I was just wondering if somebody could really explain things for the layman on the "financial crisis" at hand. I have some hypotheses on what's going on, but am generally lost on the whole idea. I'll see if I can hit main question points that are on the top of my head:

1. Why did WaMu, a relatively large bank, go under whereas other smaller banks are still somehow afloat?
2. How is this bailout supposed to help, especially if all it does is add to national debt?
3. Why are Wells Fargo and Citigroup fighting over Wachovia when Wachovia is crumbling? Is the "bailout" supposed to make them money by acquiring Wachovia, and if so, why can't Wachovia be salvaged with the bailout?
4. I heard the bailout means a bank can write off its riskiest mortgages...if a mortgage is written off, who does the lender end up paying or can the property be sold on the cheap?
5. Federal gov't is now a mortgage lender after taking over Freddie and Fannie. Will those mortgages be sold to other lenders, or will the gov't overlook them....if so, do those mortgages get better rates since it's the gov't (and adjustable rate mortgages are linked to the prime)?

I like to think of myself as somewhat educated, but when it comes to $$$, I'm not the brightest. I hope those are good questions that somebody can sorta answer. I have tried sifting through some news articles, but I usually get overwhelmed.

here's my take on the first three....and mostly from what i've read on cnn or wherever

1) Banks had differing levels of exposure to the bad debt. So those with the most risk who didn't have enough cash flow to cover basically went under.

2) It keeps the money flowing between these big financial companies. If nothing is done a lot of business transactions requiring lending grind to a halt.

3) The remnants of these banks are still worth a lot. They stand to benefit a lot down the road. Lot of great assets end up getting swallowed up at bargain rates. There's just not enough big players left anymore with the cash to take on these companies (or even willing to risk the cash).

OK, I will give it a shot. BTW, I was watching a special on Fox News last night that did a good job of explaining the whole mess from the very beginning. If you somehow find that, it would be worth it. Anyway, here it goes with a simplified example.

It's all about the balance sheets of banks. Banks' assets are the loans they make to borrowers and their liabilities are their deposits from savers. To be solvent and have owner equity, the current value of assets have to be greater than the liabilities. Banks created a lot of assets, and a lot of revenue, by making real estate loans to people that, as is now becoming painfully clear, they shouldn't have. Subprime, Alt-A, No Doc, et al are all flavors of mortgage loan that were made to people with less than good credit. They were able to do this because they could use the mortgage backed securities market to recycle their cash so they could make more loans. Quick example, I open up the First Bank of Goosifer and convince 100 people to deposit $1,000 each into savings accounts or buy CDs. So that's $100,000 total. I put $2,000 aside as a safety cushion called bank reserves, and take the other $98,000 and get to work lending it out under the BoG private home mortgage program. I quickly make $98,000 worth of mortgage loans, making about $1,000 in fees. I turn around and with the help of my local investment banker, turn the loans into mortgage backed securities and sell these MBS to investors. They sell like hot cakes. Investors pay me $100,000 for my $98,000 of MBS, a nice 2%+ profit. The investment bank makes a nice fee, too. I now have $103,000 of cash on my balance sheet, including $2,000 of bank reserves and $3,000 of equity. Now rinse and repeat, go out and make new loans, turn them into MBS, and sell the MBS. Do this over and over. The problem is, the loans were crap and started going bad. The borrowers stopped paying. Soon investors stopped buying MBS, many of which BTW were rated AAA by rating agencies. I have a fresh batch of loans ready to be securitized and freshly made MBS, but no one wants to buy MBS anymore so I am stuck with them. All my cash is tied up, so I can't make new loans. Then the mortgages on my balance sheet and in the MBS on my balance sheet, my assets, start to go bad, too. I start suffering losses. Other loans should be marked down, but I don't know or want to know how much to mark them down. Cash gets tight, so I try to borrow money from other banks, offering my loans and brand new MBS as collateral. No one wants to lend against my crap loans and MBS because they have plenty of their own crap loans and MBS to worry about, and worry that my crap stinks even worse than theirs. So the fed steps in and offers to temporary "swap" my crap MBS for some shiny new treasury bonds. Banks can then use the treasuries as good collateral to borrow against and get some cash. Demand, as you can imagine, is overwhelming. But the swap program is only temporary and not nearly enough, and the craps continue to stink more. So much so that my savers start to smell it when they come in to make a deposit and withdrawal, and decide to pull their savings accounts and take their money elsewhere, a bank run. This is bad because the only cash I have is the $2,000 or so of bank reserves. I quickly run out cash, and call the FDIC to come in and either take over and liquidate me, or broker a shotgun marriage or fire sale of the BoG to another bank. Hello WaMu and Wachovia.

OK. Now lets take a look at WillyNilly's specific questions.

1. They were much more aggressive in how many loans they made and their lending standards. Pick a payment loans, option ARMS, etc. are very stupid loans to make. They had the scenario above happen to them.

2. The bailout plan, in a nutshell, is the permanent super-sized version of the Federal Reserve's temporary swap program. The Treasury will go out and BUY the crap MBS (and loans, too, I believe) that are on banks (ever wonder why Goldman Sachs decided to convert to a bank from an investment bank?) balance sheets. It's like a giant enema for the financial industry, flushing $700 billion of crap MBS out of the financial system and replacing it with cash. The bailout will give the banks fresh cash to play with. The expectation is that they will use to cash to go out and make new loans and we will all live happily ever after.

The problem is that if the banks sell the MBS to the treasury at a "market" price, they will be forced to realize losses on them, and the suspicion is that banks have not fully marked down their MBS positions because if and when they do, they will realize that they are insolvent, their liabilities are greater than their assets, even though their assets have been converted back to cash.

The big question is, how much will the Treasury pay for the crap? What is it currently worth? No one really knows the true worth of the MBS because the market for them is completely shot, distressed sales only, and no one knows how bad the loan defaults and losses will be. If the Treasury pays more than they should, then the Treasury will end up suffering losses on their $700 billion pool of crap. If they overpay, then the Treasury, and the taxpayer, ends up eating the loss instead of the banks, a nice public sector to private sector transfer of wealth.a

3. Wachovia is valuable because it has a large depositor base in an area where Wells and Citibank does not. Citibank has (had?) a sweet deal on Wachovia as the FDIC was going to eat the losses on Wachovia crap assets above a certain amount. Wells is offering to pay a lot more with no FDIC loss backstop. Wachovia is insolvent and short on cash, and can't survive on its own. It, like many banks, need an infusion of new cash equity to salvage the business value that remains.

4. The banks can writeoff bad MBS and loans anytime they want. All that means is that the recognize the loss, something they are loathe to do. The bailout will give banks a chance to sell crap MBS, maybe even at a profit relative to what they have the crap MBS marked at/down to on their books. Even if a loan is marked down to $0, the bank still has an incentive to maximize the recovery on the REO property. Now if they are desperate for cash, they might be willing to sell the property at a "deal" relative to the current "market" value of the property. Problem is, home prices are in a freefall right now in most places (AMS can talk about this in detail.)

5. For the loans and MBS that exist on Fannie and Freddie's balance sheets, the government already implicitly, and now explicitly, guarantees principal loss risk. To the extent they can find a buyer, they will continue to sell their MBS to recycle their cash, just like in the example above. They will turn all of the mortgages into MBS, not try to sell them as whole loans to other banks. As far as making new loans, the government wants to maintain normalcy and liquidity in the home markets, so Fannie and Freddie will continue to make loans at favorable rates, but probably at higher credit standards than what they had been doing.

http://www.youtube.com/watch?v=_MGT_cSi7Rs



http://video.google.com/videosearch?q=Burn...emb=0&aq=f#

I wish I had time to respond to this whole post...not right now, unfortunately! But the main one..




Different rules. In 2004, the SEC made changes to the rules (Paulson, as head of Goldman Sachs in 2000, had previously testified in favor of the change) allowing investment banks worth over a certain amount (I want to say $5 billion) to opt out of the old requirements, which limited them to borrowing 12 times their capital. All 5 eligible banks did so, and were now able to leverage themselves as much as 40 to 1.

This is why it's the 5 largest investment banks that have been in the news lately - they're the ones that no longer had sufficient regulation to keep them from getting into trouble.

Um, no. WaMu was a standard commercial bank.

These guys bought crap assets (read, mortgages that were 6x+ borrower's actual income) that they later couldn't resell, when people realized they were crap. The basic difference between this bubble and previous bubbles is the sheer amount of leverage that was used by institutions gambling. The banks that did not gamble with crap assets are, for the most part, still strong (BoA, Wells). Crap assets came due, banks had to mark-to-market, which was far, far, far below par, and everything collapsed because some banks did not have enough capital to meet obligations, investors got scared and stopped lending to them.

The biggest difference between this bubble and previous bubbles is that previous bubbles were largely financed by Main Street's cash, and individuals lost their own money. Here, the banks had so much of this crap on their books when the sh!t hit the fan that it caused a domino effect.

If you want a fall guy for this whole thing, look no further than Mr. Spitzer. When he destroyed the incentives for Wall Street to have a bevy of high-priced analysts, he also took out the research desks that would have caught this bubble before it effectively destroyed the financial system. Research desks are charged with, mainly, making sure that everything the bank does is kosher for the bank. With the research teams that Spitzer destroyed in '01 and '02 I doubt Lehman or BSC would have levered the amount of crap they did.

Thanks for the replies, esp goosifer's concrete example. It does shed more light into what's going on.

Oops, my bad - was in a hurry and didn't read the bank name carefully, thought he was talking about the investment banks. Thanks for the catch.

OK, here is a Google Presentation Slide Show on how we got into this mess - not safe for office due to language, but it is an accurate explanation of what transpired.

too funny

i actually wished it kept going

I about fell out of my chair reading that.

Would be even funnier if I hadn't lost thousands of dollars last week!

Boy, that sure really made things simple.

"They %##'d up" :D

Glad to have made things crystal clear. Unfortunately, all kidding aside, this is a pretty accurate representation of what really occurred. Sad but true......

Love it

very informative thread..

fyi..dow below 10,000 first time since 2004

WAMU actually went under because of the panic. WAMU customers withdrew $1.9 billion cash in one day. Because everyone was withdrawing all this money, the company didn't have any money to run their daily operations.

tolik, please explain about these analysts. Are they gov't employees?

no, these were the guys making $120k start out of UG, $250-300k average out of b-school / at associate level at the i-banks, standard IB path (remember, the ibank has always been broken up into sales, trading, and research). they had a "cozy relationship" with the equities they covered (e.g. they got free crap for giving good reviews, and the banks got business from the companies the analysts covered). Spitzer put a stop to this, thinking it would be good for most investors.

But the research analysts second job was making sure their own banks were safe. When the research desk became too expensive, the research teams were largely destroyed (it no longer made sense to keep these guys on the books at the same price as traders and salespeople). and what resulted was that there were only a few individuals in the banks, rather than an entire group, screaming FIRE. Result is much worse than whatever negative effects general investors may have felt from "relationship" between banks and companies their research analysts covered.

It may end up below 9000 by tomorrow.

wow..I can relate my entire portfolio to your previous thread on the horton/ cvs stocks....

This American Life - The Giant Pool of Money

Really nice tutorial on the mortgage crisis and its affect on the economy.

I don't really have any feeling either way about Spitzer, but it seems to me blaming Spitzer is a red herring. This is a lot bigger than just a rule change that Spitzer implemented.

I agree, but that was the straw that broke the camel's back.

My understanding that some of the biggest investment pools receives their money from union employees that are indirectly working for the taxpayers. Overall, were these funds managed wisely or is it SOL for teachers and state workers? Arnolds want money from the Feds or supposedly CA will close up shop at the end of the month. School districts and their employees send money Sacramento so retirees can have that monthly check, is those safe from the politicans?

My tim horton stock has taken a real beating. It goes back to "I know I should sell but I don't." I knew I should have sold it when it hit $39.... now it is as low as it has ever been. My cvs isn't doing as poorly as my walgreen's... that is baaaaaaaaaaaaad.

I wish I saw that at the office today... I would have viewed it from there. Great stuff!

I'm betting there are a few folks in Bentonville counting their blessings that the clowns in D.C. kept Wal-Mart out of the banking business. Now hopefully Wal-Mart management can put enough pressure on the Chineses to ship Holiday goods to sell at bargain prices. On the down side, the unknown is far the Feds will let the bankrupty judges wipe out debts and are some planning to run up their CC in the near future.

What I want to know is what's in it for me? Here's my situation:
- My wife and I purchased a house we could afford and based it on one salary in case one of us did not have an income.
- We worked our butts off and saved our money until we had enough to buy a house we could afford.
- We got a loan based on what we could afford....realistically, not what the bank said they could lend us with those unconventional mortgage loans.
- Our house doubled in value within 3 years. We didn't refinance or take equity out because I felt the extra payments wasn't something we could afford.
- We purchased two new cars and they were paid for in less than a year. We purchased cars we could afford.
- We don't go out and purchase big ticket items on credit unless we have the money to pay it off immediately. We buy what we could afford.

I think you can see the pattern here. We spend less than what we make and buy things only when we have the money and can afford it. I feel that has put us in a very strange position. People who lived "high on the hog" and bought things they couldn't afford are now the focus for relief. Well, what about me? What's in this whole damn thing for me? Pisses me off.

Sucks, don't it?

Next thing you know you'll be bailing out people who racked up huge credit card bills buying flatscreen TVs and Louis Vuitton bags.

And then the big grand finale will be the student loan bailout of all those political science majors who partied for four years while getting "college degrees."

Actually, I constantly hear ads, even on the right wing radio station, for services that will help those $10,000 or more in debt. The message is that we will help you blow off part of what you owe your creditors. No, if and or but; this is "legal" stealing. It one thing when your job goes south, a family member is sick or hurt and racks up a big hospital bill, or a nature disaster strike, most of us want to help and understand starting over again by filing for bankrupty. Still it hard to feel pity for those who ain't putting in 110% at work, driving a "rich" person vehicle and spend like a sailor on leave.

In regard to student loans, presently it takes a miracle for even a bankrupt judge to write it off. Even one man who moved from receiving a government disablity check to the tradition social security had some of the check garnished for past student loans. He fought it in courts and lost.

One needs to be careful with those debt reduction companies. From the FTC: Advertisements Promising Debt Relief May Be Offering Bankruptcy

My opinion on Student Loans - if one gets a Student Loan it needs to be paid back, period. I know a guy who hasn't paid a dime on his student loan in 20 years. IMO he stole the thousands he was loaned and should never be let off the hook. I think the principle & interest should be taken from his wages and taken out of his estate when he dies. If he dies with nothing, well, he wins I guess.

And how exactly is somebody taking $25k/yr for four years of poli sci going to pay that off? They'll kick and scream about tuition having been too expensive (even though it was only $8k, the rest being living expenses), and eventually will be bailed out just like the homeowners who were "scammed."

The same way everyone else who ever paid off (or is paying off) a student loan - one payment at a time (&/or eventual lump sum if they happen to save the money). If they have no intention of paying it off they shouldn't be taking it to begin with. I didn't take out any student loans & worked through college. It' wasn't so terrible.

EDIT: BTW, I didn't live on campus either - I lived at my parents home and commuted, sometimes by bus if I didn't have a running car.

this mess really added up to a lot more than I thought would. The numbers are really staggering.

Basically amounts to a 2.2 trillion dollar bailout.

CNNMoney posted a good article summing up what the Fed is dealing with now:
CNNMoney Article: The Fed's $2.2 trillion fire hose

Way back in October 2008 when this topic was posted, I don't even think I could have imagined the scale of this. We're really going to be dealing this for a while.

Well said. And for most of it, me too.

Interesting. Thanks for posting this.