The best explanation so far

An 8 minute comedy video of the financial mess that gets it right. It hits the nail in the head, and it's about a year old.

How it all started

Over the past few days I've been talking at work how the financial crisis started, I gave multiple reasons for why it happened, but here is a sort of simple reason as to why the global economy is going bust.

Everyone is trying to blame the bad mortgages, and homeowners who could not pay their debts. This is not really the case bad debt from mortgages only accounted for between $200-$300 billion of debt. The problem is that banks around the world, espescially the US and Europe being completely over leveraged, and in some cases leveraged 30:1, which means that you are borrowing 30 times the amount of money you have in reserve. With that you can either make 30 times your average profit or on the downside 30 times the loss. With High Risk there is high reward, but also very high dangers. But banks have their own regulations on what they can hold right? Yup its called the Basel II accord. "The purpose of Basel II, which was initially published in June 2004, is to create an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to guard against the types of financial and operational risks banks face."

The riskier the loans a bank owns, the more capital it must keep in reserve.So when banks follow this rule they should be safe, but hello AIG, and thank you for your complete and utter disastrous methods of taking banks money. You see AIG would offer banks a way to get around the Basel rules, via unregulated insurance contracts, known as credit default swaps. The bank calls AIG, and are told that historical loss rates on American mortgages is close to nothing, what drew in European investment, and AIG would sell them subprime securities for 2% of face value, and were guaranteed against default for 5 years.

"Although AIG's credit default swaps were really insurance contracts, they weren't regulated. That meant AIG didn't have to put up any capital as collateral on its swaps, as long as it maintained a triple-A credit rating. There was no real capital cost to selling these swaps; there was no limit. And thanks to what's called "mark-to-market" accounting, AIG could book the profit from a five-year credit default swap as soon as the contract was sold, based on the expected default rate. " (Porter Stansberry) Profit was written off right away by AIG, and as long as they kept their triple A credit rating they could do this as much as they wanted."The bank could leverage itself to the full extent allowable under Basel II. AIG could book hundreds of millions in "profit" each year, without having to pony up billions in collateral."

AIG never had the collateral to back up their loans, and the proft that they wrote off never actually happened. The next to nothing chance of loss on mortgages? Much worse and many times higher than they thought. Those securities in some cases were worth $0.15 to the dollar. Everyone seemed to notice this and on September 15th AIG credit score was lowered. And this is where the proverbial dominoes fell, when AIG's credit score was lowered, they needed to come up with capital to come up with an $11 billion charge, they actually managed to do this, but when they were downgraded all those swaps finally reared their ugly heads and AIG had no money to come up with the collateral they needed. Let's not forget that AIG leveraged themselves out too, and had their own debts they needed to pay. OOPS they went Bankrupt and went to cry for help.

Then "Lehman Brothers failed on the same day. Merrill was sold to Bank of America. The Fed stepped in and agreed to lend AIG $85 billion to facilitate an orderly sell off of its assets in exchange for essentially all the company's equity."

Now it gets scary when you look at the facts:
"Why do you need to know all of these details? First, you must understand that without the government's actions, the collapse of AIG could have caused every major bank in the world to fail.

Second, without the credit default swap market, there's no way banks can report the true state of their assets – they'd all be in default of Basel II. That's why the government will push through a measure that requires the suspension of mark-to-market accounting. Essentially, banks will be allowed to pretend they have far higher-quality loans than they actually do. AIG can't cover for them anymore.

And third, and most importantly, without the huge fraud perpetrated by AIG, the mortgage bubble could have never grown as large as it did. Yes, other factors contributed, like the role of Fannie and Freddie in particular. But the key to enabling the huge global growth in credit during the last decade can be tied directly to AIG's sale of credit default swaps without collateral. That was the barn door. And it was left open for nearly a decade."

SO now you know why the execs needed their $400,000 little get away, it was a stressful time when you almost destroyed the world banking system. THe pain will continue and it will get worse, much worse before it gets better, but it will get better, and hopefully the government and banking systems will enact rules to prevent any future forms of fraud that banks and their executives committed to chase a profit.

The Bailout

Alexis de Tocqueville said: "The American Republic will endure until the day Congress discovers that it can bribe the public with the public's money."

Thomas Jefferson said: “I sincerely believe that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale.”

Can we be fooled to bail out the banking system with our own money? A few years ago Bush vetoed a bill which would have spent $32 billion dollars to give children from low income money insurance. F*ck them he said we don't have the money, when the rich boys from New York, and Washington come crying to him that they screwed themselves over he almost trips over himself to race to give them money. OK our financial system is f*cked, banks screwed it up, now we have to save them, but they had months if not years to fix their sinking ship. Ins ted of just directly giving the money to the banks for their bad debt from the bad mortgages they gave out, they could have given the money to the home owners who lost their house to the foreclosure, but wait that would eliminate the bad debt, and the high foreclosure numbers, and stupid thought might actually help people who need the help.

So they now want $700 billion dollars to save the economy, they must have spent hours if not days coming up with the figure to resurrect our economy, right? A treasury spokeswoman when asked about the figure said:

"It's not based on any particular data point," a Treasury spokeswoman told Forbes.com Tuesday. "We just wanted to choose a really large number."

Great, so we enlarge the national debt for a figure they pulled out of their ass. In 1992, Sweden faced an almost identical crisis with their banking system after a housing market collapse but did they fork over money, NO!
"Banks had to write down losses and issue warrants to the government.

That strategy held banks responsible and turned the government into an owner. When distressed assets were sold, the profits flowed to taxpayers, and the government was able to recoup more money later by selling its shares in the companies as well"(Ny Times)By requiring equity from the banks for their bailout, it almost guaranteed that the banks would do everything they could not to require the assistance, and forced the banks to find capital themselves. And the best part is when the banking system corrected itself, the government, or tax-payers got their money back, maybe not all of it but at least their was a return on their investment.

"By the end of the crisis, the Swedish government had seized a vast portion of the banking sector, and the agency had mostly fulfilled its hard-nosed mandate to drain share capital before injecting cash. When markets stabilized, the Swedish state then reaped the benefits by taking the banks public again." See their plan worked!

But this whole situation reminds me of a Dilbert comic, and maybe I'm the wuss but I don't think we should just give a banking system that screwed themselves and the rest of us free money.