It is better to be an outcast, a stranger in one’s own country, than an outcast from one’s self. It is better to see what is about to befall us and to resist than to retreat into the fantasies embraced by a nation of the blind.
Chris Hedges

Thursday, September 18, 2008

Building a House of Cards

Governments and institutions are telling everyone not to panic and stay the course. This to give the top 3% of society time to liquidate before the coming collapse. By the time the little guy at the back of the line gets wise, there will be nothing left.

Economists themselves cannot agree on what is happening. The instruments of the coming catastrophe were established during the climate of fear surrounding 9/11. The stock market could have collapsed then. The bust and Enron had exposed the weak underbelly, and delicate nature of the market economy. The Securities and Exchange Commission (SEC) needed to do something different to inject capital and confidence back into the marketplace.

So, the SEC relaxed the rules governing some investment banks. Five solid banks: Goldman Sachs, Merril Lynch, Lehman Bros., Bear Stearns and Morgan Stanley, restricted to operating on a 12:1 debt-to-capital ratio for lending, were sanctioned by The SEC to increase their debt to capital ratio to 30 and in some cases 40:1 . In a single stroke, these five institutions; were infused with tens of trillions of dollars. Overnight, it was as if the US mint had printed trillions of dollars and injected it into the economy. These banks don't lend to people, they lend to companies like Freddie Mac and Fannie Mae (Fannie-Mac). Fannie-Mac lend money for mortgages.

Lenders need security for loans. Those insurers are governed by Regulatory bodies to make sure there are sufficient assets for repayment in the event lenders forfeit. To get around these regulatory bodies a new term called "credit default swaps" entered the financial vocabulary. There is no regulatory body for credit default swaps. AIG became the holding company for the credit default swaps that would secure this new investment capital.

The set pieces were all in place.

Home mortgages could be had for a 0% downpayment. First-time home buyers flocked to take advantage with mortgage rates stabilized at 5 & 6%. It became a sellers market and the real estate boom started. New home construction took off, accounting for 15% of new jobs. Houses selling for $100,000 in 2001 were now being evaluated for $200,000 and then $300,000. Ordinary people by the thousands were channelled into seminars where they were told to leverage their mortgages into buying more houses and become millionaires overnight. The magic was many did become millionaires.

Flush with money, banks and lending institutions rode the wave into a new consumer-driven economy. Credit was extended to anyone. In America, a $50,000 income was guarantee enough for a million dollar loan. Illegal immigrants could borrow money. Consumer spending for home furnishings, cars, boats, second homes, education, stocks, and travel was paid for with credit cards and second mortgages. Sub-prime financiers for large-scale construction projects, guaranteeing incredibly high returns, attracted pension funds and the life's savings of retirees and baby boomers hoping to retire early.

Even the war in Iraq, costing $2 billion dollars per week, and a US national debt at $10 Trillion dollars and growing at $600 dollars a second couldn't slow it down. Inflation was steady, GDP was growing, and dollar remained strong. The first inkling people had that something was wrong was when oil crossed the $100 a barrel threshold. It was a gust of wind that teetered the house of cards.


Anahera said...

As a layperson to these matters I appreciate the understanding reading this post gives to me. Can you insert into your post (or a new one) exactly what a "sub prime lender" is? And give some examples that a layperson like me may have heard about. Thanks hon.

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