The huge losses in the financial market have only shown me how little I understand about the inner workings of finance. Thankfully I know a whole lot more because of the crisis. Much like you quickly become more knowledgeable about a disease when you find out you’ve contracted it, this current mess has done well to at least give me a basic understanding of what happened.

My analysis might be flawed, and even my lexical understanding of the market itself might be highly colored by analogous terms I understand better than econ speak but I think I know what’s happening.

Functionally everyone involved purchased things they could not afford and did so with easy credit that was available to them. Consumers did this, banks said they will give them the credit, the secondary mortgage companies like FNMA and FHLMC (Fannie Mae, Freddie Mac) who help provide the backing for these mortgages were complicit. These mortgages and other loan based credit are then bundled and sold to other financial groups/institutions as investments. The federal reserve helps regulate this by setting limits on fractional reserve style banking, and regulating the deposit based lending from banks. In this sytem we’re dealing with two types of monetary supply. The first is cash based created through the treasury, the other is in the form of interbank loans. The federal reserve determines the percentage interest rate at which banks can loan each other money to make sure they stay within the fractional reserve guidelines determined by their total deposit amount.

Clear as mud?

What happened? People bought more than they could afford. Whether is was a mortgage that they directly couldn’t afford or other things that contributed to their inability to pay back the loans/credit they had taken out. The economy has boomed recently because of the increased credit. As purchasing power increases due to increased credit available to everyone, more people purchase more things. Banks started holding much lower amounts of fractional reserve (deposit to loan ratio), and investors were more likely to purchased the bundled bonds. These investments get spread around to countries, international banks, hedge funds, etc…

In this case the inability to pay means that those providing the money for the loans will lose money. These bonds and bundles are normally grouped to minimize this, but when a vast percentage of people cannot meet their financial obligations we find ourselves in the current situation. If no one can pay the price for the current market of houses, then the values of those homes and other goods/services will come down. Dropping value of assets combined with an inability for the consumers to follow through on the initial purchase price and you have dissappearing money. The bond holders and purchasers of the bundles lose money. They are then less likely to purchase more bonds. Credit tightens and that economic boom based on credit dries up. Less things will be sold. Less money will change hands.

The bubble burst. What the $700 billion dollar bailout does is it give the Treasury the authority to purchase $700 billion of those securities to provide financial backing to the institutions that created those loans. This doesn’t mean it would cost the taxpayer $700 billion, since there would be some return on investment. My issue is the power it would give the treasury. It opens up the door to even more cronyism in government finance. It might assuage things… but what it was meant to do was to inspire confidence in the financial market.

It failed already.

Wall Street continued to take a huge dump after a slight boost when it passed the Senate. People are pulling their securities investments, taking huge losses in the process. Every investment based company is affected.

Foreign companies and government also purchased these securities and are hurting. The huge monetary supply of the US acts as a cushion, but other countries are going to be hit just as hard.

Credit will be harder to come by, prices will go down, failing companies will shed workers, and the baby-boomers who are now retiring are going to have to rethink how they’re going to retire.

Tags: financial crisis
Categories: BJ, Philosophy etc
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