Tuesday, September 30, 2008

Explaining the Crisis.

What’s so difficult to understand?

People deposit money in banks in checking accounts (sometimes called demand accounts because they can demand it at any time) saving accounts and certificates of deposit which are payable in 30 days to 3 years though, most people expect to be paid on demand.

The bank then loans the money in a thirty year mortgages. The bank can’t demand it’s money as long as the scheduled mortgage payments are paid.

There is a recession the depositors demand their money to pay the mortgage, gas, or groceries. The bank can’t repay because the money is in thirty year mortgages.

The bank goes bankrupt and every one who does business with the bank loses. The original depositor/mortgage holder loses his savings and home.


Fannie Mae and Freddie Mac were created to deal with this problem. They borrow money on the bond market and buy mortgages from the banks pushing the problem back a level.

But because of the collapse of the housing market no one wants to but these bonds because the value of the houses backing the mortgages is less than the face value of the bond.

So the whole housing market crashes and even more people lose.


So, as the economic back up last resort it was proposed - that the government buy the problem mortgages, giving the banks the money to pay their depositors and rescuing the system.

Then in a display on non-partisan idiocy the yoyo brains in the House of (non) Representatives vote this down. And even still more people will lose.

That’s it with about twenty levels complexity ignored. This was high school economics when I was in high school, not the college prep economics, the consumer economics for dummies that every one took.

Is there any question why the Congress had a lower approval rating than George Bush before this started?


Charli Carpenter said...

Here's something I for one don't understand: if no one will buy all these bonds, how do we know what their price is? If we don't know what the price is, how will the government determine how much to buy them for?

hank_F_M said...


As I understand it, the details were something that got considerable discussion in the Congressional hearings, it is to be negative or backwards auction.

The government will announce that it is using xx billion of its authority to by bonds and will buy them from the lowest bidder. The banks will bid a much less than the face value of the bonds. A bank that is offering 50% of the face value will get to sell before a bank that is offering 60% of the face value.

Since most of the mortgages will be repaid, the government will get most of the face value of the bond back plus interest on the face value. (25% of the sub-prime loans are in default, which means that 75% are not) I think on net the government will lose some money but most of the 700 billion will come back over thirty years. This is a bad deal for the banks except that they need the money (like now! not over 30 years) from selling the bonds to stay in business.

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