On The Economic Situation

Oh, come on…the whole economy thing isn’t that hard to understand.

Anne talks to a mortgage broker. Anne has less than stellar credit and may not much money for a down payment. She’s also not financially sophisticated, so she may not understand the consequences of an adjustable rate mortgage.

Chris walks into Bank A and puts his money in a money market savings account after the bank manager tells him its “just like a savings account”.

Mortgage broker, Barney, doesn’t actually take on the risk of the loans himself, but he doesn’t receive a commission usually based on the size of the loan.

So Barney encourages Anne to take out the biggest mortgage she can afford and may use the introductory interest rate as a “sample” of her monthly payment.

Barney arranges this mortgage with Bank A. Bank A need to maintain a capital ratio, so it contacts IBanker A.

IBanker A puts a bunch of good mortgages, okay mortgages and crappy mortgages together in a package(like Costco!) (this is often referred to as a “pool” of mortgages) and sells them to Rich People A, Pension Fund B, and a number of banks (plus keeps a tiny bit with a ginormous interest rate for themselves).

The expectation of everyone is that some percentage of these mortgages will fail (based on historical events), but that over all the mortgages will be fine.

However, they do not take into account the fact that Barney, in his rush to get his commission, didn’t check the information carefully.

Or that Bank A, in a rush to get the bad mortgages off its books, didn’t consider the conflict of interests between themselves and the mortgage broker. (Blame Phil Gramm here.)

Or that the IBankers, since they are paid a fee and don’t have a real stake in the stability of the mortgage pool, just wanted to sell them and didn’t give a damn about making sure that everything was done properly. (Blame Phil Gramm again here.)

So 6 months later with the introductory rate of her loan goes up, and Anne can no longer afford her mortgage (along with millions of other people), the mortgage pools begin to collapse. (Blame the Fed here)

Unfortunately, the mortgage pools are owned by insurance companies, banks, investment banks, broker-dealers, pension plans, etc. and in many cases make up a large portion of these companies’ “safe assets”.

These safe assets are used to “insure” debt (we’ll call them bonds) issued by the companies. (Lehman Brothers issued bonds that were backed in part by its interests in these mortgage pools).

When the company begins to falter, suddenly, its bonds aren’t worth as much.

Unfortunately, for Chris, that money market savings account is NOT a savings account. It’s a money market fund. And his money market fund had 10% of its assets in bonds issued by companies like Lehman who backed their bonds with mortgage pools. So Chris loses 10% of his savings *poof* because those bonds are now worth less than the gum on my shoe.

Now if those mortgages continue to fail, and the mortgage pools continue to fail, almost every financial services company in the country will find itself in deep, deep shit. And people like Chris will be screwed. As well, the vast majority of us, because those financial services companies are the intermediaries in the financial markets.

To analogize, it’s like if all the grocers in the country suddenly went bankrupt. There would still be food, we just couldn’t easily get to it, because there’s no one to make the transactions happen.

Note for Senator McCain: At no point was the SEC even permitted to be involved in this transaction you little shit. It was the Fed you freakin moron. How can you be POTUS if you don’t even know which agency regulates banks?!?

This Jay Smooth video is great, too, about the explanation Russell Simmons’ gave for the misogyny in some hip-hop, when he was on Oprah last year.

Thanks, Cara, for introducing us to this guy! Am watching a bunch of his archived stuff this afternoon…