How did this financial mess get started in the first place?
Answers
4075 points
EthanR answered one year ago …
Great question, Brad. Like a drop of water that continues until a mighty flood occurs, this is my belief and opinion of how our financial mess began. It was a perfect storm of the following six events:
1) Special interest groups were pressuring the Bush administration into creating loans for low income families, so they could also become home owners. Bush and friends caved in to these groups for political purposes.
2) Thus were the zero down loans developed. But the problem was that with zero down, the payments became too high for the borrowers' income levels. So the mortgage industry had to create ways to solve that problem. Enter the stretching of debt to income ratios and the pushing of interest only loans, ARM's, 40 year loans, and eventually negative amortization loans.
3) Enticed by suddenly looser standards and low interest rates, people who had little business buying homes began to do so. This created a market for more investors to buy low end homes, rehab them, and flip them to these buyers at higher prices.
4) Remember also, that the 2000-2002 stock market was brutal. Many investors began to look for ways to diversify their assets, or just get out of the market completely, even though it rallied in 2003. These investors saw great opportunities in a real estate market that was just beginning to show greater than normal annual rates of appreciation.
5) Banks began to package their high risk loans and sell them in bundles as CDO's to other institutions.
6) The media jumped on the bandwagon, especially cable channels like HGTV and other home channels. They began producing shows that had people flipping homes and making all kinds of money. That spurred others to try doing the same, until finally the last fool was buying at the top of the market.
I think you know the rest of the story. And it hasn't been pretty. So basically, right now the markets are self correcting, and will eventually return to more normal levels of price and appreciation. Uncle Sam will bail everyone out, and the taxpayer will pick up the tab.
421 points
WayneMulligan answered one year ago …
Great answer from Ethan (as usual)!
I weigh in with my own answer on the TickerHound Blog:
http://blog.tickerhound.com/?p=90
Best,
Wayne
249 points
engcomp answered one year ago …
Wayne's Article and Ethan's answer certainly explain how this mess started. Reading Wayne's article, I aksed myself 'who are the winners?'. Speculation is a zero game. What one loses (here the taxpayer), someone else must win, unless assets are wantonly destroyed as in a war. In this mess, the winners are (1) property speculators as explained by Ethan; (2) bankers and brokers as explained by Wayne. The scary part is that the money that has been siphoned off may be more than a few hundred billion dollars. We are seeing only the tip of the iceberg.
Wikipedia says this about CDS-s:
Credit default swaps are the most widely traded credit derivative product[2] and the Bank for International Settlements reported the notional amount on outstanding OTC credit default swaps to be $42.6 trillion[1] in June 2007, up from $28.9 trillion in December 2006 ($13.9 trillion in December 2005) and by the end of 2007 there were an estimated USD 45 trillion worth of Credit Default Swap contracts.[3]
In the US, the Office of the Comptroller of the Currency reported the notional amount on outstanding credit derivatives from reporting banks to be $16.4 trillion at the end of March, 2008.
The default ratio on these loans (not just housing loans but also loans on ill-conceived commercial properties and loans that are downright fraud) is likely to exceed what the US Government is willing or able to spend on bailouts. What will happen then? Hopefully, both Wayne and Ethan can answer that question?
249 points
engcomp answered one year ago …
Congress was told in 1991 that this mess would happen. Please read the testimony given by Stephen Pizzo on 13 September 1991...
http://www.newsforreal.com/written.html
or see a synopsis here...
http://www.salon.com/tech/htww/2008/04/04/the_next_black_monday/index.html
Do you agree that Congress should be held accountable for the mess the banking system is in? Mr. Pizzo's testimony is based on his analysis of the Savings & Loans crisis. He had this to say:
"As we autopsied dead savings and loans, we were absolutely amazed by the number of ways thrift rogues were able to circumvent, neuter, and defeat firewalls designed to safeguard the system against self-dealing and abuse. One of the favorite methods was to link up like-minded thrifts in the daisy chains through which they could circulate inflated assets and hide their rotten loans to each other and to each other's customers from regulators."
He said "Banks ... will do exactly the same thing" if they are deregulated.
190 points
HoughtonAndAtkeson answered one year ago …
Treasury Secretary Hank Paulson said, "The root of financial crisis is the housing problem." And the root of the housing problem is that home prices are coming down and that too many people bought homes with too much leverage.
One would have thought the Internet/tech bubble of the late '90s would have taught people to be careful with leverage, but that doesn't seem to be the case. Real estate investing is the ultimate leverage game. In the past 10 years, it has been done with less and less skin in the game -- a recipe for the disaster we are living with today.
2082 points
alanj answered one year ago …
Great answer from EthanR. Except that the policy for low income housing started much earlier than the Bush administration. It was more like the Jimmy Carter administration. Passing into law which allowed loans to low income people. People who have very little means to pay the loan back. And over the years the lawmakers made it easier and easier to get a home loan. And now it has finally caught up with us.
I blame all three branches of our government but, mostly Congress. They are the ones who create bills. Which the President can sign into law. If he vetoes the bill the Senate can override the veto and pass the bill into law.
678 points
BoxCar answered one year ago …
It is a naturally occuring phenomenon as long as the human race has existed since it
set out to "Go Forth and Multiply" every 3 generations (66.6yrs) when the 4th arrives
neither the aged nor newborns are working and thats the straw that breaks any type
of economy from Egyptian pharoes times to Easter Island to Communist Russia.
So if you REALLY want to hold someone accountable, ask yourself just who is it that
first set out this policy of "Go Forth and Multiply"? Thats the culprit who causes human
race to go over the cliff of economic destruction every 3 generations since 1796.
Historical years are 1860s, 1930s, 1990s (Bosnia/Rwanda) and NOW. I'm not
making this up, Solar Mortality Theory predicted onset, 1st bank failure in 2007.5
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