> Sam wrote: > The investors don't trust the banks so they won't invest.
Ah, dammit Sam. Now you've made me pity you. Look, here's the deal. Take off your partisan hat for 2 minutes. Here's the billion foot view. If somebody has a good business idea they seek funding to execute on it. Investors, who don't have good ideas, can fund the entrepreneur in 2 ways: bonds and equity. Bonds are a loan that says I give you $10, you return me $11. The extra dollar is interest. Equity is a contract that says I give you $10, you give me 10% of the business. Both of these involve risk with bonds less risky and equity more so: 10% of nothing is nothing, but even a bankrupt business probably has assets that can be sold to get even a part of your $10 back. This brings up the concept of insurance. You know car insurance. you give the agent a premium each month and in exchange he promises to 'make you whole' should you crash your car. The agent may have to pay for a new fender or may have to replace the entire car. Essentially you've transferred your risk the agent in exchange for your premium. By doing this you're ensured that "your business", which is your job/family/life, will have recourse should an unexpected event happen. Let's expand on that. What if the insurance company gets hit with 20 people who all total their cars on the same day? Or, for example, hurricane Katrina hits. Well, luckily there are gov't regulations in place for insurance companies that state they need to PROVE they are prepared for some event of this nature; that they have the cash on hand to deal with it. Ok, back to business. So as a matter of daily business, entrepreneurs borrow money from banks, make monthly payments, the banks make interest, the businesses create jobs, the jobs add value to raw materials which creates wealth. There's trust in there. The banks know that they're taking a risk by lending out their capital but, as tBone mentioned, they can manage this risk with actuary tables, et al. With the sub-prime mess much of what you say about crapping lending practices is all true. But that's not what's caused the trust problem. Phil Gramm's legislation did. It created the legal environment to create all kinds o nasty products one of which is the Credit Default Swap (CDS). This is essentially an insurance policy. Here's how it works: Let's say you decide to lend Ford some money by buying their bonds. You think it's a good deal because you don't take the equity risk if they go under and Ford will pay you a good interest rate because they suck right now. A few days go by and you start getting nervous. You want to insure your buy - or "hedge" - in case even the bonds go down so you call your insurance agent. He explains that traditional insurance doesn't cover this .. BUT! Thanks to Phil Gramm (and clinton who signed and bush who allowed) you can enter into a "swap" contract with your agent. In exchange for your monthly premium your agent promises to cover your loss. Great! But wait. The premium looks pretty small compared with the value of your bonds. So you ask the agent to put up little collateral to prove he can pay your bonds. And, because you're an elite, you index the collateral to your agents credit rating. He agrees! Great! You're hedged, collecting your interest from Ford, and all is well. A year goes by. You start considering all this money you're paying to your agent for this swap. He's pulling down a huge bonus based on YOUR premium and you're stuck with your little bond interest. Then you realize you can create your own swap! Sweet! Thanks Phil! Next thing you know, you're "swapping" with all kinds of buddies by hedging their bets. Now you've got all this cash coming in every month and you're not doing squat to earn it but sign a few contacts every now and again. Life is good. UH OH! Ford just went down and went down hard. Even bond holders are hit. Well, no biggie, you're hedged, right? Well, it turns out the incestuous credit rating agencies have finally noticed that your insurance company - which holds your Ford hedge - has been signing a bunch of other Ford swaps too and thus might have exposure. So they downgrade their credit rating. UH OH! That's make you sweat, but then you built in that collateral index remember? Well guess what? Your insurance company is AIG and the swaps collateral call requires them to put up $14billion. Now. They're toast. You just lost your hedge. AND you know you're going to lose something on Ford. Well, the credit rating agency sees this and downgrades your credit. UH OH! Turns out now YOU get a collateral call from all of your swaps. You have to post $200,000 tomorrow. In cash. Mmm. Big problem. Not is lost however, you'll just get a loan right? Wrong. The banks have realized that: (1.) You have risk that can't be quantified. Another collateral call could come in and wipe you out, thus wiping out their money they're loaning you. (2.) They have their own swaps and their own collateral calls to worry about so they need to hoard all the cash they can get in case one comes in. (3.) They've got a ton of other loans out and they suddenly realize they have no idea if any of that is coming back. i.e. credit ratings have just become worthless. So you get no money. You go down. So now the government has to step in ... but to do what? See this isn't a problem with Ford. If it were the gov't could just clean that up and be done with it. The problem is that all investors are now tied in an unholy web where credit ratings and risk have become incalculable. Think of it this way (Bill Gross' analogy): when you go to Burger King you pay at the first window and get your burger at the second. What if you no longer trusted that you'd get your burger? You wouldn't pays yo money. None of these systemic problems have been solved which is why banks didn't suddenly start lending. CDSs can be made from anything. And have. Hopefully now you understand how sub-prime is a contributing factor but that the real problem is near-systemic failure and its associated loss of trust which still exists. No loans (liquidity) means no investment which means no jobs which means falling consumer purchases which means lowered profits which means fewer jobs which means less purchasing ... and on. Which also means even MORE risk and uncertainty which means even LESS loans. That's the crisis. (I didn't proof any of this so if there are mistakes too bad) ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~| Adobe® ColdFusion® 8 software 8 is the most important and dramatic release to date Get the Free Trial http://ad.doubleclick.net/clk;207172674;29440083;f Archive: http://www.houseoffusion.com/groups/cf-community/message.cfm/messageid:275747 Subscription: http://www.houseoffusion.com/groups/cf-community/subscribe.cfm Unsubscribe: http://www.houseoffusion.com/cf_lists/unsubscribe.cfm?user=89.70.5
