The Root Causes of the Credit Crisis

On the surface, this whole credit problem seem to have been caused by the mortgages.... however, I wonder if there's something more behind that. Two issues come to mind:

1) Oil
2) The bank system


1) Oil
The oil hike preceded the mortgage crisis. Obviously that does not mean that it caused the mortgage crisis. However, consider this. The Mortgage crisis happened because of the subprime mortgages. Most people in the US live in the suburbs, so obviously, a lot of those people had subprime mortgages. Due to their location, they are very dependent on their cars to commute everywhere, and specially to do groceries. With the price of oil going up, their budgets tightened. So, obviously, they started using their credit cards more and had to try to cut expenses. Slowly, foreclosures started, as credit could be less and less used. Eventually, creditors were less and less willing to extend credit until this whole mess happened.

2) The bank system
The government is too easy with the banks. Banks are allowed to create money out of thin air based on how much money people may have in the future. All they did was to take a greater risk and now the government is covering for them with taxpayer money. Lovely.

 

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Root cause: People in general and especially Americans do not take personal responsibility for the consequences of their actions and poor judgements.

Since the root cause has not in any way been identified or modified, government is simply making things much worse by contributing to the problem.

 

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Correct.

Just imagine if there was a REAL reason for the economic woes. Like sept 11 or a global famine or a REAL war(not that shitty little occupation in Iraq or that NATO circle jerk in Afganistan).

Nothing but poor financial management and JERK OFF stock brokers/greedy bankers and Globalists calling in a few debts and buying liquidated assets - is causing this. Let it happen and REFUSE TO WORK FOR THEM.

 

I think you have the "bank system" reversed, the cause of the crisis is that banks stopped doing just that.

At its simplest level the problem is this:

(A) Mortgages make up about $11 trillion in investments in the US.

(B) Most of those are held by companies in the lending industry (banks included, but not just banks).

(C) Unfortunately, for solid economic reasons, most mortgages are sold in bundles, and different banks buy undivided interests in those bundles. Think of it this way, suppose you and nine friends chip in and buy a lottery ticket and win $1 million. Who owns "the first penny" of that $1 million? The answer, from a legal perspective, is that all 10 of you own every penny equally, you all have a 1/10th undivided interest in that first penny and every penny after that that makes up the million dollars.

(D) Because so many more mortgages failed than anyone expected based on the statistics applicable in prior years, and because no one has any idea how many more missed payments there will be (save "a lot"), all these lenders own equal interests in budles of mortgages, good and bad, and there is no way to figure out whio owns which, because they all own timy interests in all of them.

(E) Because we have no idea what the ultimate default rates will be, we can't figure out what anyone's given bundles of mortgages is worth in terms of cash flow of the loan repayments, as those are future payments, and we have no historical basis for guessing at the default rates.

(F) Because we can't even guess at that, no one wnats to buy any of those bundles...you never know if you are overpaying or not.

(G) That means that $11 trillion in assets are now not saleable. If they are not salable, then in a certain sense (future cash flows be damned) they are worth $0 right now. These $11 trillion used to trade so easily, that banks considered them, for the most part, as good as cash, just like T-Bills.

(H) Banks (and lenders generally) take money from someone and they they lend it to some one else. Banks take deposits, and use the money on deposit to make loans, *but* they are required to have some assets of their own so that when an account holder makes a withdrawal, it is not all gone.

(I) The $11 trillion good as cash mortgage bundles were a major component of those "capital" assets.

(J) But those are illiquid and effectively worth squat to the lenders today... and *that's* the "credit crunch." The lenders need capital assets to make their loans safely (and by law they need a banks need a minimum amount to lend at all), and $11 trillion of the most liquid assets that ever existed turned into hunks of worthless stone, tied around their necks (and balance sheets).

Since they can't count on those assets to pay off depositors, they can't count them into capital, and as a result, most do not have the capital cushion (or actual "capital requirement" in the case of real banks) needed to continue lending. Problem? lenders, by definition, are in the business of lending.

The oddity is, most of those mortgages will be repaid, and in a few years, when the bulk of them are paid and we have a good statistical understanding of how many people are in default, the liquidity will return to these mortgage bundles. We are frozen by an inability to price, when that returns (and it has to since these mortgages expire). People will be able to tally their losses and resume normal activity.

 

The question isn't how many missed payments, though, it's how many will miss payments in the future, by how much and which securities are tied to which mortgages? You ould have to investigate not just a few mortgage company, but every mortgage company, and you'd have to figure out who they sold those mortgages to, and which securitization they were bundled in. Each mortgage generating company in involved in countless of these things.

It might be worth it to trace them all, despite the hundreds of millions of legal fees, but the fact that what matters is the future default rates and the paradigm has shifted on that means that doing all the tracing might not yield an answer accurate enough about future defaults to be worth it.

 

Read around, since you do not believe me, the banks' problem is that they do not know if they have the 10% capital requirement needed to make loans, so they stopped. The reason they don't know, is that they can't price these assets, the reason they can't price them is that, because we can't predict the future default rates, no one will buy them.

How do you "automate" the process of determining future default rates when past default rates serve as no guide because the entire real estate market has changed in a novel way? You might as well use "Google's Trillion page index" to pick tomorrow's lottery numbers.

 

A major problem with predicting likely failure rates is that nothing like this has ever happened before so, pundits and economists be damned, no one can be sure what the ripple effects of this will be to the wallets of those who are trying to pay their mortgages.
This is the first time since before WWII that Amerivans have more in debt than they have in savings and an increasing number of poeple are living so week to week, that if they were out of work for a month, they will likely start to default on house and car loans.
Not only have wages been effectively stagnant for 35 years, as was said already, people are living, irresponsibly, beyond their means.
Let's say a miilion people in the finance industry lose their jobs in result of the banks tightening their belts (which is not out of the question)...
How many of them woulr default on thier mortgages and car payments?
What troubles would that spell to car manufacturers, since credit for these poeple would go to shit, and banks have to tighten their credit requirements, people will buy more and more used cars.
How many will the car manufacturers have to lay off?
How many of THEM would default on their mortgages?

No one can tell - and all the politicians are scared if they don't at least TRY something, they will lose their jobs the next time around, because their constituants would blame them for things getting worse.

 

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Does anyone have a clear breakdown of the bailout plan?

 

I'm sorry to say that so far no one has even come close to pinpointing the real root cause of the crisis. But that's understandable because I doubt if a single person who's posted in the thread knows anything about actual banking internals.

Besides the obvious greed of bank managers and employees who's salaries and bonuses were tied to the amount of money they were lending, that was made possible by a little known instrument: the CDS - "credit default swaps."

The CDS is a device invented by JP Morgan 11 years ago. JPM had billions in loans to corporations and foreign governments, and under federal law it had to keep HUGE amounts of cash in reserve in the event some of those loans defaulted.

What they did was create a sort of 'insurance policy' against those loans going bad. It worked by selling (swapping) those huge loans to other financial institutions to assume the risk and paying them them a monthly fee - an insurance premium, if you will.

That took the loans completely off their books and freed up a TREMENDOUS amount of cash that had preciously been tied up in their fractional reserves. They even set up an entirely separate department to handle nothing but CDSs.

Every bank across the globe saw the wisdom in the plan and jumped on board.

Things went fine until the sub-prime bubble started to burst and the banks and investment companies holding CDSs started loosing major money on them. AIG was one of the hardest hit because it was holding 14 billion in CDSs. It had been good business for them before the bubble burst because they had been raking in millions a year in the form of those "insurance payments" to hold those instruments.

So despite all the greed and the sub-prime mess, it was actually the CDS that made the meltdown possible.

 

These days everyone's an economist.

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I have a sort of related question, is there any point to having a legal ceiling on the national public debt when congress can just vote to raise it any time it gets close? It's been raised 7 times in this administration, including a provision in the bail out bill to raise it to $11.3 trillion.

 

Checks along the way - in theory, anyway.

 

The government gave up on the constitution itself a long time ago...nevermind pesky budget ceilings.

Truman was one of the first to subvert the law of the land by entering the Korean war without the approval of congress.

In earlier times he would have been hanged for treason.

 

But all the CDS market did was shift the risk, not create the risk. The risk moved from JP Morgan and other lenders, expecially on their mortgaged backed securities, to other institutions like AIG. But, and here I think it's you who may not udnerstand the market, those swaps are not all out of the money. What happened at AIG is not that they had to payout on the swaps, but that they were forced to post collateral to cover do many of them *and* the value oif the swaps is tied to the value of the loans being covered (the mortgage backed securities). The accounntants for AIG therefore had them to a huge writeoff of the CDSs, well in excess of what most people think AIG will have to pay on them at the end of the day. The double whammy for AIG was they needed both to declare paper losses because of the write down of the CDS assets *and* they needed cash to post as collateral covering their possible claims under them.

CDS's are fine. They hurt a lot of people who had them in this market, but when floods happen and insurance companies lose money as a result, you don't suggest that insurers stop offering flood insurance to customers.