Back in the 80's, I bought a used Firebird. It was a beautiful car, I got allot of compliments. I bought it from a licensed chevy/pontiac dealer who had been in business for decades and was well respected in our town. The dealership had its own garage filled with certified mechanics. The car came with a sticker that said it had been throughly inspected for quality and passed all the tests. Now, I don't know much about cars, I have to rely on those people who are certified that they know about cars to tell me if what I'm buying is a good one or a bad one.
A month after I bought my sweet ride, the engine stopped. An electronic module blew up inside, and the engine had to be replaced. A month after that, the same thing happened to the transmission. A month after that, the brake system master cylinder crapped out. Even though the car lot paid for half the repairs (on my insistance and threats of legal action), it still cost me an additional $3000 to keep my shiny new ride on the road.
Now, I don't know if that sales lot just had a bunch of inept mechanics that did the once over, or that they knew they were selling me a lemon. All I know is that I went to a reputable place with all the right papers and certifications, and what I got was a shiny exterior around a piece of crap.
I told that story to tell you this one :-D
I've heard people blame the housing market for the economic meltdown we're in the grip of right now. While that market did play its part, it was not actually the culpret. Let me explain.
You see, the government had this plan to get people with not so good credit into their own houses, so they set up loans through the government housing loan agencies. This caused the housing market to start to rise which caused housing prices to start to rise. Other banks saw an increase in the real estate market and began to make their own loans to people with poor credit. As a side note, some of them were loaning money to people who had already demonstrated that they had a poor understanding of financial matters to buy houses that were far too expensive with little or no down payment and very small monthly payments. For the first 3 to 5 years. What they hid from these borrowers was that after this 3 to 5 years, their payments would tripple or more. This is called predatory lending. You see, those banks had this brilliant idea that since the housing market was so strong, they could make these loans, get a few years of payments (and commissions), forclose when the balloon payments hit, take as much as they could from the borrowers at bankruptcy, and sell the house again. It was their way of 'flipping a house'. They made money hand over fist.
Enter the major financial institutions. These were not banks, they were investment firms which had recently been deregulated to be able to carry mortgages and bundle them in with low risk investments in what's called a derivative. These firms were also commissioned to rate these derivitives. So, these firms bought these high risk mortgages, packaged them in with other low risk investments, stamped a AAA rating (saying it's the best low risk investment), and sold them to people all over the world. They made money hand over fist.
People all over the world invested in these derivitives because they were from well respected American financial institutions who had been in business for decades that certified these derivitives as being a great deal. And hey, these financial institutions had been labled by Wall Street and others as 'too big to fail' (can you say 'titanic'?), so they gotta be good, right? The financial firms said yeah, let's sell them all over the world, and it'll share the risk, if a few of them fail, it won't cause a major problem in any large sector.
So along goes the world economy, fat dumb and happy, making money hand over fist. And then, something strange started to happen. But I'll get to that in a minute.
Enter the oil futures speculators. They start buying up oil futures contracts like they were oxygen tanks in a sinking submarine. The price of oil skyrockets. The price of gas skyrockets. Since almost everything, including food, airlines, mail, shoes, nintendo's and nail polish rely on gas to be transported, those prices started to skyrocket. Suddenly, that family that took the $300,000 mortgage for $500 a month couldn't even make that payment anymore. The families that took the $120,000 mortgage for $1200 a month couldn't either. They needed electricity or their kids would be taken away by CPS. They needed food. They needed gas for their car to get to work. But all these things cost twice what they did when they took out the mortgage, and their salaries had stayed the same. Funny how investment firms, stock brokers, oil companies and futures speculators were making money hand over fist, but John Q Public hadn't had a raise in 3 years, isn't it?
Now, here's the strange part. Back in '07, a really odd thing started to happen. Insurance companies started going bankrupt. And it wasn't just one or two, it was a slide up the chain, and the largest ones were starting to look shaky. Why was this happening? Remember the financial firms that packaged all those high risk mortgages in AAA derivatives? Well, they went to the insurance companies and said hey, we want to take out policies on our derivatives. The insurance companies looked at the large, well respected, decades old firms who had the certifications and said hey, if you wanna throw money at us, who are we to argue?
When prices started to rise, those mortgages, which were the foundation of the derivatives, began to fail. Since the housing market was beginning to fail, the financial institutions couldn't flip those houses (which were quickly losing their value), so they began to collect on the insurance. It became such a stampede that the insurance companies went bankrupt. With no insurance pool to draw on, the financials had to start dipping into their own reserves. But since they were unregulated, they didn't have to have deposits with the FDIC that matched the money from their investors the way the banks that make the mortgage loans have to have for their depositors. So very quickly, their own wells ran dry. Soon, these major american cornerstone financial institutions ran out of money, because they were backing derivatives that were worth a third of face value or less, due to the overwhelming default of the high risk mortgages they'd packaged in them and stamped a AAA on. They had no more money to lend, couldn't pay off their debts or dividends, and were facing bankruptcy themselves.
That's where TARP began. Because investment firms all over the world had invested in these 'toxic assets', and now the assets that they showed on their books were worth only a third of what they were a year before, they started going under too. Remember the 'shared risk' idea? And since the government is the one that certifies the institutions that are allowed to use the AAA stamp, they needed to do something fast or all the major financial institutions in America would collapse, distroying our economy, taking the economies of those other countries with us, and distroying the government's credibility on the world market.
And guess what? The financial firms that caused this fiasco knew they were holding toxic assets, that's why they took out insurance on AAA rated investments.
This is a case of blatent fraud, of a ponzi scheme the size of which hasn't been seen since the 1920's, of irresponsibility in so many facets of the market, where John Q public has no way to understand its workings and can only rely on the government's backing of the institutions certified that they know what the hell they're doing. People all over the country and all over the world had bought a shiny pontiac firebird that looked great on the outside, got compliments from everyone, and was a piece of shit under the hood. And Lehman brothers, AIG, CITIGROUP, and the rest of them, knew it.
Now, I didn't use allot of names of government bills, or financial institutions, etc. to fill out this story, those are all over the web if you want to know who the individual players are. But that wasn't my purpose here. I also didn't add in the credit markets who had their own hand in predatory lending and incredible rate hikes with no notice, which is another branch of our economy that's frozen and causing us grief. I didn't talk about credit swaps, or a couple other less important factors. Feel free to add any in yourself.
My purpose here was to show where this 'crisis' really came from, the major financial institutions, how they got themselves and the rest of us in such a mess, and why the government, after taking the brakes off that had been put there specifically to keep this sort of thing from happening, got involved in such a big way.
Hope you enjoyed my little essay on why the 'free market' system doesn't work, and that you understand a little better what's happened to our world's economy in the past 2 years.
As always, if you let the wolves guard the hen house, you'll end up with no chickens.
