Thursday, October 16, 2008

The Credit Crisis in Simple Words, Part 1


Recently I read an article in Time magazine describing the causes of Wall Streets meltdown. Here is a collection of quotes from that article, 'The Price of Greed' and some observations.

"How were we supposed to know that people who lied about their income and assets would walk away from mortgages on houses in which they had no equity? That wasn't in our computer model. -The Price of Greed by Andy Serwer and Allan Sloan

You would like to think this is an over simplification of the truth, but how committed is someone who does not own any equity in their property.

In normal times, problems in the economy cause problems in the financial markets because hard-pressed consumers and businesses have trouble repaying their loans. But this time; for the first time since the Great Depression; problems in the financial market are slowing the economy rather than the other way around. -The Price of Greed by Andy Serwer and Allan Sloan

Is this a contradiction of the first quote? People could repay their loans?

..subprime is Wall Street's euphemism for junk.. -The Price of Greed by Andy Serwer and Allan Sloan

How can the government bail out banks that have junk for assets? It would be like pouring money into a black hole. It sound like banks were investing in pie in the sky assets.

If you borrow 35 times your capital and those investments rise only 1%, you've made 35% on your money. If, however, things move against you; as they did with Lehman- a 1% or 2% drop in value of your assets puts your future in doubt. -The Price of Greed by Andy Serwer and Allan Sloan

Now you can understand why the economy has lost faith in the financial system. This shouldn't be possible. Banks and the people who run them should be too scared to take on this much risk. More fear then the loss of their job.

If AIG croaked, all the players who thought they had their bets hedged would suddenly have "unbalanced books." That could lead to firms other than AIG failing, which could lead to still more firms failing, which could lead to what economists call "systemic failure." -The Price of Greed by Andy Serwer and Allan Sloan

Domino effect. Everyone pays the price, even the people who played be the rules.

Blankfein argued that confidence in global markets had built up to a dangerously giddy level and that investors weren't being compensated for assuming outsize risk in securities like esoteric bonds and Chinese stocks. -The Price of Greed by Andy Serwer and Allan Sloan

Irrational exuberance.

..Wall Street's classic business model, which works like a dream for Wall Street employees (during good times) but can be a nightmare for the customers. Here's how it goes. You bet big with someone else's money. If you win, you get a huge bonus, based on the profits. If you lose, you lose someone else's money rather than your own, and you move on to the next job. -The Price of Greed by Andy Serwer and Allan Sloan

It is a corrupt system that protects the powerful.

What ever the politicians do, we as a society are going to be poorer than we were. -The Price of Greed by Andy Serwer and Allan Sloan

The people at the bottom of the food chain are the people who suffer the most. In other words the people at the heart of the cause get away, while the battlers bear the biggest burden.

We all will have to start living withing our means; or preferably below them. If you don't over-borrow or over-spend, you're far less vulnerable to whatever problems the financial system may have. -The Price of Greed by Andy Serwer and Allan Sloan

If you aren't tempted to carry large debt you will have a better chance of escaping the turmoil in the financial markets of the world.

more reading
The Credit Crisis in Simple Words, Part 2, The New Economist, Questions About the Credit Crisis, Money Makes the World Turn


photo By
Lisa Kong