsifying accounting records to make it appear the company was doing well.

7. So those are the tangible markets for mortgages, housing and securitization firms. There's also a market based on those that's all paper trading...it's called the derivatives market. If you've heard of stocks like Apple Corp. or Microsoft, you've likely also heard of their derivative Options on those stocks. The Options are priced based on the actual stock -- fluctuations occur exactly like tangible markets -- supply/demand and equilibrium, but the exchange of product usually doesn't take place. Example: I buy an Option for Apple @ $10 -- Steve Jobs comes out the next day and says Apple's business did really well. Investors are drawn to companies that do well so with the Demand for holding Apple increases, the stock will likely rise. Say the Option rose to $12...I now have the ability to sell that option to someone else and take my $2 profit...$12 sale price - $10 purchase price = $2 profit.

In short the derivatives market got out of hand (credit-default swaps) and helped to artificially drive up the prices of home -- the oversight committees that were supposed to be cracking down on unethical behavior were asleep at the wheel...likely b/c they saw no harm -- they all thought "Housing prices always go up". Again, dumb assertion for any investment.

8. Home-Equity Lines of Credit: When you have a home, you can borrow money against that home, but only up to the amount you've paid off your initial mortgage -- it's called equity. So if I've paid off $50,000 of my loan, I can borrow against that and get $50,000 cash if I put the home up as collateral. If I default on the payments, the bank repossess my home, they sell it to retrieve their $50,000 and whatever remained on the first mortgage and then give me what's left over, if anything. When housing prices rose, so did the equity in the home. If I paid $50,000 of $200,000, I can get 25% of the home value in home-equity line of credit (cash in my hand). When prices rose and that house became a $350,000 home, my home-equity line shot up b/c it was easier for the bank to come in, sell my home, reclaim ALL of their money ($200,000 minus what I had paid) and had a nice 150,000 buffer to do so. So they increased the amount they'd loan.

8. So now the problem. Mortgages reset after the initial grace-period of low payment (sub-prime/Ninja) and those in the homes couldn't afford the payment. The bank started repossessing homes at an exponential rate. Reduced Demand -- Same large supply...prices have to come down. When home prices fell, so did home-equity lines of credit. Those who took out home-equity lines of credit were asked to pay them back b/c the house price no longer justified the amount given (the bank couldn't repossess the home and sell it to claim their money...the houses weren't worth enough). So added to the normal defaults caused by CRA/Sub-Prime/Ninja loans, you now had people defaulting on Home-Equity lines of credit...further increasing the speed at which home were foreclosed on. Bigger drop in Demand, same large supply of homes, prices fall further...

9. So, banks got caught holding some of the mortgages that defaulted, Fannie/Freddy got caught holding 65+% of those loans that were toxic (defaulting), AIG and the other insurance companies that were supposed to support these guys by insuring defaults didn't have the money to do so b/c they all came to them at once so they declared bankruptcy, the derivatives market stopped trading b/c nobody knew what packaged loans were toxic (no trust, no trade), the banks stopped loaning b/c they didn't know how badly they were affected...so we had these house of glass that came crumbling down and put a stop in all trading...stocks, bonds, real estate, derivatives, etc. etc..

10. Who is to blame? Lots of folks -- both parties, incompetent oversight committees that failed to act, banks, consumers and investors. The problem is Fannie/Freddy enabled both the banks to loan by securitizing their loans, no questions asked. They also supplied the derivatives markets by re-rating mortgages (making investors believe they were getting a chocolate bar and not a turd). By initiating CRA, the government artificially inflated the housing market by increasing Demand w/ people who couldn't sustain their place in the market. The poster below says it well.

Here are a few clips of the discussion over Fannie/Freddy - one includes Obama taking part in suing Citibank for not abiding by CRA loaning standards (giving loans to unqualified consumers) -- whoops:

http://www.youtube.com/watch?v=hxMInSfanqg&feature=related

http://iusbvision.wordpress.com/2008/09/30/obama-sued-citibank-under-cra-to-force-it-to-make-bad-loans/

Look at the number of Sub-Prime Loans given:

http://bp2.blogger.com/_otfwl2zc6Qc/SH9S3arkp9I/AAAAAAAAFJc/o2KV2UAfsZA/s1600-h/sub.bmp

Look at housing prices that correspond to the loans given above...and then the plummet!

http://mysite.verizon.net/vzeqrguz/housingbubble/



Hope that helps a little...if not, check Wikipedia.