Do you understand the basis of the financial problem we are facing?

Question

Just shedding a little light on this situation we are all witnessing in the financial markets.

Fundamentally the problem stems from what financial types call leverage. Even middle class Americans "use" leverage, when, they buy a home. It works like this:

Typically, a buyer will place 20% down on a home purchase. For this example, we will say the buyer in question is placing $20,000.00 down on the purchase of a $100,000.00 home.

Now, lets assume for a moment that the home increases in value by 10%. Did the home owner make 10% on his/her money?

No, they made 50% on their money! 20% down of $20,000.00 netted in this example a $10,000 profit, which, is a 50% return! This is why home ownership increases the wealth of the middle class so substantially.

Like wise, Wall Street "leveraged" mortgage backed securities.

Problem is the housing market declined! So, from our example from above, lets say the home fell in value by 25%. So, now the home is worth $75,000 instead of $100,000.00. Lenders call in the loan, and, not only do you "lose" the $20,000 down payment, but the "asset" of the home, and, owe $5,000 to the bank!

I am sure this has played out in epic proportions to many financial organizations, and, I've heard, that some financial instruments were leveraged at 5, 3, and even 1% asset to loan value.

Imagine controlling a $100,000.00 asset for just $1,000.00. When the asset rises by 10% to $110,000.00, wow, your investment obtained a 1,000% return on your money! Likewise, a drop of 25% in the value of the asset housing market finds you in deep sh*t. You could end up owning the bank, in this example, $75,000 on a $1,000.00 investment. Ouch.

It is risk exposure from decreasing housing values, which has greatly weakened these firms!

Answer 1

Yea and you can thank the democrats for that!

Answer 2

Yes, I do.



For people who don't understand what is going on, here is the story in a nutshell. Decades ago, when you wanted to buy a house you went to local bank and applied for a mortgage. If the mortgage was less than three times your annual income and you had a good credit history, the bank would loan you the money and you would pay them interest and some principal every month for 30 years. Then Wall St. got a bright idea: buy up all the mortgages from the banks, collect a few thousand into a pool called a CDO (Collateralized Debt Obligation) and sell shares in it. The owner of each share would get a pro-rata share of the incoming monthly mortgage payments, analogous to what a bond owner gets.



What happened? It sounded like a great idea and soon all mortgages were sold and repackaged into shares. It didn't take long before the banks realized that they could issue mortgages of five, six, even eight times the buyer's annual income or sell them to people with terrible credit histories. After all, the shaky mortgages would soon be somebody else's headache. That's what happened. Lehman, Merrill, and others bought billions of dollars of mortgages that the homeowners had no hope of ever repaying on schedule and nobody wanted to buy shares in these worthless CDOs, so the brokers got stuck holding the bag with billions in worthless loans.

Answer 3

Everyone including the government is spending more than what is coming in.



This country is shot through with high debt and no way to pay it back.



Theft, fraud and abuse in all areas come from it. Government employees steal 22.5 Billion a year. Doctors, Hospitals and Drug Companies steal 100 Billion from social security, in the private sector reports say employees steal 50 Billion a year, shop lifting accounts for 25 Billion, Credit Card Bad Debt (no payment) is so high the numbers are not available, Identify theft accounts for several million per year and the list goes on.



The basis of the financial problem is the human being.

Answer 4

While what you have described is a factor in the economic problems the true reason behind the collapse is poor management.



All kinds of disasters, problems, fluctuations, and issues arise when in business. If you have a good management team you can weather ALL of them. What is actually happening here is that the collection of problems which have occurred have outpaced the abilities of the management to handle (primarily because most people in management SHOULD NOT BE THERE!!!!).



This is actually a good thing for business (at least for the ones that survive) as it will allow them to dump their bad managers and get a fresh set of people.

Answer 5

Thank you so much for explaining this so well and simply. I know this but it's helpful to see it again.



Can you believe we are doing an $85 billion bail out to AIG? This is insane. The CEOs and management teams need to be held accountable to taxpayers and their employees. They are calling the shots and are obviously not fit to do so. But it seems like again and again they just walk away without harm or paying any kind of price. You don't hear them speaking to the public about their actions, apologizing, anything. That is beyond arrogant. That is a coward and a bully.



edit: There was overbuilding because of greed (high returns and many underestimated the risk, they thought housing was safe, which it normally is but when you up the reward so goes the risk) and there weren't many other opportunities that offered nearly as attractive as a return for the perceived risk. Anyone that understands business and finance saw the potential for disaster. I know that I did. But what can you do? You need a place to live. This is also why it is essential that we have a diverse economy with lots of areas for growth and different rates of return for different risk values. We are all risk averse. If we take on risk then we want compensation for it. Somehow this simple notion escaped the housing market because housing is typically safe and therefore stable. But with 20% returns in a year, what people said, housing is no longer safe. It should be 5 to 7% return. That's normal and expected, average. 20% is abnormal and a warning sign to me. But people got greedy and ignored the warning signs. Make as much money as you can and get out. That's not healthy. It just underscores the other problems in our economy. It's why McCain is an incompetent yutz. The cost of living is out of control. That really strangles other parts of our economy. It's better if people have more money then investments can be made. We can have greater competition but if everyone is paying so much for housing then something has to give. There is less money for other things. Jobs are going overseas and foreigners are being brought here. This does not make a healthy economy for the natives. We are too short sighted. We are too greedy and unrealistic in our demands.



edit: McCain is far worse for the economy than Obama. That's nonsense. I am not voting for McCain. He favors deregulation. Hello!!!



edit: One problem with regulation is that it increases the costs of doing business so regulations need to be balanced against the cost and what is received from them. McCain clearly doesn't get this at all. He is willfully ignorant and that is evil.



edit: Suthrnga is onto something. The people selling these "funds" didn't understand them. They said that. You can look it up. Investors didn't want to buy them anymore. The money dried up. It's a complex puzzle really but you can pull things out to try to get some kind of understanding that is useful. It helps if you have some education in these areas (economics, finance, business, management) and experience, which I definitely have. I'm grateful to have it because finance is difficult. Economics is challenging but not as hard as finance.



edit: There are a lot of arrogant know it alls in business that make snap judgments. I have seen it. It seems rare to find intelligent and thoughtful people, of which I have and am forever grateful to have worked with them because of course I learned a lot. You have to be humble to learn. If you think that you have it all figured out or your ego forces you to then that is going to be a major inhibitor for your growth. If you are in a power position then the decisions you make will negatively impact others but you won't see it. It will make you seem cold and evil. There is a lot of greed in finance. It's one reason I left. There is a lot of immoral and unethical behavior. Here's an example. Selling annuities to people that shouldn't be investing in them. One top investment "advisor" was #1 because he sold annuities to everyone he could because the commission is very high on them. They aren't appropriate for most people.

Answer 6

O.K. . . . a small overlooked insight to the problem . . . hedge funds don't higher MBA's to write financial models . . . they hire math nerds . . . think MIT grads . . . these kids sit in cubicles and write the mathematical formulas on which the majority (including the NYSE) of all investment accounts are traded . . .



The MBA's and executives then make decisions on these financial models . . . however, they are not capable of understanding the math that is used to formulate the information . . . It's sort of like looking at employment numbers at face value . . . you have to know all sorts of numbers . . . immigration, death, natural attrition, public consumption . . . and on and on . . . to really understand the numbers . . . but no one ever does that . . . they just look at the employment number and make a snap judgment



So the executives were operating on a very similar basis . . . they didn't understand the fundamentals of the fundamentals . . . remember, these programs trade automatically WITHOUT human input . . .



And then there's mark to market accounting . . . and the spread as mentioned . . .

Answer 7

The over-building in the housing industry turned the real estate market from a seller's to a buyer's market. Thus, the decrease in housing values. This turned many new mortgagees upside down in their investment.

Answer 8

Good question. Most people haven't a clue about finances or the real reasons behind the economic problems of today. And most will not take the time to listen or learn. All they want to hear is who is going to give them more. If you think it's bad now, wait and see what Obamanomics will do to the nation if people don't wake up and start taking responsibility for their finances and futures.

Answer 9

The problem is the government putting Wall Street on the taxpayers teat. When we look our children in the eye don't we feel that we're to big to fail? How come we don't get a bail out but Wall Street does?



We're teaching Wall Street that when they do something risky then go ahead and do it super risky. Because the taxpayer will always bail them out.

Answer 10

More clearly, the problem resulted from a lack of oversight and attempts by companies to employ creative accounting to obscure the facts.

Answer 11

Yes, its true.That´s why this crisis is unstoppable and all that junk debt is owned by US Fed.USA is in fact on default.



Dont cry for me Argenti... Oops! Dont cry for me USA!



aaahahahaha!

Answer 12

McCain can't seam to grasp the urgency in wanting to form a 9/11 commission to investigate this problem when we all no nothing ever come out of these investigation and they take months some even years .Will someone please explain this to McCain .



OBAMA/BIDEN 2008

Answer 13

yes, it's a simple equation, deregulation + greed = disaster and hyperinflation

Answer 14

The problem is deregulation and greed.