I have a natural tendency to resist and distrust arguments that I feel are unsupported, uninformed, and motivated by some polarized ideology; we will be surrounded by these sorts of arguments in the weeks and months to come. The stock market crash today, and the failed bailout bill that fueled it will be remembered for a long time to come. While many hardworking people in Washington will no doubt work tirelessly over the next few days to find some common ground and a bipartisan agreement about what to do with our economy, others will recede into their respective corners and scream. The argument that no action is better than improper action is not a sound and logical one. I am not trying to say that I have decided once and for all the fate and state of the American economy as it exists today, and that I, the expert, have seen into the crystal ball and know what is in store for us if we simply filibuster our hearts out, but I will say that I can think of plenty of examples where some action (however misguided) is better than no action. No doubt we will all be masters of burning house analogies after a few more weeks of this financial crisis, but still I think they do have some value. What scares me is the deep menacing hatred that many Americans now brandish for the financial industry elites. Will the war on terror now be replaced by the war on Wall Street? Will we allow ourselves to again dig ourselves into a ditch that we cannot get out of, as it seems we have in Iraq, all because of hotheadedness?
I will admit that I am appalled at the excesses involved in the run up to our current financial crisis. However, I think there are few of us without financial blood on our hands. I don't like the image of a Wall Street Executive basking in the Carribean Sun under his golden parachute any more than you do, but I do believe that I should not allow that image to distract me from the task at hand. As Americans we are all now faced with the potential for one of the worst financial crises in recent history, and we need to separate that problem from our emotional reactions to the greed and lack of integrity that brought us here. If my local firefighter came by my house to ask for donations, and lit my house on fire as he walked away, I would be very angry. No doubt I would chastise him for the irony of his actions in regard to his duties as a fireman, and I would bring legal action against him and wish him ill especially if my family or property was significantly injured by the fire. However, before I go about retaliating I should probably put out the fire because...my house is burning down. Even if he runs away, never to return again, I would still want to put the fire out before chasing him down and exacting my revenge. And what if he has a change of heart and is willing to help me fight the fire before the truck gets there...should I tell him he's only allowed to help if I get to beat him with a bat while he's doing it?
This may seem obscure, but my point here is simple. I do not support a blank check for Paulson, but alsoi I do not suggest a congressional filibuster, or a demand for prohibitative executive paycuts, or any other stubborn stipulation that prevents a passing of some form of economic rescue package. I have tried to read extensively on this issue, and I don't believe anyone who understands the problem is suggesting that we have the option of "waiting it out" right now. I don't advocate scare tactics, and yet the potential for complete finaicial credit freeze scares the hell out of me. I have studied enough microeconomics to know that I have no clue what would happen if the credit blood of our finaicial system dried up, but that it would be much worse than the average American would like to believe. People need to stop framing this issue as an 'us against them' or a 'Wall Street vs Main Street' problem. This has become the financial and political test of our generation, and politicians and advisors alike need to act quickly and effectively to find a common solution. So for anyone out there obsessing over the sins of Wall Street...stop, just stop. This crisis is no longer contained to Wall Street, and we need to address it before it becomes a true crisis on main street.
Monday, September 29, 2008
Sunday, September 21, 2008
The Corner of Wall and Main
I apologize in advance if I ramble or am loose with language/logic here because this was written as a sort of 'midnight rant'.
This is certainly an interesting time to be an American with a basic understanding of math and psychology. Think of it this way...if you were an impoverished person, call him Freddie, trying to make your way in the vastness of suburbia, and you were out of work and out of luck, wouldn't you wake up every day and wish someone would cut you a break? Wouldn't you cling to every hope that you could pay the bills and keep a roof over your family's head for another month?
Now imagine that one day you went to a bank asking for some assistance, and they rolled out the red carpet, prepared the paperwork, and offered to lend you more money than you could even fathom with your house as collateral. It isn't surprising that most of us, placed in that situation, would sign on that dotted line before the ink even dried. I mean...a guy has to feed his kids right? Seems reasonable enough, and the bank must know what they are doing loaning you this money because it's what they do for a living...right?
So far it sounds to good to be true, which it is, but most people would judge this tale on its surface as a wretched and malicious banker preying on the needy and trying to lock them into some form of eternal wage-slavery. But now step out of those shoes and imagine that you are a mortgage broker.
There has been a lot of action and new growth in the industry in the last few years and it is all very exciting. Unlike in times immemorial, where banks would hold mortgages on houses themselves and directly manage them as income generating assets, your bank is now able to sell new mortgages up the line to investors and the golden gates of Wall Street. In fact, you can't seem to sell enough mortgages, and you keep looking for ways to increase your steady flow of new loans. You realize that your competitors are finding ways to get more mortgages than you and are stealing your investors away, so you decide to turn the knob a bit. You lower the minimum requirements for new loans, and you keep trying to come up with new ways to convince home owners to borrow. Unfortunately for you your competitors are doing the same thing. This race to the bottom continues until you find yourself issuing loans to your down-and-out friend Freddie, the one with no job and a family to feed. You can't really understand how you can manage to loan him money, let alone hundreds of thousands of dollars, when in the past you wouldn't have even given him a simple line of credit, but that doesn't really affect you much anymore because you sell his mortgage up the investor line as soon as the ink dries.
The loan you just gave to Freddie is a financial invention, something that never existed five or ten years ago. These loans are sometimes called NINJA Loans (or NINA loans, but that sounds way less hardcore) which stands for No Income No Job or Assets. Now if you are thinking that sounds like a stupid concept for a loan, you are right! In fact you never would have considered a contract for such a loan when you had to manage it yourself. Giving money to people who have no money to begin with and don't have any way to make more money seems like a bad business to be in. Lucky for you it isn't your problem anymore because you don't actually hold these loans, you sell them up the investment line (and those investors are way smarter than you anyway cuz they wear custom suits and drive around in BMWs and shit...sweet). Some days you could swear that the person signing the $300,000+ mortgage agreement was actually a hobo that you gave $2 for a bus ride last week, but you shake it off and cash your commission check.
Now imagine that you are a (formerly) high paid investment banker at some prestigious firm, oh let's say...Lehman Brothers, maybe Bear Sterns, and you work in these hot new markets: MBIs and CDOs, Mortgage Backed Securities and Collateralized Debt Obligations. Now you get to throw around fancy acronyms every day at work and it makes your fat paycheck seem justified (you feel like you're doing important work with all those charts and numbers and...stuff). Now you'll admit that you are pretty intelligent...you had to be to get where you are now, and you'd say you are good at your job. You sell investments, and these new ones that you are trading are the flavor of the month (or year(s)). These MBIs and CDOs are huge collections of loans given with homes as collateral (also known as mortgages). But these are not your typical personal mortgages, these loans have been collected, sorted, sliced, diced, and deep fried until they became financially unrecognizable. In fact, the only way you know how much these things are worth is because your computer has aggregated data on thousands of similar loans and combined the characteristics and credit ratings of all the slices into a complex set of graphs, data tables and predictions. You take the numbers in front of you and you use them to calulate expected values and arrange these products into investment portfolios which you then hold or sell to large financial istitutions like banks or hedge funds.
The problem is you want to buy as many of these MBSs and CDOs as you can get, because they are selling like hotcakes and you really want that bonus check next month so you can pay for that third garage on your 2nd house in the Hamptons (which you just paid for with a $2,000,000 dollar mortgage that is sorted, sliced, diced, and deep fried on some other investor's desk right now). Luckily because of the changes in regulation you no longer have to hold 1/15th of the value of all your investments in liquid cash...I mean why do you even NEEDS liquid cash anymore? Electronic transactions are so much faster and waaaay more ninja. So you get to invest twice as much money for each dollar in the vault, but you do understand that there is some (vague) risk involved, you did go to business school after all and I think there were some math classes at some point... you don't remember it all kind of faded away after you hit the beer bong. Anyways investments apparently all involve some level of risk, which your boss says is bad, so you decide to throw some money at that risk. You want the constant income stream of these packaged loans so you can give your investors a good return and get your wife those new implants, but you want to assure that your firm still gets the money even if some of the debtors don't make payments.
So what do you do? You do what every god fearing American does when they want to have their cake and eat it too, you buy insurance. But you need LOTS of insurance because you own these complex collateralized bundles of mortgages, so your firm makes billion dollar contracts with enormous insurance agencies like AIG. Now it starts to get hazy, maybe it's because you are drinking Single Barrel Wisky out of a crystal glass with ice made from dolphin tears, or maybe your still kind of messed up from that trip to Cabo last week, but it seems like AIG and the other companies that sell you insurance for these MBSs are gonna have the same problem as you do...hey don't want to have risk or liquidity. Lucky for them they can do what every god fearing American does when...oh dear we've heard this before haven't we?
Ok so every one sells everyone else insurance and this income stream paid for by the investments which are backed by the millions of loans that are sold to investors by millions of banks that hold millions of houses as collateral, seems safe enough right? I mean historically mortgages have been pretty solid investments, and even when someone happens to be a deadbeat and they default you can always sell the house and get your investment back...works like a charm! But wait...it seems like, historically, people that qualify for these NINJA loans would never have been given mortgages in the first place, or even credit cards for that matter, so why is it we think of the value and risk of these mortgages in historical terms? Well because those are the numbers that we have stored on our computers...and without value data it is waaaay to complex to collect and process all the real time data about these loans into a coherent system. Plus it's not our job to manage these mortgages, our investors just want their money to grow...numbers go up.
Problem now is Freddy has exhausted his new found resources. He bought some groceries, circled jobs in the wanted section, and drove around town trying to find a new way to bring home the bacon, but he came back empty handed. He's stuck in a house he can't afford with a dwindling savings account filled with the money that his banker friend lent him and the monthly payments are so high that he won't be able to buy food next month, so he stops making payments. Problem is Freddie isn't alone, his sister Fannie can't pay her for her new mortgage either, and all their cousins have been defaulting over the last few months. Now the bank has to go around and auction off their houses to recoup the initial investment capitol, which will then be distributed up the line until it is given to the investment holders (god knows what they will do with it since they hate liquid assets anyway...). But since all these houses are going into forclosure at once the market is beginning to sag, there are more people trying to sell houses then there are buyers, so prices begin to drop. This downward spiral continues as more people stop making payments on houses they can no longer afford as they realize that the house is so devalued that it isn't worth the monthly nut anymore. This cycle continues, and meanwhile the bank is stuck with 1000s of houses it can't seem to sell, and the investment holders start wondering where their monthly payments are. They see that their income stream is short so they call on their insurers to make up the difference.
This information has a ripple effect and now because of the panic these financial giants are all unsure about the value of their invetsments. These MBSs and CDOs were not labelled 'good' and 'bad' but some shade of grey inbetween. There is no good way to tell which ones are healthy and which ones are essentially worthless, so the credit rating agencies have to take the companies down a notch. Problem is, the lower your credit rating, the more liquid assets you have to hold for each dollar you invest. The companes can't fork over the dough, so they all begin to fall like dominoes...
And that kids is why for every dollar you earn in your life you will only see 25 cents (I will say to my grandchildren as our contry continues to pay off the debt that we buried ourselves under in order to prevent the fallout from these "financial weapons of mass destruction")
more on that later...
This is certainly an interesting time to be an American with a basic understanding of math and psychology. Think of it this way...if you were an impoverished person, call him Freddie, trying to make your way in the vastness of suburbia, and you were out of work and out of luck, wouldn't you wake up every day and wish someone would cut you a break? Wouldn't you cling to every hope that you could pay the bills and keep a roof over your family's head for another month?
Now imagine that one day you went to a bank asking for some assistance, and they rolled out the red carpet, prepared the paperwork, and offered to lend you more money than you could even fathom with your house as collateral. It isn't surprising that most of us, placed in that situation, would sign on that dotted line before the ink even dried. I mean...a guy has to feed his kids right? Seems reasonable enough, and the bank must know what they are doing loaning you this money because it's what they do for a living...right?
So far it sounds to good to be true, which it is, but most people would judge this tale on its surface as a wretched and malicious banker preying on the needy and trying to lock them into some form of eternal wage-slavery. But now step out of those shoes and imagine that you are a mortgage broker.
There has been a lot of action and new growth in the industry in the last few years and it is all very exciting. Unlike in times immemorial, where banks would hold mortgages on houses themselves and directly manage them as income generating assets, your bank is now able to sell new mortgages up the line to investors and the golden gates of Wall Street. In fact, you can't seem to sell enough mortgages, and you keep looking for ways to increase your steady flow of new loans. You realize that your competitors are finding ways to get more mortgages than you and are stealing your investors away, so you decide to turn the knob a bit. You lower the minimum requirements for new loans, and you keep trying to come up with new ways to convince home owners to borrow. Unfortunately for you your competitors are doing the same thing. This race to the bottom continues until you find yourself issuing loans to your down-and-out friend Freddie, the one with no job and a family to feed. You can't really understand how you can manage to loan him money, let alone hundreds of thousands of dollars, when in the past you wouldn't have even given him a simple line of credit, but that doesn't really affect you much anymore because you sell his mortgage up the investor line as soon as the ink dries.
The loan you just gave to Freddie is a financial invention, something that never existed five or ten years ago. These loans are sometimes called NINJA Loans (or NINA loans, but that sounds way less hardcore) which stands for No Income No Job or Assets. Now if you are thinking that sounds like a stupid concept for a loan, you are right! In fact you never would have considered a contract for such a loan when you had to manage it yourself. Giving money to people who have no money to begin with and don't have any way to make more money seems like a bad business to be in. Lucky for you it isn't your problem anymore because you don't actually hold these loans, you sell them up the investment line (and those investors are way smarter than you anyway cuz they wear custom suits and drive around in BMWs and shit...sweet). Some days you could swear that the person signing the $300,000+ mortgage agreement was actually a hobo that you gave $2 for a bus ride last week, but you shake it off and cash your commission check.
Now imagine that you are a (formerly) high paid investment banker at some prestigious firm, oh let's say...Lehman Brothers, maybe Bear Sterns, and you work in these hot new markets: MBIs and CDOs, Mortgage Backed Securities and Collateralized Debt Obligations. Now you get to throw around fancy acronyms every day at work and it makes your fat paycheck seem justified (you feel like you're doing important work with all those charts and numbers and...stuff). Now you'll admit that you are pretty intelligent...you had to be to get where you are now, and you'd say you are good at your job. You sell investments, and these new ones that you are trading are the flavor of the month (or year(s)). These MBIs and CDOs are huge collections of loans given with homes as collateral (also known as mortgages). But these are not your typical personal mortgages, these loans have been collected, sorted, sliced, diced, and deep fried until they became financially unrecognizable. In fact, the only way you know how much these things are worth is because your computer has aggregated data on thousands of similar loans and combined the characteristics and credit ratings of all the slices into a complex set of graphs, data tables and predictions. You take the numbers in front of you and you use them to calulate expected values and arrange these products into investment portfolios which you then hold or sell to large financial istitutions like banks or hedge funds.
The problem is you want to buy as many of these MBSs and CDOs as you can get, because they are selling like hotcakes and you really want that bonus check next month so you can pay for that third garage on your 2nd house in the Hamptons (which you just paid for with a $2,000,000 dollar mortgage that is sorted, sliced, diced, and deep fried on some other investor's desk right now). Luckily because of the changes in regulation you no longer have to hold 1/15th of the value of all your investments in liquid cash...I mean why do you even NEEDS liquid cash anymore? Electronic transactions are so much faster and waaaay more ninja. So you get to invest twice as much money for each dollar in the vault, but you do understand that there is some (vague) risk involved, you did go to business school after all and I think there were some math classes at some point... you don't remember it all kind of faded away after you hit the beer bong. Anyways investments apparently all involve some level of risk, which your boss says is bad, so you decide to throw some money at that risk. You want the constant income stream of these packaged loans so you can give your investors a good return and get your wife those new implants, but you want to assure that your firm still gets the money even if some of the debtors don't make payments.
So what do you do? You do what every god fearing American does when they want to have their cake and eat it too, you buy insurance. But you need LOTS of insurance because you own these complex collateralized bundles of mortgages, so your firm makes billion dollar contracts with enormous insurance agencies like AIG. Now it starts to get hazy, maybe it's because you are drinking Single Barrel Wisky out of a crystal glass with ice made from dolphin tears, or maybe your still kind of messed up from that trip to Cabo last week, but it seems like AIG and the other companies that sell you insurance for these MBSs are gonna have the same problem as you do...hey don't want to have risk or liquidity. Lucky for them they can do what every god fearing American does when...oh dear we've heard this before haven't we?
Ok so every one sells everyone else insurance and this income stream paid for by the investments which are backed by the millions of loans that are sold to investors by millions of banks that hold millions of houses as collateral, seems safe enough right? I mean historically mortgages have been pretty solid investments, and even when someone happens to be a deadbeat and they default you can always sell the house and get your investment back...works like a charm! But wait...it seems like, historically, people that qualify for these NINJA loans would never have been given mortgages in the first place, or even credit cards for that matter, so why is it we think of the value and risk of these mortgages in historical terms? Well because those are the numbers that we have stored on our computers...and without value data it is waaaay to complex to collect and process all the real time data about these loans into a coherent system. Plus it's not our job to manage these mortgages, our investors just want their money to grow...numbers go up.
Problem now is Freddy has exhausted his new found resources. He bought some groceries, circled jobs in the wanted section, and drove around town trying to find a new way to bring home the bacon, but he came back empty handed. He's stuck in a house he can't afford with a dwindling savings account filled with the money that his banker friend lent him and the monthly payments are so high that he won't be able to buy food next month, so he stops making payments. Problem is Freddie isn't alone, his sister Fannie can't pay her for her new mortgage either, and all their cousins have been defaulting over the last few months. Now the bank has to go around and auction off their houses to recoup the initial investment capitol, which will then be distributed up the line until it is given to the investment holders (god knows what they will do with it since they hate liquid assets anyway...). But since all these houses are going into forclosure at once the market is beginning to sag, there are more people trying to sell houses then there are buyers, so prices begin to drop. This downward spiral continues as more people stop making payments on houses they can no longer afford as they realize that the house is so devalued that it isn't worth the monthly nut anymore. This cycle continues, and meanwhile the bank is stuck with 1000s of houses it can't seem to sell, and the investment holders start wondering where their monthly payments are. They see that their income stream is short so they call on their insurers to make up the difference.
This information has a ripple effect and now because of the panic these financial giants are all unsure about the value of their invetsments. These MBSs and CDOs were not labelled 'good' and 'bad' but some shade of grey inbetween. There is no good way to tell which ones are healthy and which ones are essentially worthless, so the credit rating agencies have to take the companies down a notch. Problem is, the lower your credit rating, the more liquid assets you have to hold for each dollar you invest. The companes can't fork over the dough, so they all begin to fall like dominoes...
And that kids is why for every dollar you earn in your life you will only see 25 cents (I will say to my grandchildren as our contry continues to pay off the debt that we buried ourselves under in order to prevent the fallout from these "financial weapons of mass destruction")
more on that later...
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