I don’t understand much about the big economic issues going on right now – especially the $700 billion taxpayer funded bailout of the fat-cats on Wall Street – but this article made me feel less dumb. These quotes in particular stood out but the whole thing was accessible to the layperson:
Normally this would have been bad for both the homeowner and the guy who wanted to get paid for his hamburger, which might very well be the mortgage lender, but not really a big deal for you or me. (If enough of this occurred, of course, it could lead to a general slowdown and hurt pretty much everybody.) But this impact was magnified by the fact that most of the mortgage lenders sold the right to the payments under the mortgage to third parties. These third parties broke up the rights to the payments from the mortgages into lots of little pieces, combined these pieces with the rights to payments for little pieces of lots of other mortgages, repacked these in “creative” ways, and re-sold them to fourth, fifth and sixth parties. Four, five and six then used these promises as their own equity in order to raise further debt of their own. This would be like you using an IOU from your neighbor as your down payment for a mortgage. So when lots of these over-leveraged homeowners started to miss mortgage payments, parties four, five and six had less money than they expected, and they had problems making their own debt payments if they themselves had taken out enough debt. Oh yeah, many of these debt contracts are in fact between parties four, five and six.
Unfortunately for you and me, parties five and six are the financial institutions where we have our life savings deposited.
Shouldn’t Wall Street know better than to ride the bubble this far down the drain? I’ve always been told the glorious market would prevent stupid or poor behavior through the idea of “moral hazard.”
And now the consequences of doing nothing:
If investors lose confidence in the safety of money market funds, mutual funds, demand deposit accounts and the other storehouses of value in the modern economy, we would have a problem that would make somewhat higher taxes and moral hazard seem like child’s play. Trust me – you do not want to experience a full-scale bank run in contemporary America. I’m not sure how many people realize how close we were to the wheels coming off at about noon yesterday, as major commercial-paper processing banks like State Street lost 30% – 60% of their value in about 2 hours. Want evidence: When was the last time you heard of the U.S. government identifying a problem, developing a multi-hundred-billion-dollar program and announcing it within about 48 hours?
From everything I’ve been reading, a bailout of some sort seems necessary – the only question most people seem to have is about giving away a blank check and getting nothing in return. But I do know there are commenters who know a lot about this stuff. Maybe they could find the time to let us know what they think about this article?
And lastly, one thing about all this stands out – there are many different and competing strategies about how to handle this crisis. So many so, that it seems ludicrous to imagine it doesn’t matter which path we choose because they all end in the exact same clearing.
Just more evidence, if the last 8 years weren’t enough, that it matters who wins elections.