Want to understand the banking crisis?
Sep. 27th, 2008 04:57 pm![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
pecuniumRDF has kindly explained it all.
Joe goes to the track and bets $2 on a horse.
Two guys standing nearby get into a discussion and Fred says to Sam, “I’ll bet you $5 that Joe wins his bet.”
Next to them are Bill and Bob. Bill says: “I’ll bet you $10 that Fred welshes on his bet if he loses.”
Next to them is Sally. Sally says: “For $3 I’ll guarantee to Bill that if Bob fails to pay off, I’ll make good on the bet.”
Sally then goes to Mary and borrows the $7 needed in case she has to ever pay off and promises to pay back $8. She doesn’t expect to every have to pay since she believes Bob will always make good. So she expects to net $2 no matter what happens to Joe.
A quick calculation indicates that there is now 2+5+10+3+7 = $27 riding on the outcome of the horse race.
That, in a nutshell is what happened.
For bonus points: How much has been invested in the horse race, and by whom?
.... ready for the answer?
Answer:
$50,000 by the owner of the horse who is expecting to recoup his investment from the winnings of the horse and other future deals. Everyone else is gambling, not investing.
And that's both the problem, and part of the solution. The analogy there, isn't really an analogy. Most of the huge losses people are looking at (and the one's they are talking about bailing out) are the people who are gambling on Joe's bet.
Joe is the bank. The people who take out the Mortgage Backed Securities are the guys gambling on Joe's Bet (that the his horse will come in). Sally, Susan, et al., are playing with Credit Default Swaps and other derivatives.
The guy who took out the mortgage? He's the one who owns the horse. If he can't keep it healthy, and fed, and trained (which is what his $50,000 is being spent on), Joe will lose his bet.
So there's a whole lot riding on Joe's choices, (in this example about 13 times what Joe has put up) all so none of the middle players have to worry so much.
Joe collects up a whole buch of bets, and wants the money now. We'll assume Joe is a Great Tout when it comes to playing the ponies, and his picks usually win. They win often enough that he's living off of them (this is why those guy are willing to back his play). This whole thing works, so long as Joe stays careful, because no one will have to pay off, and money is changing hands and everyone is happy.
Once Joe's picks are off.. all those people up the chain, who were gambling; with money they didn't actually have, they are screwed.
So... (if I understand this right)... paying off the mortgages, which keeps people in their homes, lets them stay where they are; not lose their jobs, spend money in the community, buy a new(ish) car every five years or so, would actually fix the problem.
Because that would keep all those folks upstream from Joe from having to pay up; which is good, because they weren't really investing, they were speculating.
Oh yeah, it would be cheaper too; and could be done without handing huge powers over to some tin-pot guru.
Paulson, Bernanke, Greenspan and their ilk spent the last few years selling us pie in the sky about how swell, and safe these complex credit swaps were, and recommending people buy houses they could barely afford with mortgages they could never pay.
Then the creditors got the Bankruptcy Bill passed (mandating debt peonage to those who got in over their heads). Then the ads for reverse amortization loans to first time buyers started running. What a happy co-incidence. Greenspan was touting ARMs, telling the home-buyer they really ought not be so wedded to the fixed-rate loans.
Had to keep the orgy of spending going; and the stones were gonna be bled if they went bust. The Banks said it was a good deal, and banks are in the business of lending money; money which they think will be paid back.
Only they didn't have to worry about it any more, because Fred and Bill and Bob and Sally and Susan have promised them that if the guy with the horse goes tits up: they will get paid, and own the horse.
So what the fuck do they care anymore if the bets are good... they can't lose. Right. The only guy who has a sure thing is the guy running the con. That only works if the con is done right. These dumbshits couldn't even do that; they had no way to close the con down.
Well, it seems they might, and The Blow Off, is being played out in D.C. right now.
(thanks tolyorn, who tracked down the original link)
Joe goes to the track and bets $2 on a horse.
Two guys standing nearby get into a discussion and Fred says to Sam, “I’ll bet you $5 that Joe wins his bet.”
Next to them are Bill and Bob. Bill says: “I’ll bet you $10 that Fred welshes on his bet if he loses.”
Next to them is Sally. Sally says: “For $3 I’ll guarantee to Bill that if Bob fails to pay off, I’ll make good on the bet.”
Sally then goes to Mary and borrows the $7 needed in case she has to ever pay off and promises to pay back $8. She doesn’t expect to every have to pay since she believes Bob will always make good. So she expects to net $2 no matter what happens to Joe.
A quick calculation indicates that there is now 2+5+10+3+7 = $27 riding on the outcome of the horse race.
That, in a nutshell is what happened.
For bonus points: How much has been invested in the horse race, and by whom?
.... ready for the answer?
Answer:
$50,000 by the owner of the horse who is expecting to recoup his investment from the winnings of the horse and other future deals. Everyone else is gambling, not investing.
And that's both the problem, and part of the solution. The analogy there, isn't really an analogy. Most of the huge losses people are looking at (and the one's they are talking about bailing out) are the people who are gambling on Joe's bet.
Joe is the bank. The people who take out the Mortgage Backed Securities are the guys gambling on Joe's Bet (that the his horse will come in). Sally, Susan, et al., are playing with Credit Default Swaps and other derivatives.
The guy who took out the mortgage? He's the one who owns the horse. If he can't keep it healthy, and fed, and trained (which is what his $50,000 is being spent on), Joe will lose his bet.
So there's a whole lot riding on Joe's choices, (in this example about 13 times what Joe has put up) all so none of the middle players have to worry so much.
Joe collects up a whole buch of bets, and wants the money now. We'll assume Joe is a Great Tout when it comes to playing the ponies, and his picks usually win. They win often enough that he's living off of them (this is why those guy are willing to back his play). This whole thing works, so long as Joe stays careful, because no one will have to pay off, and money is changing hands and everyone is happy.
Once Joe's picks are off.. all those people up the chain, who were gambling; with money they didn't actually have, they are screwed.
So... (if I understand this right)... paying off the mortgages, which keeps people in their homes, lets them stay where they are; not lose their jobs, spend money in the community, buy a new(ish) car every five years or so, would actually fix the problem.
Because that would keep all those folks upstream from Joe from having to pay up; which is good, because they weren't really investing, they were speculating.
Oh yeah, it would be cheaper too; and could be done without handing huge powers over to some tin-pot guru.
Paulson, Bernanke, Greenspan and their ilk spent the last few years selling us pie in the sky about how swell, and safe these complex credit swaps were, and recommending people buy houses they could barely afford with mortgages they could never pay.
Then the creditors got the Bankruptcy Bill passed (mandating debt peonage to those who got in over their heads). Then the ads for reverse amortization loans to first time buyers started running. What a happy co-incidence. Greenspan was touting ARMs, telling the home-buyer they really ought not be so wedded to the fixed-rate loans.
Had to keep the orgy of spending going; and the stones were gonna be bled if they went bust. The Banks said it was a good deal, and banks are in the business of lending money; money which they think will be paid back.
Only they didn't have to worry about it any more, because Fred and Bill and Bob and Sally and Susan have promised them that if the guy with the horse goes tits up: they will get paid, and own the horse.
So what the fuck do they care anymore if the bets are good... they can't lose. Right. The only guy who has a sure thing is the guy running the con. That only works if the con is done right. These dumbshits couldn't even do that; they had no way to close the con down.
Well, it seems they might, and The Blow Off, is being played out in D.C. right now.
(thanks to
lyorn, who tracked down the original link)
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no subject
Date: 2008-09-28 04:15 am (UTC)no subject
Date: 2008-09-28 05:34 am (UTC)no subject
Date: 2008-09-28 06:03 am (UTC)Let me see if I understand this:
If Joe's horse wins:
Fred owes Sam $5.
If Fred doesn't pay, Bob owes Bill $10.
If Fred pays up, Bill owes Bob $10; if he fails to pay, Sally owes that money to Bob--and an additional dollar to Mary.
If Joe's horse loses:
Sam owes Fred $5.
Bill & Bob's bet is in limbo; I assume neither of them owes money. (Or, as I suppose is more likely in bizarre banking games, Bill owes Bob because Fred didn't welsh, even though he didn't lose; see above.)
My head hurts. From what I can tell, it doesn't matter if Joe's horse wins or loses; the rest of the money is changing hands anyway. (Unless the B&B bet is off if Fred doesn't owe money?)
It was nice seeing it spelled out in simple terms. Also useful to realize that, even in simple terms with tiny numbers, it hurts my head.
no subject
Date: 2008-09-28 08:43 am (UTC)The Bankruptcy Bill is one of the biggest loads of crap that's floated through Congress in decades. I wrote a tirade against it when it was trying to get through Congress and despite the best of my abilities, people reading actually defended the banks! They couldn't see how nefarious the legislation was. It blew my mind.
Link
Date: 2008-09-28 01:32 pm (UTC)no subject
Date: 2008-09-28 03:35 pm (UTC)On another note, I really think that people forgot that if you borrow any amount of money, you will be required to pay it back in full. It is a VERY basic priniciple. Money doesn't fall from the sky or magically appear. Being tempted is not the same as being forced. People were tempted, and they bought in. And they are losing out. The government is in the middle of negotiating a harder fucking for us, and a great payoff for the top guys. I think we should learn from this lesson instead of crying about it. Don't get me wrong, what happened WAS fucked up. But it wasn't the frat guy taking advantage of the drunk sorority chick. This was a consensual clusterfuck.
People need to learn that its up to them to make intelligent decisions in their own best interest. There's no easier way of putting that. As the government finishes up enacting this massive steel financial dildo, we need to be aware of WHO votes for it and make sure that they do not get back into power ever again.
no subject
Date: 2008-09-28 04:56 pm (UTC)no subject
Date: 2008-09-28 05:59 pm (UTC)Funny in retrospect, since I was railing against subprime lending in the credit card market and talking about how it was profoundly stupid and was going to blow up in all of our faces. I still think it's a bad idea, but subprime consumer credit, sans banking, is still going strong. I villanized the wrong subprime market as the harbinger of doom.
Oh, and added you. Good journal.
no subject
Date: 2008-09-28 06:10 pm (UTC)Because there are scams. I am not an economist. I am, at best, a tolerably educated person. When it comes to things out of my depth I go to an expert. The honest expert gives me good advice.
But when I go to a dishonest expert, how am I to know he is cheating me? This wasn't, to use your analogy, the frat guy and the drunk chick, it was the skeevy dude at the keg slipping her a roofie with her drink.
They sold mortgages they knew would go tits up. Take a buyer who has less than stellar credit (and don't even get me started on the problems with credit. I have a crap credit score... why? Because I have no debt, and no credit cards with which to get debt. Ergo, because I pay my bills on time, and only buy things with cash, I am not someone they trust with lent money, but back to the guy with less than perfect credit).
That guy can't afford an, "honest" loan, because the payments are too high. Do they refuse him the loan? No, whatever for? This mark is good for a couple of grand in fees (which they will take off the top), generation fees, preparation fees, escrow costs, closing fess, and maybe a coupla points on the risk of the loan.
How to get this fat off the mark? A zero-down, zero-princple ARM. He pays no cash. He pays only the interest on the loan (which is more free money to the bank) and the actual cost of the debt goes up (three years of no reduction to principle). Then, when the loan is about to reset; and the payments go through the roof, they will sell the mortgage to someone else; based on the various swaps, insurers and the idea of the ever rising value of the home.
They probably also told the victims not to worry, the value of the house would rise, and they could sell, or re-fi, and it wouldn't be a problem.
If a someone cheats you, you aren't supposed to be on the hook for it. Yeah, you lst money up front, but the back-end... no.
When someone is licensed to sell people things which can put them in the poorhouse, if manipulated, it's the duty of the licensing agent (in this case the gov't) to set effective regulation, and enforce deterrent punishments, so legal robberies don't take place. If they don't, it's unjust, and immoral, to take it out on the people they fleece.
It's even worse to blame the victims by telling them they ought to have known better, blame them for not knowing; telling them it's their fault they got slipped a mickey.
no subject
Date: 2008-09-28 06:16 pm (UTC)And the card companies are making out like bandits. Some of the horror stories I found in my research when railing against the bankruptcy bill... people who had paid thousands in interesst on hundreds in principle; the creditors were still claiming to be losing money because the principal wasn't paid down.
Never mind the vig already collected was 6, 7, 10 times the amount lent.
Know what the companies call people who don't carry a balance? Deadbeats, because they aren't making more than about 4 percent on the money (from the discount rates to shops... and what does that do to prices? Am I paying extra when I use cash, so the store doesn't lose money when someone else uses a card?).
no subject
Date: 2008-09-28 07:57 pm (UTC)It's even worse to blame the victims by telling them they ought to have known better, blame them for not knowing; telling them it's their fault they got slipped a mickey.
AMEN. Thank you for this.
no subject
Date: 2008-09-28 10:18 pm (UTC)no subject
Date: 2008-09-28 11:14 pm (UTC)We've been here before. It used to be we had this sort of bubble collapse cycle every 20-30 years. It's been almost 90 since we had the last one. What changed? FDR's administration shoved a lot of regulations through congress (and I mean shoved... his first 100 days is famous because it got most of the work of his tenure done; before the reactionary elements could get their feet back under them). Reagan started to disassemble that (S&L, here we come) and the slow dismantling continued to the present Bush, who took the lid off the jar and said, "it's here for the taking." Well the folks who could, took.
If you aren't trying to blame anyone, what was your point with the comment about people needing to remember they have to pay what they owe, and the date rape allegation? Because the last has with it the idea the victim is to blame. They put themselves in a situation they shouldn't, and they were taken advantage of.
These aren't people who set out to game the system. They were gamed by it. They went to buy a car, and were; knowingly, sold a lemon. Now they are being told they have to return the lemon to the crook who sold it to them, and pay for it. With the present bankruptcy laws they have to attend classes, pay off part (or all) of the debt, and take a hit on their credit rating.
It wasn't consensual.
Why? Because someone cheated them. That person has people excusing them by (as you did) telling us the poor schlub who was sold the lemon should have known better.
These people were trying to make intelligent decisions, in their best interest. It's just the game was rigged and they were lied to (or, as with the bankruptcy bill, had the rules changed on them). Alan Greenspan, the market guru the people who are supposed to be in the know are telling us is, "fucking brilliant," said, "first time buyers shouldn't be so wedded to the idea of a fixed-rate loan, when an ARM will give them more flexibility, and may let those with less than perfect credit get a loan." [I paraphrase]
Why should someone who isn't a Warren Buffet, hell not even a Bill Gates, disbelieve him? Disbelieve the banker who reccomends the ARM, who tells them it will cost less, and make it possible for them to get a house?
When the numbers out of a audit of Freddie and Fannie show that not less than one in five of the checked sub-prime style loans were to borrowers who qualified for prime mortages. When people who eligible for prime, but but couldn't keep up with the terms built into the sub-prime? Who is going to say, "I don't like that loan," and go someplace else to try to find a better rate? Who is going to know they are being lied to? How many were under pressure to "buy now" because the market was hopping, and the seller might get a better offer if they couldn't put up a deposit now?
When the seller is being dishonest, and the buyer can't be expected to have the expertise (if I were to explain to you why a specific russian manuscript was worth tens of thousands, how would you know if it was true or not? If I was shown to have defrauded you would you say, "Hell, I ought to have known better" and just wash your hands? Or would you try to recover the money I took under false pretense) it's not the buyer's fault.
People need to learn that its up to them to make intelligent decisions in their own best interest. There's no easier way of putting that. That's blaming the people who took out the loans, not the people who sold them. "Personal responsibility" isn't that simple.
no subject
Date: 2008-09-29 01:53 am (UTC)Pointing out where we went wrong is not effective because the people that execute these types of pressure deals STILL make a profit off of them. It's the middle and the ground level employees that get ground between the gears. It's the families that get ground underneath them. But the machine still generates real revenue for the top.
What has the government done to change that? Until the government and the financial sectors have made SIGNIFICANT observable and measurable progress, US (the little people) discussing it has zero affect.
no subject
Date: 2008-09-29 03:08 am (UTC)Exactly.
no subject
Date: 2008-09-29 03:22 am (UTC)Because when someone tells me something is academic, that means there's no point to talking about it, because it's all dead and gone. But you keep complaining that it's not dead and gone. That the problems persist. That means it's not in academia it's out in the real world.
Pointing out where it went wrong is the only way to make the changes effective. Pointing out where it's going wrong is why the bailout bill Paulson and Bush tossed out wasn't swallowed hook, line and sinker.
But hey, you want to leave it to the guys doing it now, the way they are doing it now, well; as you say, you bought it, you pay for it.
Me, I'll keep talking about it.
no subject
Date: 2008-09-29 03:27 am (UTC)Depending on what happens between Bill and Bob the money which is guaranteed by Sally may not have to be spent.
The thing which isn't as clear as it might be... these are all or nothing bets, or at least odds bets, so that Sam won't pay as as much as Fred would.
And the initial bet is, in theory, collateralised; so the other stuff is being done with the idea there is an asset behind it. But the various deals, etc. have all been done to the point they have more money in play than the collateral was worth; even if it didn't lose value.