Totally non-biking Q - about the economy!

[Eden]

So I'm hoping that some financial type (Mr. Silver?) can explain something to me....

So I understand the basics of why big investment banks are going down.... the sub-prime loan debacle, people repackaging and selling loans that were bad investments, etc. But my question is who got rich here???

Money can't just disappear so I'm wondering exactly where did it all go. Someone had to have made out in this whole scheme, but I'm having a hard time fathoming exactly who it was. The banks and investment firms are having problems, the homeowners certainly aren't coming out of this well off, homebuilders are not getting rich are they?? So who is it - who is at the top of this pyramid anyway?

[redrhodie]

I'm no expert-- but I sold my house at top price in 2006, which was right before housing prices began receding. I guess it's people like me, who bought low and sold high (I'm still not rich, though , it was a tiny house). I wasn't trying to play the market, just chance made me need to move right then. Jeez, I feel a little guilty, but it was pure luck.

I'm sure anyone in real estate (realtors, loan brokers, appraisers, lawyers) who got paid at the time of the transaction also made money.

[Eden]

That was one theory that my husband and I came up with - but it just seems like there couldn't possibly be enough of the little people making a bit of money to put a bunch huge investment banks in serious financial trouble could there? Maybe there could be.

Maybe I'm just expecting that some of the scammers have to have run away with the loot.... but I know that many of the middle men who were packaging the bad loans and reselling them were so leveraged themselves that even though they were making money hand over fist for a while, even they lost their shirts when the whole bubble collapsed. Maybe some were smart enough to get out before it happened.

I suppose I've been imagining is some unnoticed shadowy figure in the background counting the cash they made off of this whole mess and chuckling at the state that these big companies managed to get themselves into because they didn't do their homework....

Of course I was joking around and said to my husband that our government probably engineered the whole thing to get China to invest all their money and then crashed it all on purpose to bring the Chinese economy down.... I was totally joking, but he said that someone has already put forward that conspiracy theory.......

[Veronica]

The money was never really there.

The short answer is that the cost of borrowing money is supposed to be based on risk. If you are a low risk you pay less than somebody who is a high risk. As the value of mortgages moved through the financial system (see below), the risk was not being priced correctly. This means that investors at the far end of the process had not paid enough to cover the chance that their investments might go bad. Those investments are now going bad and investors now have to back fill their payments. They don't have enough reserves to do that and it is crushing some of them. Add to that the banks are looking at their reserves and getting worried, so they are not lending money cheaply anymore. This means that any company that lives on borrowed money (like an insurance company or poorly run investment firm) is at risk.

It started with the housing loans that people really couldn't afford. The loans get put into a pool bought by investment companies who issue bonds. The bonds would be paid back from the value of the pool of mortgages. The bonds get insured based on their risk rating. Some (many?) pools of these loans was rated by rating agencies as being good, but they were garbage. Since people were buying homes with no money down there was no reserve value in the house. The loans start to go bad. The overall value of the pool drops. Bond issuers need to pony up more money to insure the bonds. Money they do not have.

So, who owns these bonds? Banks, insurance companies, investment firms. All sorts of people indirectly. And that is why this is so bad.

NPR and This American Life did a great job of explaining it in their report A Giant Pool of Money. You can listen to the report at that link.

[gnat23]

NPR and This American Life did a great job of explaining it in their report A Giant Pool of Money. You can listen to the report at that link.

Seconded on this program. I caught it randomly on the radio on my way to the grocery store, and I just sat in the parking lot so I could listen to the rest of it. It's a great primer on how we got to where we are now.

-- gnat! (tho, not so much advice about how to how to get *out*)

[maillotpois]

Good answer, V. I doubt my economic book publisher father in law could have put it any more clearly.

[redrhodie]

I'm totally out of my realm here...but I'm sure you're right. There are shadowy figures who made billions. The CEOs of Fanny and Freddie are walking away with a lot of loot. Nice!

Homeowners like me, who managed to not lose our shirts, are probably inconsequential compared to the big guys.

[jobob]

Thanks Veronica!

[Bruno28]

I think this explains it pretty well.


http://www.youtube.com/watch?v=TD5JTPhBhJw

[Dogmama]

I heard some politicians blaming the banks for issuing home loans to people who could not afford them. Baloney. People need to be responsible for their own financial situation. Banks didn't force people into these houses.

Gawd, I sound like my parents!

I'm completely sympathetic to people who are having problems through no fault of their own. But, I see many people who couldn't afford the house, the SUV, the boat, etc., crying the blues. Just because the credit card company will lend you $10,000 doesn't mean you have to spend it. But many people do. (shaking head like dog getting water out of ears...)

[crazycanuck]

DM, I have to disagree. Banks will lend you the $$ no matter what. I blame the banks & folks who live beyond thier means.

An example, when we wanted to our bank would lend us $$$$$$$$$ & we thought.. No freakin way, what would the re payments be like if interest rates went ...

[Dogmama]

CC - I think we actually agree. Except I don't blame the banks - they're out to make money. People need to be responsible consumers.

My Visa has a $27,000 limit. No way would I charge that amount. I'd be paying on it for years. The goods I bought would be gone & I'd still be making payments. Bah!

BUT, if not Visa, Mastercard, AMEX, etc. would lend that same amount.

[bmccasland]

I think it's a bit of both. Some folks a gullible, then there's the "must have new toys" mindset. There's a hard sell for stuff, help to buy new homes, etc. We're now a few generations away from those that were adults during the Depression, and I think those lessons are mostly forgotten. I could be wrong, but most stores would much rather you buy on credit than use lay-away.

I remember buying a house in the 90's and being pushed to get a "3,2,1 buy down" type loan. What stuck in my mind was that I'd owe more money at the end of 3 years than on day 1. I thought that was pretty stupid, and got a conventional loan. Did that stop the sales rep for the development, NOOOO.
"You'll be able to furnish your new house, decorate... Have it all now, don't wait! Refinance in 3 years!"
No thank you, I'll be conservative now, and not hate you in 3 years.

I could hear my Grandmother saying "make do or do without" "waste not, want not"