The Root Causes of the Credit Crisis

[Baron Max]

So, a bunch of poor people ruined our economy? Nonsense.

No, it wasn't just poor people! In fact, it was probably more of the middle class than anyone else ...most poor people are poor because they haven't learn to fuck over the system yet!!

Banks are equipped to deal with defaulted loans. They are not able to deal with the hallucinated wealth of packaged mortgage securities that suddenly lost their percieved value.

Then they really weren't equipped to deal with defaulted loans, were they?

Baron Max

 

[nietzschefan]

Are you anti-US style capitalism (private profits, public losses)?

Absolutely. ALL businesses/Corporations/Limited should be FULL disclosure, just like personal income tax. The fact Corporations pay less taxes(less percentage) than individuals already gives them a huge advantage.

 

[Avatar]

Then they really weren't equipped to deal with defaulted loans, were they?

I think that's the problem - they had the means, but they didn't act, because greed on immediate profit took hold of them.

 

[Billy T]

...Then they really weren't equipped to deal with defaulted loans, were they? Baron Max

Although well explained to you in post 90 you obviously do not understand yet. I will try to make it simpler for you:

Yes in the last few months a tiny fraction of the loans in the repackaged and traded securities of many did fail, but that loss to the banks was less than a few percent of the loss when these packs of loans were "marked to market" on the banks books for the third quarter reports*. If these derivatives were never created and then sold to other banks all over the world, then banks would not be frozen and the losses would be very small.

Dumb Joe American had nothing to do with the construction of these tranches - typical very complex documents** several hundred pages long filled with formulae. They were used to grow the leverage to more than 30 (in Lehman’s case it was 32, but some are >40) Thus when a 3% default happens the high leverage completely wipes out 100% the equity. No one knows which packages have still positive equity. Thus there is no market and "mark to market" rules effective made every mortgage in the US worthless on the banks books even though 95+% were being paid on schedule! If unleveraged, the bank could cope with a modest default rate (as they expected one and had priced in).

The reason you can blame Joe is you are too dumb to understand that the problem is basically the high leverage that was created with no, zero, zip, involvement of Joe American. - Only the fat cats of Walk Street making and using high leverage in hope of multiplying their gains more than 30 fold made this disaster.

It was high leverage than sunk LTCM a decade or so ago also. The default rate, if it here not highly leveraged would barely have make the news in the financial papers. You do know what leverage is do you not?
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*I picked October 2008 three years ago as the start of the window for collapse, in part as that is when quaterly reports come out*** and my trend lines of the growing debt and of the number of Baby Boomers retiring all seems to be sustainable until late 2008.
Everyone knowlegable is now calling for end to the "mark-to-market" accounting rules, but IMHO, that would just sweep problems under the rug until the hill in the rug killed everyone.
**Most were too complex even for financial experts, so they hired some Ph.D. high energy physicsts grads to construct them.
***Banks etc holding the securities that became mark-to-market "toxic trash" mainly after 30June could no longer hide their losses. Fact that it is happing now is more evidence that Joe had essentailly nothing to do it it being a major problem. All the "Joes" in the US did not have a secrete meeting on 30 June and agree not to pay their mortgages. The shit hit the fan when it did as they banks could no longer hide the effect of the leveraged losses on their books. Leverages (achived in part by debt swaps) IS the porblem, not a slghtly higher than expected default rate due to many Joes losing their jobs. The real cause is the stupidity in the current administration: Free markets need no regulation (and many other factors).

 

[Nasor]

No, once again you're just trying to make it complex for no reason ...except perhaps in some misguided attempt to excuse the stupid freakin' borrowers.

If ....IF... those stupid borrowers had not taken out loans that they couldn't pay back, then those banks would NOT have had any bad loans to sell to any bank, regardless of the banking rules!

Look, suppose I'm a bank manager who needs a night security guard, so at the end of the day I walk up to the crack-addicted homeless person sleeping in the alley next to my bank and say "Hey, I need a night guard. Do you want to do it? Ok, great. Here is the key to the front door and the vault. Have a good night!"

The next day when the bank employees arrive to discover that all the money is gone, the bank's board of directors holds a meeting to determine whose fault it is. They want to put some of the blame on me, but I protest "No, no, it's all that homeless person's fault! None of this would have ever happened if he hadn't stolen all that money! Blame him, not me!" OF COURSE the homeless crack-addicted thief is responsible for stealing the money, and if the police catch him he should go to prison. BUT as the bank manager I also screwed up in a HUGE way. Although I don't bear moral responsibility for the theft of the money, I was certainly being negligent in my job and it is perfectly reasonable for everyone to be pissed off at me. Most people would agree that the loss of money is partly my fault, because it wouldn't have happened if I had done my job with a modicum of responsibility.

Although the current real-world situation doesn't involve outright theft, it's analogous to the situation that I just described in that he banks never should have put themselves in a position where people's inability to pay back their mortgages would result in the commercial paper market melting down and many firms being stuck owing billions in bullshit CDS agreements that they aren't able to pay.

I'm sorry that things are too complicated for this issue to be distilled down to a simple "it's the borrower fault!," but sometimes the real world is complicated, and sometimes more than one group of people is responsible for a bad situations.

No! And NO!! Those financial institution would not have had any "game pieces" if all those idiot borrowers hadn't taken out loans that they couldn't pay back!

Yeah, and in my above scenario the bank would still have money if only that terrible thief hadn't stolen everything after I gave him the key to the vault. IT'S ALL HIS FAULT!

You can sugar-coat it all you want, you can make it as complex as you want, but it all comes back to the idiots who borrowed money when they couldn't pay it back. In the real world of loan sharks, those people would have had their knees crushed with pipes! Yet, here, you and most everyone else, are trying to make excuses for them ....when they really should have their knees crushed with pipes and baseball bats.

WTF? Have you actually read any of my posts? I've said repeatedly that I think the idiot borrowers should be held responsible for taking out loans that they should have known they couldn't pay back. But the idiot bankers should also be held responsible for setting up a system that will crash and lock up the financial market when a guy who makes $35k/year can't make his mortgage payment for his $400k house.

You think it was the home buyer's fault that companies were trying to make money by buying and then re-selling trillions of dollars in CDS agreements on mortgage-backed securities that they didn't even own, and that they could never actually afford to pay out? You think it's the home buyer's fault that money market accounts and hedge funds were buying their mortgages at 10X what they were actually worth?

No. The people who can't pay back their mortgages are responsible for not being able to pay back their mortgages. The bankers are responsible for setting up a system that could be destroyed by a small number of people not being able to pay back their mortgages. Trying to excuse the bankers for their negligence by crying "but it never would have happened if people had repaid their loans!" is like crying "but the bank vault would still be full of money if that homeless crack addict hadn't stole everything after I gave him the keys and left him there all night!"

 

[Nasor]

Since I can't seem to stop making analogies today, I will try one last one, and maybe this one will be simple and direct enough that Baron Max will get it: Suppose I take out a big mortgage that I think I will be able to pay back, but it turns out I can't. After I get the mortgage, Bank A (that has nothing to do with my bank or my mortgage) says to Bank B (that also has nothing to do with my mortgage) "Hey, if you pay me $2 million, I'll give you a $1 billion is Nasor defaults on his mortgage in the next year." Bank B says "okay, I'll take that bet." Then Bank B goes to Bank C and says "Hey, if you pay me $2.5 million, I'll give you a billion dollars if Nasor defaults on his mortgage this year." Bank C says "Okay, I'll take that bet." Now Bank B is saying "Haha! I just made $500k with no risk! Even if Nasor defaults and I have to pay bank C a billion dollars, that money will already be owed to me by Bank A! I'm so clever!"

Then I default on my mortgage! Bank B says to Bank A, "Give me that $ billion you owe me." Bank A says "crap, I don't actually have a billion dollars. I was just betting that Nasor would be able to make his payment. I'm going bankrupt, see you." Bank B says "Crap! I was counting on that money to pay off bank C! Now I'm bankrupt too! See you..." And Banks C says "Damn it, I was supposed to get a billion dollars, but instead I lost $2.5 million in an insurance policy from Bank B that they can't actually pay! Crap..."

Then Baron Max shows up at my new low-rent apartment and says "WTF?!? You just RUINED two banks! They're completely out of business! And on top of that, you cost Bank C $2.5 million!" To which I respond "What? I just missed some mortgage payments! How is it my fault that Banks A and B went out of business and Bank C lost $2.5 million?!?" To which Baron Max responds "They went out of business because you couldn't pay your loan! Those financial institutions would not have had any "game pieces" if you hadn't taken out a loan that you couldn't pay back! IT'S ALL YOUR FAULT!!!"

Well, no - it's my fault that I couldn't afford my mortgage payment. The fact that Banks A and B went out of business and C lost $2.5 million is the fault of the stupidity of the bank managers for making bets about my mortgage that they couldn't afford to pay if they lost, or collect if they won. Now was that still too "complicated" for you?

Edit: Actually that isn't an analogy. It's pretty much exactly what's happening.

 

[Billy T]

To Baron Max:

If you can not understand my simplified but still general identification in post 104 of the probelm as being the high leverage read post 105's example case. It shows the role of Debt Swaps. (Called that to escape from being regulated as insurance, but they are insurance policies.)

Joe American had nothing , zero, zip, etc to do with the writing of the debt swaps also. The US economy has fallen victim to the greatest Ponzi scheme ever and the con-men who pushed it, not only to investors in the US, but all over the world. They should be treated like the crooks they are. - Cease their illegally gained assets and send them to Jail.

 

[Nasor]

Actually, I'm beginning to wonder if Baron Max is deliberately avoiding understanding the complexities of the issue because such an understanding would threaten the simplistic "It's all the borrower's fault!" view that he apparently prefers to believe.

If I get a loan that I can't pay back, that's my fault. If a bank that doesn't have anything to do with my loan makes a bet (that it can't actually afford to lose) about whether or not I'll be able to pay my mortgage with another bank (that also doesn't have anything to do with my loan), and then goes bankrupt when it loses the bet and can't afford to pay, that's not my fault.

 

[Billy T]

Actually, I'm beginning to wonder if Baron Max is deliberately avoiding understanding the complexities of the issue. ...

He is not as dumb as he appears.* He just likes to pull people's chains.

I use him and some physics idiots to post for others.

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*No need to thank me for definding you again.

 

[nietzschefan]

Why are you guys harping so much about Baron Max? Really...he just came in to stir the pot a bit. He might even already know some of the sftuff you guys are saying about leverage. He's pretty much right about people being at fault for borrowing to pay for so much stuff NOW rather than honestly buy/own what they can afford.

He just ignores the greedy otherside that was happy to loan these idiots money...when in fact THEY THEMSELVES DID NOT HAVE THE MONEY!

I swear to god, I'm going to create an outrageous persona on this board, just so I can get more play from intelligent people like BillyT on this board.

 

[nietzschefan]

He is not as dumb as he appears.* He just likes to pull people's chains.

I use him and some physics idiots to post for others.

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*No need to thank me for definding you again.

ok nevermind...

 

[Carcano]

Oh, right. Islamic banks don't charge interest.

Iran has a nationalized mortgage bank which charges fees to borrow instead of interest.

Some kind of extra charge to purchase money is necessary otherwise the system would lose money to inflation and defaults...and then there are the administration costs.

The ideal government run system would be to have no gains or loses.

 

[Nasor]

Iran has a nationalized mortgage bank which charges fees to borrow instead of interest.

Right, they call the extra money that you have to pay back beyond what you borrowed a "fee" instead of "interest". But that doesn't change what it is. A bank could also call the extra money that you have to pay back a "debt riskt adjustment surcharge" if they wanted, but it doesn't change the fact that it's interest.

Some kind of extra charge to purchase money is necessary otherwise the system would lose money to inflation and defaults...and then there are the administration costs.

I completely agree. If charging interest weren't possible, the only people who would ever loan money would be close personal friends or family who did it as a favor.

 

[S.A.M.]

I think the system in Iran is to pay your loan premium plus rent for the house to the bank. As your share increases, what happens to the rent?

 

[Nasor]

I think the system in Iran is to pay your loan premium plus rent for the house to the bank. As your share increases, what happens to the rent?

There are various schemes. Sometimes the bank purchases the house and then immediately re-sells it to the buyer at a higher price, and lets the buyer live in the house while they pay for it in installments. Sometimes they buy the house and rent it out to the buyer while the buyer makes payments toward its purchase, with the rent decreasing as the buyer owns more and more of the house.

But there's no real difference between (for example) getting a $100k mortgage at 7% interest or paying $583/month in "rent" while you make payments toward the price of the house, with your rent decreasing as you own a larger share.

Although I would never claim to be an expert in Islamic banking practices, I have read a good amount about it - mainly because it's very amusing for me to watch how they figure out ways to charge people interest, but then dance around and try to explain why it isn't really interest. You see, rather than charge interest, they just give someone a big pile of money (or a valuable asset like a house or car), and the borrower pays the loan back over time with many small payments that add up to more than the initial value of the loan. And the difference between the initial value of the loan and the amount that the borrower ultimately pays back isn't interest. We swear! It's just, uh...sort of a fee that the borrower pays to compensate the lender for the time value of their money and the risk that it might not be paid back...yeah...

 

[Billy T]

...it's very amusing for me to watch how they figure out ways to charge people interest, but then dance around and try to explain why it isn't really interest. ...

I prefer our home grown dancing around the truth for amusment. I.e. "Debt swaps" are not "insurance."

 

[iceaura]

I ran into a claim once, can't verify it, that compound interest on money is or was forbidden by a higher percentage of the world's major religions than anything except possibly murdering one's parents.

Watching these guys operate, I can see why.

 

[River Ape]

The key principle of Islamic banking has been stated as follows:
"Islam encourages Muslims to invest their money and to become partners in order to share profits and risks in the business instead of becoming creditors. As defined in the Shari'ah, or Islamic law, Islamic finance is based on the belief that the provider of capital and the user of capital should equally share the risk of business ventures, whether those are industries, farms, service companies or simple trade deals. Translated into banking terms, the depositor, the bank and the borrower should all share the risks and the rewards of financing business ventures. This is unlike the interest-based commercial banking system, where all the pressure is on the borrower: he must pay back his loan, with the agreed interest, regardless of the success or failure of his venture."

It cannot be emphasised too much that Islam was adopted in the beginning by a very commercially oriented society (compared with most of Christendom). There was nothing anti-capitalist about the merchants who financed the Islamic conquest of North Africa, Spain and the Middle East. Indeed, conquest brought investment opportunities and led to economic development unparalleled elsewhere in the world. Cordoba became the largest and most prosperous city in Europe. The contrast with medieval Europe, where conquest was driven solely by the power it gave to extort taxes from the peasantly, is striking.

Although the Quran is not an economic treatise, the success of Islam is testament to the soundness of its laws including its economic principles, of which the forbidding of usury (riba) is the most important. The periodic financial crises which occur in western capitalism are always down to the practice of usury, and would be avoided if finance were always provided on the principle of equity, rather than an unhappy combination of equity and usury. There is no "negative equity" under Islamic banking principles.

Do not see the forbidding of usury by the Prophets of many religions as in some way socialistic/communistic, it is good capitalist sense!

 

[Nasor]

Translated into banking terms, the depositor, the bank and the borrower should all share the risks and the rewards of financing business ventures. This is unlike the interest-based commercial banking system, where all the pressure is on the borrower: he must pay back his loan, with the agreed interest, regardless of the success or failure of his venture."

When a bank (or whoever) makes a loan to a business, it's understood that whether or not the loan is repaid will be dependent on the success or failure of the venture; if the venture fails, the corporation will either cease to exist or declare bankruptcy. Why do you think securities have risk ratings? It's because when you buy a security you are assuming risk. And you could only be talking about loans to companies here, because individuals buying cars or houses doesn't generate profit for the bank to share in.

It cannot be emphasised too much that Islam was adopted in the beginning by a very commercially oriented society (compared with most of Christendom). There was nothing anti-capitalist about the merchants who financed the Islamic conquest of North Africa, Spain and the Middle East. Indeed, conquest brought investment opportunities and led to economic development unparalleled elsewhere in the world. Cordoba became the largest and most prosperous city in Europe.

And interestingly, during the golden age of Islam lenders were allowed to charge interest on fiat money. The current Islamic ban on fiat money interest is a relatively new historical development.

Although the Quran is not an economic treatise, the success of Islam is testament to the soundness of its laws including its economic principles, of which the forbidding of usury (riba) is the most important. The periodic financial crises which occur in western capitalism are always down to the practice of usury, and would be avoided if finance were always provided on the principle of equity, rather than an unhappy combination of equity and usury.

Okay, now you're just ignoring reality. Islamic banks certainly tried to go with pure equity investing back in the 1970s and early 80s, but it quickly because apparent that pure equity investing wasn't very stable and they had to move away from equity financing before their entire banking sector fell apart. That was when the banks invented transactions like having the bank buy a car and then immediately re-sell it to their customer at a higher price, and allowing the customer to use the car while they pay it off in installments. Which isn't the same as an interest-bearing car loan! We swear!

Edit:In case you don't want to take my word for it:

But the post-capitalist utopia that reliance on these instruments was meant to inaugurate was dead on arrival. Those involved in the first wave of Islamic banks realized that equity financing does not make for a stable banking sector, and, after a series of shocks and bad investments, they became very conservative. It was a race to the loopholes—a search for means of sharia compliance less risky than straight-out equity investing.
...
The experts tell me that every Islamic bank has at least three-quarters of its investments structured as murabaha. Even the inaptly named Islamic Development Bank was, as of the mid-1980s, doing four-fifths of its business through murabaha, and only 1 percent through equity transactions.

http://www.american.com/archive/200...contents/islamic-banking-is-it-really-kosher/

 

[Billy T]

To River Ape:

I agree completely with your post 118 and you said it well. Several times in various posts I have said that there is much to be said in favor of Islamic banking / bonds etc. and quickly sumarized it by:

"Instead of interest, the lender usually takes a piece of the action." (but noted that was only if the loan was for some investment, not consumption)

As I understand it, if loan is for consumption (like a trip to Mecca) then there is usaully a trade made. I.e. as well as pay back the loan, the borrower will Work X months for the lender or mary his ugly daughter etc.

To Nasor (AFTER HIS POST 119):
It is true that western banks have Moody, S&P etc to rate the risk - obviously they are not very good at it or were strongly influenced by the conflict of interest that usually exists. Taking a piece of the action forces the lender to investigate and evaluate the risk. Generation of highly rated (investment grade) paper that is now "toxic trash" does not speak well for rating system that has nothing to loss but perhaps a little "face" when wrong. Being exposed to the risk of failure is a much better system than being decouple from the losses you over rate. - Do you not agree?