fifteen tons


Today was that day, perhaps the one you’re asked about many years from now, questions from your kids forced to study economics and realizing something huge happened when they were still children. The best answer I’ll conjure up is something like “man, I dunno – it was complicated.”

As best I can tell, this is what happened (and please, if I’m getting this wrong, please correct me):

1. People without any real money bought houses they couldn’t afford.

2. They could do so because banks were lending them money with no downpayment and crazy low interest rates and no stringent credit checks.

3. The banks figured they could do this, because housing prices always go up.

4. Now the banks have shitty loans, which they sell to investment banks on Wall Street who figure they can make a buck off them too – because housing prices always go up.

5. The banks then sell these shitty loan mortgages to everyone else looking for a safe investment, rating them misleadingly, and using offshore accounts so nobody could see what they were up to. Who cares? Housing prices always go up!

6. Housing prices don’t go up. In fact, the bottom kinda falls out.

7. People who ultimately bought these “safe investments” wonder where the money is, but all the ORIGINAL homeowners (from number 1 above) have foreclosed. The banks say to their disgruntled customers, “well, we never promised you a rose garden.”

8. The truth comes out, and all these banks – and everyone associated with them – lose stock value so rapidly that the shareholders revolt.

9. Now there’s no more money and no more credit being given. Without credit, the entire financial sector loses their oxygen, and the whole fucker slams to a halt.

10. The Government ponders a bailout plan to shore these banks back up and get credit flowing again.

12. The bailout plan fails because some Republicans believe it goes against their small-government philosophy, and some Democrats believe it wouldn’t actually change the way these banks behave, it would reward the people who fucked up, and the taxpayer wouldn’t share enough in future earnings.

Then the Dow falls off a cliff. Is that basically what all of you believe happened? If not, what is your take? And what happens now?

0 thoughts on “fifteen tons

  1. Bud

    To break it down further:
    1) 1999: Congress votes to deregulate the financial services industry, removing the separation between retail banks, investment banks and insurance companies. McCain votes FOR it. Biden votes AGAINST.
    2) Financial institutions take advantage of the situation, creating new kinds of mortgages. The results are good (expanded home ownership) and bad (high risks). A chorus of voices warning of disaster should home prices fall (Warren Buffett among them) goes unheeded amidst a feeding frenzy of unprecedented profits.
    3) Housing prices fall and the house of cards collapses. Congressional Republicans block passage of a desperately-needed bailout package. The stock market crashes; the US and global economies teeter on the brink of collapse.
    The rest is still to be written….
    Seemingly, either Congress passes a bailout bill, or it’s welcome to the jungle, baby.

  2. Alan

    I don’t think they sent the risk off shore at point #5 but that they made a second commodity of shitty loans through the insurance and hedge markets that compounded the risk of the shitty mortgages to the point that the shitty mortgages, a dumb but ultimately manageable risk across the whole market, create a bigger domino effect that triggered the greater collapse.
    It took MBAs to create those insurance and hedge products. Round up the MBAs.

  3. Claverack Weekender

    You missed the Kredit Krunch (TM) part:
    5a. Some banks borrowed tremendous sums in the short term interbank market to buy mortgages. (When they bought the mortgages they are basically lending money. They borrowed the money to do this at lower interest rates than they were lending at. Voila, printing money!)
    5b. As the value of homes dropped, the value of the mortgages on the banks’ balance sheets dropped. Suddenly they had less “assets” and could therefore lend 12 fewer dollars for every dollar they lost on mortgages. If you add up the amount of “write downs” the banks it runs into the hundreds of billions.
    5c. Huge companies previously thought unsinkable sunk.
    5d. Everyone furiously recalls short and medium term loans. Either because of balance sheet effects or fear of 5c.
    5e. Everyone sells assets to get cash to repay loans. Some assets being liquidated are stocks, by the way.
    5f. Asset values go down, reducing balance sheets. Go to step 5b.
    Paulson & Bernanke are scared because we are currently stuck in a death spiral of step 5.

  4. Anne

    I’m no economist, but that seemed like a very cogent summary, Ian. And one that I could actually understand. Line up an illustrator and make a little book of it!
    What worries me perhaps the most about the current financial debacle is that no one seems to know what to do about it. Not authoritatively or confidently, anyway. The Big Honchos actually behave as if they are totally spooked.
    The dismal “science,” indeed.

  5. dean

    There is so much blame to go to both sides. Republicans resisted certain regulation. Democrats blocked a house-cleaning at Fannie & Freddie in 2004. Deomcrats and community organizers (ACORN) passed the Community Reinvestment Act which actually forced banks to make loans to unqualified borrowers in the name of political correctness and racial diversity.
    It all added up to a clusterf–k.
    To those of us who may be cash-rich, this could end up as a blessing. Real estate is going to get a lot cheaper and there are going to be a lot of stocks selling for low prices. The American economy is going to bounce back quickly. I am currently removing all my cash from my mattress and intend to take some advantage of the fire sell.

  6. the Other Lee

    That’s as good a high level summary as I’ve seen, and I’m an evil MBA, but no I don’t work in Investment Banking, Mortgage Backed Securities or any of that, I’m in a whole different sector, so leave me out of the round up please. ;)
    If you want another great overview, go to “This American Life” and listen to “Global Pool of Money” and that gives a pretty good overview as well.

  7. Isis

    Sounds about right to me–and clearer than most explanations I have read–and I think the fact that there is no #11 only adds to the rightness of what you’ve said.

  8. Jody

    Two other things: May, 1997, introduction of tax free profit from the sale of a house lived in for two years.
    Tax deduction for equity loan interest, allowing one to write off cars, vacations or anything.
    While I love both of these and used them to as much advantage as possible, they also contribute to general price run-ups, one has to pay off the other.

  9. kent

    Thanks Dean for coming up with some stretchers to spread the blame.
    The fact is, the problem was caused by financial instruments that were illegal before Gramm-Leach-Bliley. Bill Clinton signed it, and a bunch of Democrats voted for it. That was in 1999.
    Then Bush became President, and made a complete joke out of oversight and regulation. Now we see the result.
    Sure there are Democrats who voted for GLB, and greed is non-partisan. But the root problem is a bankrupt economic philosophy, one that Republicans still cling to after they’ve done their level best to ruin the entire world economy.
    Maybe while we try and solve this shitstorm we could think about the other Republican economic crime — repealing anti-usury laws so that credit card companies and banks could charge loan-shark interest rates.

  10. anon

    Can’t let the “dig” at the Community Reinvestment Act (and community organizers) go unchallenged.
    Lenders loaned money to less than qualified buyers for one reason: greed. They thought they could make a quick buck. (And, as long as the housing market was rising, they were right.)
    According to the attached, more than 1/2 of the subprime loans were made by independent mortgage companies not subject to CRN.

  11. jersey

    It sounds about right, but I sell tractors for a living so what the hell do I know.
    Count me among the MBA’s hoping to be spared in the MBA round-up persecution.
    I pretty much just drank Jack Daniels, stalked undergrads, and shot pool for two years anyway.

  12. gadfly

    Like Kent said, its the usury – post de-regulation financial products are highly suspect. Subprime ARM mortgages are foreclosures just waiting to happen. You offer someone who has been paying rent all of their lives a chance to own, they’re gonna give it a shot and hope for the best. Then when their monthly mortgage payment doubles, foreclosure. Chop these types of mortgages up and turn them into securities, and you’ve got a timebomb.

  13. kiki

    My simplistic tirade for the day – We forgot about those people that were living BEYOND THEIR MEANS. For the majority of Americans car loans and credit cards are NOT necessary. They only appear to be necessary to those that MUST have it all now. Whatever happened to saving up to buy something? Whatever happened to buying a used car – not new and not leasing it? Whatever happened to paying cash for anything? What happened to common sense that tells you that $5.00 is too much to pay for a cup of coffee?
    Is there any possibility this entire debacle will correct the value we place on “things” and our immediate need to have them?

  14. kevin from NC

    There is plenty of blame to go around and there are many legit reasons for holding this bailout up to the light of day and being sure that this is the right deal for right now. This bill, had it passed would be the biggest knee jerk reaction this government has ever done and it needs some scrutiny.
    I own a very small retail business and we have our issues too and i have families working for me that depend on their jobs. Where is help for us? I know I sound like a ‘the government vault is open where’s mine?’ type right now but this is a fact.
    Why do the large investment banks get bailed out for very poor and unethical business practices? I understand that their health has a far reaching impact on the economy, but in the micro world, so does my business…and we operate with good business practices and ethical treatment of employees, clients and community.

  15. jersey

    Ian, do we know the whereabouts of that Ice Floe from the PA primary, and is there any way we can have Nancy Pelosi placed on it?
    Sweet Jesus.
    Way to provide leadership from the Speaker seat, honey. Appreciate the 777-point drop. That was awesome.

  16. Piglet

    A Paulsen Plan is a Poison Plan, designed to do nothing except empty the treasury in anticipation of an Obama Administration.
    Paulsen is to the economy what Heckuva Job Brownie is to New Orleans. His goal is to make things worse, not better, and any plan that empowers him to give away money will be gasoline on the fire.
    I’d almost rather wait four months until the grownups are in charge and we have a President who will not automatically veto any useful plan.

  17. D

    Just a few tweaks:
    On #1, this wasn’t just “people without any real money buying houses they couldn’t afford” – it was poor underwriting by banks that knew they could sell the risk to someone else. A big chunk of the foreclosure problem is in subprime, sure, but another big piece is in the Alt-A market.
    On 2, 3, and 5, the banks loosened their underwriting standards because the high demand for high-yield asset backed securities meant they could sell as many loans as they could make without anyone taking a hard look at their underwriting. Rating agency criteria focus more on the structure, not the terms of each particular loan, as anyone that paid attention knew, so the rating problem is a red herring meant to distract from the real problem, which was banks/funds/etc. buying stuff that they didn’t understand from investment banks that were happy to take advantage of their ignorance, part of their basic business model.
    Anon is right, CRA has nothing to do with this. That’s another red herring meant to pin the blame on poor folks and minorities.
    On #s 10 and 12 (and what happened to #11?), the bailout failed because it was ill-conceived and poorly understood, because the Republicans have spent the last 30 years teaching their supporters that the government cannot be trusted while gerrymandering their districts to make them highly polarized politically and thus safe for ever more conservative politicians, and because the current president used up so much trust and credibility that he was unable to deliver his own party, at the same time that the House Republican leadership was too weak to ensure the support of more than a third of their own.
    Blaming this on Nancy Pelosi (who gave what was in fact a very mild rebuke of deregulation) would be pure comedy, if the situation weren’t so serious. That was the best Boehner could come up with to feed the rubes to cover his own weakness. Pelosi delivered 60% of her party, twice what Boehner provided. It probably didn’t help any that Republican strategists were openly suggesting that Republicans oppose the plan to score political points.
    The upside, if there is one, is that this may ultimately mean a better plan, one that addresses the underlying problems rather than just the credit aspect.

  18. RW

    The Dow didn’t fall off a cliff. Sure, it was the biggest points drop, but not even close to the biggest percentage drop: “The Dow’s 7 percent decline was the 17th biggest percentage drop in its history, well below the more than 20 percent drops seen in October 1987 and the Great Depression.”,0,7168850.story
    I’m sure we have more drops to come, though. And it may yet fall off a cliff.

  19. Paul G

    I am having a hard time understanding a lot of this. Mostly because for the first time, I, the most liberal guy I know, disagree with Democrats. Not all, but I agree with more Republicans (the ones up for re-election, anyways).
    I was very happy that the bailout failed. Quick decisions are often bad ones. I do not want to save a failed system in this way, especially with urging from Premier Bush. I think of the bailout as just another straw on the camel’s back. Maybe what should die, should die.

  20. Anon

    Hey Schultz, not to let facts get in the way of your youtube spin, but any idea why more than 1/2 of the subprime loans were made by institutions that were not subject to the CRN?
    Do you think they were doing it out of the goodness of their heart, to give the tradionally underpriviliged a crack at the american dream of home ownership?
    Or, do you think that maybe, just maybe — like the rest of Wall Street — they were in it for the MONEY??

  21. Neva

    I hear you Paul G. Does sort of feel like we’re bailing that trouble making teenager out of jail for a DUI again and then giving him the BMW back. How about some tough love?
    However, to stick with the analogy,in this case, if we do nothing it’s like we’re getting back in the car with him and handing him the 6 pack.
    Or maybe I’m wrong, I hope so.
    Not to harp on my usual topic but this financial crisis is not too far from the health care crisis as I see it. Bunch of greedy people trying to make as much money as possible. Many people in the health care industry are getting really rich (yes, including some doctors, and definitely including some insurance companies) while needy people go without. We should all be ashamed.
    Of course, with this financial fiasco we’ll never have the money to fund health care reform now.
    Bin Laden must be laughing in his cave. Those greedy Americans are taking themselves down without any help from terrorists.

  22. Schultz

    I definitely think they were in it for the money and now they will pay the price for their overzealous lending habits.
    I just hate to see $700 billion dollars go to save 4 poorly run institutions.
    I think of world hunger, illiteracy, disease, the homeless, etc. and can only imagine what we could accomplish if we put that money to work to solve these problems.
    I believe the Citigroup purchase of Wachovia greatly influenced the votes of many of our representatives as it should have. (Wachovia was started over 100 years ago in my hometown of Winston-Salem and was a FANTASTICALLY RUN BANK before the First Union merger. You think you have problems- think again. People are dying on the vine in NC with their worthless Wachovia stock).
    The market is up today. Financial armageddon will have to wait another day.

  23. Rebecca

    I don’t see any mention of HELOC’s – Home Equity Line of Credit. People took out millions of dollars in phantom equity, and when the house of cards came tumbling down, they are suddenly underwater. (They owe more than their house is worth.) In California, HELOC’s are non-recourse loans. So if you spent it all, and then end up walking away, you get to keep the money! Or at least the assets you bought with the money.
    The HELOC phenomenon allowed people who actually put down money to extract their down payment and spend it. How crazy is that?
    Here’s an interesting blog by a guy in my town which details some of the stupidity here in Orange County.

  24. Neva

    Yep Schultz I’m in that boat. The company my Dad worked for was bought out by Wachovia so he (and I) have a lot of Wachovia stock. I’m not really worried b/c I don’t need the money from the stocka now. Since he had no real pension and counted on the value of his stock for his retirement I really worry now that he may not be as well off as he planned for his last years – when he most needs it for health care costs. How sad.

  25. Schultz

    I feel obligated to point out that Fannie Mae and Freddie Mac are not subject to Sarbanes Oxley regulations.
    Do some research- I think you will find this point very relevant to the current financial crisis and this year’s election.

  26. Caroline

    Fannie and Freddie are subject to SOX.
    And the bailout would help more than 4 companies. It was for any company who wanted to sell their bad mortgage=backed securities to the gov’t.
    My husband is an Evil MBA and he rocks. He should take over Paulson’s job ASAP.
    I think so much of the problem is that ‘Main St.’ doesn’t get how Wall St. affects them and the economy, in general. No one has done a very good job of explaining it, it my opinion.
    Suze Orman, who I am not normally a fan of, was on Oprah the other day and she glossed over some complicated facts but did a pretty good job.
    Ian, your ‘splanation was pretty good. Like Suze, it glossed over some stuff, but you’ve got a handle on it.

  27. kent

    > We forgot about those people that were living
    > BEYOND THEIR MEANS. For the majority of
    > Americans car loans and credit cards are
    > NOT necessary.
    There are two parties to any loan — the lender and the lendee. The fact of the matter is that in America right now, getting in over your head in debt is way too easy, and its because banks encourage you to spend money you don’t have. It’s wrong that anyone who holds down a job and lives in one place long enough to get on the mailing lists can get 20-30 credit cards, plus an ARM Mortgage, plus a home equity line of credit.
    It’s a major act of will and judgement NOT to get in over your head.
    Back in the day, it was HARD to get a credit card, and your bank held your mortage in house. If you were bad with money, you might get into hock for rent and bills, and get your utilities cut off or get evicted, but there was a limit to how far in debt you could go. Now it seems like anyone making $30K a year can be a half million dollars in debt before any red flags go up.
    If financial institutions just get back to exercising due diligence, then this won’t happen again. But don’t expect the Republicans to bring this about.

  28. Schultz

    They became subject to SOX in July of 2008.
    I’m not really interested in what happened after that date- it is what happened before that matters.

  29. Schultz

    “If financial institutions just get back to exercising due diligence, then this won’t happen again. But don’t expect the Republicans to bring this about.”
    OK- so who should we expect to bring this about? Please…..

  30. Josie

    Obama needs a campaign commercial which juxtaposes Bush after 9/11 imploring Americans to buy, buy, buy to show their patriotism and keep America strong, with Sept 08 Bush pointing the finger at consumers by lamenting that “some people went out and bought houses they couldn’t afford.”
    At least I think that’s the quote….anyone know the clip?

  31. kiki

    “It’s a major act of will and judgement NOT to get in over your head.”
    Do you really believe this? It is called common sense in my book – not a major act of will and judgement. What compells a person to fill out these credit card applications? Greed. Sense of some off-base entitlement. Looking for identity/fulfillment in ALL the wrong places.
    I would like for each person with eyeball level debt to say…I am responsible. Yeah, I bought what some schmuck at abc lending was selling me, because he assured me it would be fine. But, I am responsible for my finances. I am responsible for signing this piece of paper. I am responsible for not reading the fine print, for not heeding the advice of every financial guru who says your mortgage should not exceed 25-30% of your income. I am responsible for going to Starbucks (insert any store) while I am behind on my bills and creditors are calling. I am responsible for getting myself into this mess and I will work hard to get myself OUT of it. I will take my lunch to work, I will shop at thrift stores, I will (gasp!) make my own coffee for the drive to work. I will sell that new car and buy one that is several years old and paid for! I will make a budget and stick to it!
    Oh, but that is right. I can just claim bankruptcy and get right back into the game.

  32. Randy

    There are only a couple of things I can add to this. Obviously, the market was run yesterday by scared investors and today the money flowed back on “bargains” and you will watch the money flow out again tomorrow as people take their “run ups” out of the market. This tide will eventually settle out (and lower than before) becuase the economy is heading south. You hit the issue on the simplistic head, Ian. The one thing I’d add to your info is that everyone had a flawed idea that a house somehow was an investment and the price should act like their stock portfolio. Well, the prices have gone down and will likely go down further, just like stocks. If you think about it, the way people made money on their houses in the past was by growing the equity by PAYING OFF THEIR MORTGAGES!!!! When did we lose this concept? My kids can’t afford a house in the future if the starter homes start at 1 million dollars and keep going up. That is the reality in many parts of California and in Florida. It happened because again, some bozos came up with the bright investment strategy that a home could be a like a stock and shoot up based on speculative buying. Crazy and unsustainable, but we all liked it while the home equity ATMs were flowing. Now, the time of reconing is here.
    I for one am against this whole bail-out thing from the get go. I know that it has worked in some cases in the past, but I say let the banks fail, let things go crashing down and pay the piper. There will be much pain, but the bailout just seems to be a salve to avoid the pain and pass it on to future generations. I think we can survive and will be the better for it in the long run.

  33. T.J.

    “If financial institutions just get back to exercising due diligence, then this won’t happen again. But don’t expect the Republicans to bring this about.”
    Um, it’s happening right now. It’s freedom AND responsibility, unless there’s a bailout, in which case they won’t learn and won’t get back to exercising due diligence.

  34. Admiring Citizen

    Randy, I admire the principle of your stand.
    I take it that you are willing to bear the costs of your stand, even if those costs include losing your job, your kids not being able to go to college, or homelessness?
    It’s not often that one sees that kind of personal courage today and I salute you for it. You’re a better man than I, Gunga Din.
    You are willing to bear those costs, aren’t you Randy? Or to see your friends, family or neighbors bear them?
    If not, you need to hold your nose like the rest of us are doing and support a rescue effort while there’s still time.

  35. Jody

    Buying bad debt is not a rescue for the rescuers.
    Would you be willing to loan or give money to your friends, family or neighbors? Probably.
    Would you be willing to pay off their credit cards for purchases of salad shooters, their gambling debts or their missed payments on their vacation home? Probably not.
    If they asked you for the loan without explanation you may inadvertently be paying for their bad debt. If they told you up front that it was bad debt, then you probably wouldn’t.
    We are being told up front that the bailout is for the most toxic debt that exists. It currently will not be purchased by any private investor in the world, at any price.
    I favor an equity position in any rescued financial organization. It is normal collateral for any loan, stock purchase or reasonable transaction conducted anywhere in the world, at any time in history. The value of the product or stake is always open to negotiation and is always open to scrutiny. Only through deception, stupidity, gullibility or ignorance is this rule broken.
    Do you think people are not buying SUV’s because they can’t get a loan? Are GM employees losing their jobs because of GM’s credit?
    Is steel more expensive because Rio Tinto can’t get a credit line to develop a new mine?
    Is McDonald’s credit line cut off with BOA for daily operating reasons, or was the credit line to allow franchises to expand their stores into the “premiere coffee” market the actual credit line that was rebuked? Given the fortunes of Starbucks recently, I’d say it was the expansion plans.
    It’s plain to see that the era of stupid debt is winding down. Even though the bailout comes with tighter regulations, the regulations should be coming regardless of whether money is involved, and indictments.
    I don’t have a particular political stance on the bailout but I do know down deep that I have had a great time over the past 15 years. About half of it was brains, timing and talent and the other half was blatant speculation, unheard of gobs of free money, extension of outrageous amounts of credit and tax breaks that would break a normal government (these are personal, I’m not commenting about society at large). Given my take on the situation above I believe the bailout will not actually fix the situation and yes, I totally expect hard times, stress and my personal situation to decrease in quality…maybe a lot of quality.
    We will bear the costs in the same way, one way or another.

  36. Paul G

    Admiring Citizen,
    I am willing to bear those costs. I do not have anything, moreover, I was not stupid enough to pretend or think I should have something. My parents do not have much, but what they do have is paid for.
    Sorry to you, your friends, and neighbors, but pumping 700 billion into a dead horse is still gonna leave you with a dead horse. And another unfathomable debt.
    I have ZERO sympathy for those that got themselves into this. I wish nothing bad on them, but I do not believe they should be helped in any way.

  37. john

    I think we need to act, to act fast and most importantly to act correctly.
    Bud and Kent correctly lay the blame for this mess on Gramm-Leach-Bliley. Repealing the usury laws didn’t help much either.
    Greg (grumphreys) provides a link to a reasonable, proven model for a solution. We’re not the first country to have to deal with this. There’s no reason to re-invent wheels – or to give away the store to the people whose greed got us into this.
    Sweden came out of their mess somewhere between 2% down or slightly up, depending on whom you ask. The key ingredient, as Jody points out is providing rescue only in exchange for equity.
    But Admiring Citizen has a point, too. Fail to act at all – and quickly – and we’re in for a long, cold lonely winter.

  38. Randy

    Perhaps we’d be better off to reset this thing now rather than trying to prop it up. It may not be fun to live with in the short-term, but the markets do have a way of correcting themselves.
    As to blame – believe the NY Times – which in 1999 published a story that the Clinton Administration was pushing Fannie to accept more risky loans and people with poor credit to get people in houses (that they shouldn’t be). Now, being a conservative, it may have started there, but the Bush administration (which has been admittedly terrible) has done noting to change that – in fact, they probably profited from it as well. The article went on to predict that in financial hard times this would result in the mess we’ve been living with over the last year.
    Can it get worse? Yes. and I believe it will (bailout or not). But I also believe the businesses in this economy, while struggling, are not doing as bad as the financial section and we’ll weather the storm (or depression or recession or whatever you want to call it). The one thing I can’t stand are these financial “experts” showing up on commentary shows scaring the common man with ideas of a depression when they don’t know what the impact of this will be. It should have been voted down the first time – nobody deserves a blank check. They all seem like a bunch of crackheads looking for their next fix and $700 billion seems like it ought to do it.

  39. block

    Greenspan is the true villian! when they write someday in the future a book called, “the Great Panic of 2008”, the introducton will site that the “great” greenspan said (on the record) that the interest only mortages contruct was a good thing and should be concidered by many Americans. Yes, its could look it up! He is truely a miserable, pedantic, schmuck.

  40. Randy

    Hey Block. Have to say that ever since this blog turned me on to your album and I downloaded it from iTunes, Sweet Potato Pie is now one of my favorite songs. I like several others too.
    Agree on Greenspan. That guy continues to hover over the economy like a dark cloud.


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