By 2006 the world's currency supply nearly doubled from $36 Trillion in 2000, to $70 Trillion. This was the total of "money" held by all the central banks, insurance companies, and pension funds in the entire world: the result of Globalization. That this wasn't actual money (anything that has value) may be seen by the fact that all the commercial transactions everywhere in the world for one year would not equal $70 Trillion, but there it was. And as these "monies" were being held against potential economic crises, natural disasters, and entitlement programs, the managers in charge of these funds were anxious to make them grow without the risk of losing any on these funds. Their usual practice was to invest in US Treasury Bonds: ultra safe securities paying something like 5% interest. When the world's fund managers approached the Fed, the then chairman Alan Greenspan, either through abysmal stupidity or criminality of global proportions sent them packing.
In 2004 the Fed was holding interest rates at one percent, ostensibly to spur the lagging economy, and Greenspan decided to hold interest rates at that level. The repeal of the Glass Steagall Act of 1933 opened the way for savings and commercial banks to speculate in the securities markets At the same time the housing bubble was forming and the Global Fund Managers approached Morgan Stanley about investing in mortgage vehicles. The Wall Street investment bank was more than happy to accommodate them, and set out to purchase mortgages from savings and commercial banks, and mortgage brokers. The Main Street banks were issuing VIVA (Verifiable Income, Verifiable Assets) loans which they were glad to sell as they could get their money without waiting years for the mortgages to mature. The initial loans that Morgan bought were sound investments but weren't enough to satisfy the Global Fund Managers: these amounted to a drop of water in an ocean of currency. The mortgage payments that had previously gone to the banks that wrote them now flooded into Morgan, and the Wall Street firm invented a security based on this bundle of mortgages: the Mortgage Backed Security, which they sold to the Global Funds. But $70 Trillion is a lot of money and the managers returned to Morgan wanting more MBSs. Morgan, in turn, went to the banks for more mortgages which they were more than happy to write.
Everybody was happy. Morgan Stanley was happy; they were selling Mortgage Backed Securities like there was no tomorrow. The Global Fund was happy because they were getting a decent rate on their money, and the Main Street banks were happy because they could sell their loans to Wall Street. Besides, housing prices were rising; what could go wrong?
To keep up with demand banks eased up on their loan requirements; now they were writing loans based on stated income and assets. Still, the markets weren't satisfied so the banks wound up writing NINA (No income, no assets) loans to people who couldn't possibly repay the loans. The rationale on the part of the banks was that since housing prices were going up a borrower could take out a mortgage now, make no payments for a year, and then "flip" the property for a quick profit after repaying the loan. There was no tomorrow!
The tomorrow came. Housing prices declined in some markets that were over-built and the Wall Street banks (by now others had joined in the fun) were saddled with a glut of bad loans. The influx of mortgage payments was drying up and the investment banks were facing some serious shortfalls with the Mortgage Backed Securities. What they did was to bundle their mortgages into tranches (Fr. slices) at several levels, from good packages to highly risky bundles. This was the birth of the Collateralized Debt Obligation (CDO) which Wall Street sold to anyone who would buy them, promising higher interest rates on the poorly performing tranches. As the housing market showed signs of deflating the holders of CDOs began to worry. To hedge their bets these bondholders purchased Credit Default Swaps (CDS).
Investment banks and insurance companys had been selling CDS since the early 1990's; the holder of a security or equity instrument would pay the seller $10- $20 Million a year as kind of a premium; the seller would agree to pay the buyer the full value of the credit instrument in the event of a default or bankruptcy. It's a good deal for the seller as long as the market is strong, but when cracks begin to appear the whole process shifts into reverse with dire consequences. In 2006 things were bad; then got much, much worse. Enter the Black Hole. A hedge fund.
Hedge funds are mutual funds for the super rich and are dedicated to making their members richer by whatever means available.The hedge fund that exacerbated the housing bubble and led to its final collapse was Magnetar, named after burned out stars that exert extremely high gravitational forces that resemble (and likely are) "black holes". To get the whole story Google: The Magnetar Trade.
A brief synopsis: Collateralized Debt Obligations were the most toxic of Wall Street's inventions, bonds backed by thousands of shaky mortgages and arranged into five or six tranches. Of these divisions the first tier were touted as the "safest" and paid the least interest to buyers of these bonds. As it turned out all of these bonds were worthless, but admittedly the worst of all were the "equity" tranches, those at the very bottom of the ladder. After the record profits booked on the Street in 2005, investment bankers were worried that 2006 would see the entire collapse of their positions, as investors were leery about buying CDOs, especially the super toxic equity tranches. Then in what some investment bankers deemed a "miracle" along came Magnetar wishing to buy these very risky bonds. What the article referenced above does not clearly state is how Magnetar profited from the collapse of the CDOs they bought; by buying Credit Default Swaps. One of the biggest traders in these instruments was AIG which, along with the banks who began foreclosing on these over leveraged properties, needed bailing out as their balance sheets were literally turned inside-out.
The resulting bailouts by the government of these financial institutions have been sternly criticized by commentators as rescuing the very people who caused this catastrophe. That is one side of the issue but I believe there was no choice in the matter. These banks held deposits that would have had to be refunded by the Federal Deposit Insurance Corporation (FDIC) and there just wasn't enough money in this insurance fund to cover all the losses. The people would have suffered one way or the other.
The banks themselves were insolvent as the foreclosed properties they took over were worth far less (in some instances as much as 80% less) than the the amount of the loans they made. To fully understand the impact of these reverses we only need to apply the basic accounting equation: Assets = Liabilities + Capital.
As an example consider a bank that is capitalized at $10M and accepts deposits of $90M, giving an asset value of $100M. The bank then lends $90M out in mortgages. The balance sheet would look like this:
The $90 million is entered as a Liability Account because it is the depositors' money andmust be kept available to be withdrawn at any time. This is great if the loans are all performing well, but when the housing bubble burst and banks repossessed properties that were valued at 50% of their loan value the situation changed dramatically. The banks, according to sound accounting principles, would have to "mark to market", meaning that they would have to enter the true value of their holdings. In the case of housing values reduced by 50% the bank's balance sheet would look like this:
Multiply this situation by 10,000 and that describes the magnitude of the problem and shows why bailouts were necessary to protect depositors' funds. It didn't matter if banks held their properties at full value, as many did: they were still bankrupt. They still are.
This essay is but a flyover of the serious economic reversals this nation and the world have suffered; there is much more that time and space prohibit airing here. Greed, stupidity, and delusional thinking are still the earmarks of a corrupt government that feeds the ravening beast that is Wall Street and that is populated by appointees that shuffle between administration posts and investment banks, brokerage houses, and the Federal Reserve. Timothy Geithner, the US Secretary of the Treasury was president of the Federal Reserve Bank of New York; Henry Paulsen was CEO of Goldman Sachs, two of many examples of the fox guarding the chicken house.The next financial crisis looming in the shadows is the Commercial Real Estate market; that and the continuing disaster in the Gulf of Mexico promise more impositions on already beleaguered taxpayers,yet we have no end in sight to the fictitious "war on terror". One of Obama's campaign promises was to end the war in Iraq: "you can take that to the bank," he said. Yet, now we have General Petraeus saying that we are in Afghanistan to win. Who does he think he's kidding? The fictitious "war on terror" is a black hole into which we have been dumping lives and treasure that we can ill afford. Any lingering doubts on that issue? Look at this;
And what of the global pool of money, the $70 Trillion that sparked the Sub-prime debacle? According to the IMF this fund, the world's savings, has grown to $83 Trillion! That is nearly five times the currency that changes hands in the whole world in one year. What are they saving for? Greenspan could have raised the Fed Funds Rate to 5% and channeled the funds into the US to stimulate economic growth, create jobs, fund entitlement programs, and to develop true energy independence; this bastard belongs in jail!
In closing let me encourage all Americans to vote for Independent candidates for the House and Senate who will put America first. Democrats and Republicans are both sides of the same coin; they've had their day: America needs a new day, and we have people who hold great promise for our future. Two men in in particular that I'd be willing to bet you've never heard of, both self-taught geniuses, are holding up a lamp of hope. Their names: Stanford Ovshinski and Jacques Fresco. Google their names an learn what the oligarchs in Washington don't want you to think about. These men and others like them are true American to whom we may point with pride; more than that they are true humanitarians who visionary work promises a bright, prosperous future for all mankind. That they are little known is a shame; if they remain unknown would be a disgrace. Ignorance is a poor excuse.