Recently sent to a friend who inquired about the recently announced government intervention in the impending financial "meltdown":
Here's my take: First, the part that most people understand, housing prices are declining. In more fiscally conservative times this would be a bad enough thing, but not something that I would agree with taxpayer financed intervention for. But what works in theory, "Thou shall not kill," seldom comes without exception.
So housing prices are declining and the banks which lent that money are leveraged, which is fine by most modern theories of economics. This is important to understand -- banks are leveraged, they lend money they don't have. One might ask, why are housing prices declining? It's because banks came up with complicated loans(adjustable rate mortgages), mortgage brokers pursued people in a predatory fashion(subprime lending), and some people just wanted to make money on rising home values. In short, people were greedy. A lot of people, not just "Wall Street". Now, leverage works both ways, and you don't need a lot of defaults or foreclosures to bring down a bank. For my part, I sort of see the leverage that banks employ as a match and the greed of the last several years made it easier to spark. As soon as the housing prices start to decline, the match is lit. When Congress talks about propping up housing prices they are talking about putting out the lit match. Which might be a good idea these days. Why? Here's part two:
Because banks are risk adverse (who isn't?) and because someone had the bright idea to deregulate the derivatives market (commodity futures modernization act of 2000) banks recently started bundling thousands of loans and reselling them with no government oversight. This gets complicated so I might not have this 100% correct: These loans are then split in the pieces (according to quality) and repackaged and resold. These are CMOs (Collateralized Mortgage Obligations). They are bought and sold, but because only a relatively few people can deal (or even understand) them, their actually value isn't well understood. These are called Level 2 assets. Then, people start insuring and re-insuring these assets by trading, essentially, the risk that mortgage holders would default. These because a broad category of assets known as credit default swaps (CDS) Because these are extremely hard to quantify, these are called Level 3 assets. I'm pretty sure there are other types of Level 2 and level 3 assets. I'm sure that not all of them are bad. Think of them all as firewood. Firewood is useful. Lots of very dry firewood can be dangerous. Think of the everything related to mortgages as very dry firewood.
So get rid of the match and you still have a conflagration waiting to happen. How bad is the problem? I've seen at least one estimate that right before this started unraveling there was a estimated 500T worth of derivatives ... I use "worth" very loosely. I don't know how bad it really is.
No one does.
But they can guess ... and they can be scared. And banks can stop lending to each other because they are scared. And that fear can do enough to cause four of the five largest US investment banks to sell or considering selling themselves and enough to cause the world's largest insurer to take a $85B loan from the government at roughly 11% interest. It's enough to cause my workplace to eliminate half of my co-workers.
But then again, maybe it isn't that bad. The short sellers on wall street want to know. They've been wanting to know for months now. Their voice of dissent is going to be quashed (they aren't all virtuous either, "naked" shorts are the equivalent of eco-terrorists) But it's enough to know that some people want the truth. Because maybe, just maybe, it isn't that bad.
This last week in wall street was interesting to say the least. But it isn't a meltdown. Not by a long shot. Let's all hope it isn't as bad as they aren't saying.
I finally got around to reading this article in an issue of the New York Times Magazine a couple of weeks ago. It references one of my favorite numbers, the Dunbar Number, and has encouraged me to be more active on Facebook. We'll see how that goes. Dunbar aside, it's really this idea's that got me interested: "This is the paradox of ambient awareness. Each little update — each individual bit of social information — is insignificant on its own, even supremely mundane. But taken together, over time, the little snippets coalesce into a surprisingly sophisticated portrait of your friends’ and family members’ lives, like thousands of dots making a pointillist painting."
During most of my weekday mornings, I spend a portion of my time engrossed in news as it pertains to the market. On slow news days this doesn't really amount to much. On days like the last two, it renders me rather unproductive. (It doesn't help that the only other engineer left in the building doesn't have a lot to do right now and loves to discuss the stock market) If you haven't been keeping up to date, Merrill Lynch has been bought by Bank of America, Lehman Brothers has filled for bankruptcy, and AIG has been more or less taken over by the government. For those trying to keep score, this is only a week after Freddie Mac and Fannie Mae were taken in to conservatorship by the government. Toss in the demise of Bear Stearns a number of months ago, season with IndyMac and a number of other failed names, and you have quite a bitter broth. What's for dessert? WaMu.
I'm actually hoping that this is the news that leads for awhile. I'm pretty sick of hearing about lipstick on pigs.