Panic has been the prevalent sentiment on the world’s financial stage the last few month’s. Bankers have made booboos when estimating the amount of risk they run when loaning out money. Off course bankers are people too and just as bend on making a good sale as any second hand car dealer. They just earn more money and have bigger bonuses, which makes their motivation on making sales even stronger.
One of the great things about the US is that anyone can achieve their “American Dream”. Having your own house is considered a right, just like bearing your own arms. If you can’t pay for your property, no problem! The banks were always there to help you with the necessary cash at low interest, even if you weren’t sure you could pay the mortgage after Uncle Sam, Wal-Mart and Texaco had taken their cut. Millions of mortgages were sold to people who could barely pay their daily necessities, let alone an over the top mortgage. The banks weren’t too worried. Housing prices were always going up because ever one was buying. If Billy-Bob couldn’t pay anymore, he and his family could report to the nearest shelter, the bank would sell his property and still get their money, right?
Even the risk itself was a way for banks to make money. They could sell the mortgage backed debt or put them in collateralized debt obligations or CDOs. This way the liability could be kept off the balance sheet of the bank and even become an asset. Mix the mortgage backed debt with some other types of debt and presto! , a new product was born to sell to hedge funds, insurance companies and investment trusts and bring in lots of dinero. The commission alone was enough for investment bankers to finance another Lambo or a house in Aspen. Some investment companies even came up with CDOs backed by other CDOs, inventively named CDO squared. A whole new industry in trading other peoples debt sprang up and all was well in the great scheme pyramid
Billy-Bob in the meantime had great problems coming up with the cash for his mortgage every month. When finally the day came he didn’t pay, the bank told him they had no choice, put him and his family on the street and put his house up for sale. The problem was that it wasn’t just Billy-Bob that had troubles. His neighbors could soon be found in the same shelter as well and soon thousands of houses were up for sale. During 2007, nearly 1.3 million U.S. housing properties were subject to foreclosure, up 79% from 2006
The problem with a great invention like the free market is that the price of everything is determined by the amount of things that are for sale versus the amount of people that want to buy those things. In the case of Billy-Bobs house, the amount of buyers was virtually zero. So the bankers began to worry because if no-one wanted Billy’s house for a decent price, the mortgage became worth a lot less then they had estimated before. In fact, the value of Billy-Bobs mortgage became virtually zero as well. The value of mortgage backed CDOs is as good as the value of the collateral behind it. Guess what? Suddenly the CDOs, Squared CDOs, quadrupled CDOs and so on were not so hot after all.
The whole structure, built like a domino row on top of a house of cards began to topple. Bear Stearns was the first to have to close down two hedge funds that primarily invested in sub prime, mortgage backed securities. On June 22, 2007, Bear Stearns pledged a collateralized loan of up to $3.2 billion to "bail out" one of its funds, while negotiating with other banks to loan money against collateral to it’s other fund, the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund. Merrill Lynch seized $850 million worth of the underlying collateral but only was able to auction $100 million of them. Millions of dollars evaporated overnight and Bear Stearns, who came to the funds rescue, finally had to foreclose the funds that once were worth billions.
In the meantime all was not so well anymore in the great scheme pyramid. Most US and a lot of European banks had invested heavily in the CDO pyramid scheme. Asian banks were a lot less exposed but since the global financial world isn’t defined by boundaries even they would be affected.
The blood of the world’s economies is pure cold cash. As long as this cash is liquid, can be spent like water, it can be used to make more cash. Companies lend money from banks, for instance to invest in new factories. Banks lend this money from other banks if they don’t have enough cash in their vaults. They can also lend money from the government but that’s bound by strict rules. When the sub-prime backed CDO pyramid started to collapse, the banks suddenly weren’t so eager to loan out money to each other or to businesses that wanted to expand. The banks’ credit portfolios, lists of expected revenue from businesses and other banks that owed money suddenly became a whole lot less valuable and a lot more risky. If Billy-Bob didn’t pay what about other companies, credit card holders and (shudder) car owners?
Like I said before, the price of everything in a free market is decided by the amount of sellers vs the amount of buyers. In this case the price of loaning money went up because the amount of eager sellers decreased dramatically vs the amount of eager buyers. The effect on the economy is still going on. Companies can’t expand because of lack of (cheap) funds. They’ll have to fire people who then don’t have money to buy stuff. Other companies can’t sell their stuff because there’s nobody with enough money to buy! Prices go down, profits slump and after a while depression sets in.
So far the only visible casualties have been Bear Stearns, Northern Rock and a few hedge funds. Dozens of banks world wide have suffered heavy losses but will survive. It’s now a matter of keeping trust. In my opinion, the world will look at Asia as the next leading economic powerhouse. It will be very interesting to see what the US government will do to make sure this won’t happen again. If I can make a small prediction, it will be something in the line of stricter regulatory rules, Basel III and tighter reigns for financial institutions. This may help in a small way but will be at best a remedy for the symptoms, not a cure for the disease. Prudent spending instead of unbridled consumerism would be a much better cure. If Americans can’t learn that a shopping spree is okay as long as you can pay in cash instead of pulling the plastic and that the extra value of your house shouldn’t be spent on a new big screen TV, the next bubble is already around the corner.
One of the great things about the US is that anyone can achieve their “American Dream”. Having your own house is considered a right, just like bearing your own arms. If you can’t pay for your property, no problem! The banks were always there to help you with the necessary cash at low interest, even if you weren’t sure you could pay the mortgage after Uncle Sam, Wal-Mart and Texaco had taken their cut. Millions of mortgages were sold to people who could barely pay their daily necessities, let alone an over the top mortgage. The banks weren’t too worried. Housing prices were always going up because ever one was buying. If Billy-Bob couldn’t pay anymore, he and his family could report to the nearest shelter, the bank would sell his property and still get their money, right?
Even the risk itself was a way for banks to make money. They could sell the mortgage backed debt or put them in collateralized debt obligations or CDOs. This way the liability could be kept off the balance sheet of the bank and even become an asset. Mix the mortgage backed debt with some other types of debt and presto! , a new product was born to sell to hedge funds, insurance companies and investment trusts and bring in lots of dinero. The commission alone was enough for investment bankers to finance another Lambo or a house in Aspen. Some investment companies even came up with CDOs backed by other CDOs, inventively named CDO squared. A whole new industry in trading other peoples debt sprang up and all was well in the great scheme pyramid
Billy-Bob in the meantime had great problems coming up with the cash for his mortgage every month. When finally the day came he didn’t pay, the bank told him they had no choice, put him and his family on the street and put his house up for sale. The problem was that it wasn’t just Billy-Bob that had troubles. His neighbors could soon be found in the same shelter as well and soon thousands of houses were up for sale. During 2007, nearly 1.3 million U.S. housing properties were subject to foreclosure, up 79% from 2006
The problem with a great invention like the free market is that the price of everything is determined by the amount of things that are for sale versus the amount of people that want to buy those things. In the case of Billy-Bobs house, the amount of buyers was virtually zero. So the bankers began to worry because if no-one wanted Billy’s house for a decent price, the mortgage became worth a lot less then they had estimated before. In fact, the value of Billy-Bobs mortgage became virtually zero as well. The value of mortgage backed CDOs is as good as the value of the collateral behind it. Guess what? Suddenly the CDOs, Squared CDOs, quadrupled CDOs and so on were not so hot after all.
The whole structure, built like a domino row on top of a house of cards began to topple. Bear Stearns was the first to have to close down two hedge funds that primarily invested in sub prime, mortgage backed securities. On June 22, 2007, Bear Stearns pledged a collateralized loan of up to $3.2 billion to "bail out" one of its funds, while negotiating with other banks to loan money against collateral to it’s other fund, the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund. Merrill Lynch seized $850 million worth of the underlying collateral but only was able to auction $100 million of them. Millions of dollars evaporated overnight and Bear Stearns, who came to the funds rescue, finally had to foreclose the funds that once were worth billions.
In the meantime all was not so well anymore in the great scheme pyramid. Most US and a lot of European banks had invested heavily in the CDO pyramid scheme. Asian banks were a lot less exposed but since the global financial world isn’t defined by boundaries even they would be affected.
The blood of the world’s economies is pure cold cash. As long as this cash is liquid, can be spent like water, it can be used to make more cash. Companies lend money from banks, for instance to invest in new factories. Banks lend this money from other banks if they don’t have enough cash in their vaults. They can also lend money from the government but that’s bound by strict rules. When the sub-prime backed CDO pyramid started to collapse, the banks suddenly weren’t so eager to loan out money to each other or to businesses that wanted to expand. The banks’ credit portfolios, lists of expected revenue from businesses and other banks that owed money suddenly became a whole lot less valuable and a lot more risky. If Billy-Bob didn’t pay what about other companies, credit card holders and (shudder) car owners?
Like I said before, the price of everything in a free market is decided by the amount of sellers vs the amount of buyers. In this case the price of loaning money went up because the amount of eager sellers decreased dramatically vs the amount of eager buyers. The effect on the economy is still going on. Companies can’t expand because of lack of (cheap) funds. They’ll have to fire people who then don’t have money to buy stuff. Other companies can’t sell their stuff because there’s nobody with enough money to buy! Prices go down, profits slump and after a while depression sets in.
So far the only visible casualties have been Bear Stearns, Northern Rock and a few hedge funds. Dozens of banks world wide have suffered heavy losses but will survive. It’s now a matter of keeping trust. In my opinion, the world will look at Asia as the next leading economic powerhouse. It will be very interesting to see what the US government will do to make sure this won’t happen again. If I can make a small prediction, it will be something in the line of stricter regulatory rules, Basel III and tighter reigns for financial institutions. This may help in a small way but will be at best a remedy for the symptoms, not a cure for the disease. Prudent spending instead of unbridled consumerism would be a much better cure. If Americans can’t learn that a shopping spree is okay as long as you can pay in cash instead of pulling the plastic and that the extra value of your house shouldn’t be spent on a new big screen TV, the next bubble is already around the corner.
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