Partners in Stupidity
Many free market apologists, as well as commentators on this blog, are determined to blame the current financial crisis on governments forcing banks to loan money to bad clients, (only partially true), not enough land on which to build, (true in only a few areas, but not in any way the cause), and finally, bludgers lying on their loan applications.
National Public Radio (NPR) has a great programme on the subject, which is worth listening to. It describes how gullible consumers and over-eager mortgage brokers conspired with Wall Street, through the new CDO derivative, to spend like there was no tomorrow.
The bank made a imprudent loan. I made an imprudent loan. So the bank and I are partners in this deal.
Take the time to listen to the story The Giant Pool of Money.
October 1st, 2008 at 11:34 am
The basic mathematical rule of fractional reserve banking.
If banks maintain r as the reserve ration for cash on hand as a function of total deposits (where r=.05 means 5 percent), the money in the system based on a deposit D and re-lent by the bank up until its reserve ratio is reached is
T = D / r
If banks keep 100% (r=1.0) of deposits nothing can be lent, the dollars stay in the vault.
T = $1.00 / 1.0 = $1.00 total
If banks keep 50% of deposits on hand, $0.50 is lent to borrower B who spends and it is redeposited (a monopoly for simplicity), another $0.50 of deposits, they can lend 50 percent of that and you get $1.00 + $0.50 + $0.25 + $0.125 + ….
T = $1.00 / .50 = $2.00 total
Most financial institutions have been operating with three to five percent reserve ratios (not good IMHO).
The velocity of money through the economy is quite rapid.
That’s all good though, its worked that way for donkey’s years. The deregulated and artificial securitization of debt however not only incorrectly lowered the perceived risk of billions of dollars in loans but it involved a wholly new class of “assets” … the default credit swaps which themselves became counted as “money” subject to the multiplier of fractional reserve.
Sixty some TRILLION dollars worth. The Gross World Product does not approach this number.
700 billion is peeing upwind into a Typhoon.
It is based on the imagination of “the smartest guys in the room”… and so now we know where those Enron weenies went.
respectfully
BJ
October 1st, 2008 at 12:09 pm
It has been suggested that the most appropriate deal is to for the Fed to simply exercise eminent domain to ANNUL the CDS issues. Then we might sort out the rest of the mess in some fashion at a cost that relates to reality. I’m still thinking about that. What I WANT is for the rich pr!cks who profited from this cr@p sandwich we’ve been served to have to eat it. I want them dumpster diving for their free fncking lunch and I live in hope that they will suffer. I regard it as unlikely, but hope is like that.
respectfully
BJ
October 1st, 2008 at 12:58 pm
One more aspect you forgot is that the repeated previous bailouts by the government mean that these so called ‘risky’ loans, aren’t actually that risky.
Of course companies are profit maximizing, but they also balance this with risk. If the government didn’t keep bailing them out they’d have to actually think about this risk when making decisions and would probably accept lower profits to avoid the risk.
New Zealand is heading down the same track, because we keep bailing out failing businesses too.
Oh, and there’s no reason to apologise for the market.
October 1st, 2008 at 3:02 pm
bjchip,
1) Capital Reserve size hasn’t changed much lately. It’s not the problem (mostly - Freddie and Fannie were running at absurdly low capital requirements, but they’re unusual).
2) Most of these “rich pricks” are just joes who were in the right place at the right time to have loads of dosh stick to them as it blew past. The biggest difference between a very successful trader and an average trader has always been luck. They made undeserved dosh, they’re not as smart as they thought. But 99% of them weren’t out to screw anyone.
3) Don’t be silly, you can’t annul them. Most of the CDSes issued were done so in good faith and have been bought by people who paid real money for them, are relying on them, and know they are really worth good money. Some of them are worth 30% of what they were bought for - but even (a) what if you’ve backed your bond risks with CDSes? and (b) making them worth 0% of what they were bought for is hardly the answer.
4) The notional value of CDS market isn’t as sensible a number as you think. Never trust a notional.
Because if I back company to $100 mill, and then hedge that by selling ten CDSes of $10 mill with a slightly better margin, and then someone buys those and CDS for another compnay and sells an equivalent CDS that bundles them together, then it theory we’ve got $300 mill of CDS - but really we’ve only $100 mill bundled up three ways by 3 different people.
Likewise I could buy bonds from A, and bonds from B, and a CDS from A covering B’s bonds, and a CDS from B covering A’s bonds, and end up with covered risks (ie if A or B goes under I’m fine, only if A and B both go under am I in trouble). Yield on the bonds covers the CDS cost. So really it’s just the small margin between them that’s changing hands.
October 1st, 2008 at 3:52 pm
“If the government didn’t keep bailing them out”
They don’t. They take them over. Which leaves the shareholders with nothing - or close enough to nothing so as not to matter.
October 1st, 2008 at 7:51 pm
Icehawk
Back in the day I would meet these guys… out in the hamptons. I could not feel sorry for them if they were being burned alive while being drawn and quartered. The most amoral slime I’ve ever had the displeasure of dealing with.
The problem with the CDSs is that they WERE treated as collateral, as being worth something and the valuations placed on them weren’t real, and the money borrowed against them leveraged the whole steaming pile to a position roughly over our collective noggins.
TANSTAAFL. The value seemed real enough but the value came from the dilution of ownership… and now judges are saying to lenders who are trying to foreclose, basically, a new version of “habeas corpus” . Lender can’t produce proof that they own the paper, lender cannot foreclose. You’d be lucky to get 30 cents on the dollar. Mark to market and those things ARE worth nothing. Nobody will buy them. Might make good bulk for recycling into toilet paper. The only way this CAN be managed is for government to guarantee them… except that the notional value is overwhelming.
October 6th, 2008 at 2:06 pm
US Government Bonds will always be worth something! You can burn them in winter to keep warm - all 6.2 TRILLION of them
Seriously though, let’s look at some of this with clear eyes.
The heated ‘debate’ between National and Labour in NZ over the advisability of 2% or 22% of GDP as a borrowings ceiling is put into some interesting focus when you remember that the USA’s current debt is 350% of its GDP.
The farce that is the current debt crisis (thought someone keeps saying it’s a credit crisis for some reason,) is a combination of poor lending risk management, coupled with greed and misdirection.
The credit companies here used to lend money to boy racers for their cars, at 100% of purchase price, but with a premium for not having a deposit. They then lent them more money for MAG wheels, down lights, sound systems and paint jobs that added no value to the vehicle, but often brought its debt:value ratio to greater than 1.2:1.0. When the ‘owner’ defaulted on fines for no WOF or Registration, the finance companies loaned them the money for those as well, so the vehicle wasn’t impounded. The theory was that the premium of 100%+ finance covered the default rate - sadly, theory didn’t match reality. More sadly, the people who had invested their pension savings into these credit companies lost their savings - while the managers had drawn great salaries and bonuses.
Change ‘vehicle’ to house, change ‘credit company’ to bank. Add in a layer of greedy bastards who decided to take BIG commissions for packaging these mortgages into BIG bundles, ($10 mil, then $100 mil, then $1 bill) and selling them off as ’securitised investments’, and paid themselves a few hundred mill over a couple of years, and you’ve got today’s debt crunch.
Getting rid of a car that isn’t worth what someone expects you to pay for it is easy, you just park it outside their office and walk home. Getting rid of a house that isn’t worth what someone expects you to pay for it is just as easy, you just post the keys through the letter box of their office and ride off to a rental.
In the mean time. Some folks have lost everything, some folks have gained and lost nothing and some people have made fortunes.
That, my friends, is called ‘The American Dream’; it’s coming again soon to a generation near you! Now, what is the NEW ZEALAND DREAM? Remember - TANSSTAFL!