|The appetites of Wall Street|
|Written by L. M. Lloyd|
|Friday, 20 May 2011 05:35|
Ok, I've been doing a lot of research on the financial sector, and what caused the financial collapse a couple years ago, and I think there is something I need to explain, because people seem to have a fundamental misunderstanding about what really happened, and what caused it. Now, this is all pretty complicated, so to try and make it clear, I'm instead going to create a hypothetical situation, which illustrates the problem, instead of going into details about Credit Default Swaps, Collateralized Debt Obligations, and all that sort of thing.
So, say you are really hungry, but you don't have any money until payday a week from now. So, you get an idea that you will go to one of those restaurants that will give you the meal on the house, if you can finish their giant steak. Of course, you don't want to get in trouble if you can't finish it, so you ask a friend of yours to loan you the money for the dinner, just for the night, and promise you will give it back to him tomorrow, plus another buck on payday, just for the trouble of loaning you the money. You are pretty sure you can eat the whole steak, at which point the meal will be free, and you can give your friend his money back, and even if you can't the worst that happens, is you pay him back everything on payday. Still, to put his mind at ease, you tell him that if for some reason you can't pay it tomorrow, then you will give him a dollar for every day you don't pay him back. So far, so good, right? Your friend likes the deal, because no matter what, he gets extra money, and if you keep his money longer than you promised, he actually makes more than if you pay it when you say you are going to. As long as you don't lose your job, or welsh on the deal, then everything is good. Nothing too complicated.
So, you go to the restaurant, you eat your meal, and let's say you don't actually finish it, and have to take a little longer paying your friend back. No big deal. You pay him back, and he is happy with the money he got. Normally, this would be the end of it. However, he happens to have a friend who is a natural born trader, who notices that he got a pretty good return on investment, and thinks there has to be a way to turn this into a real revenue stream. So, he starts taking out ads in papers, offering to provide this same service to anyone. He quickly learns that he needs to be careful who he offers to do this for, but on the whole, he makes money at it. Enough money, in fact, that he sets up a company to do this, and starts hiring people. Pretty soon, there are competitors, and several companies vying for this business of making loans to people to cover their meals, for an interest rate. Problem is, there is plenty of demand, after all everybody needs to eat, and everybody is short of cash once in a while, but there are a limited number of people who are a safe-enough bet, that you aren't going to lose your shirt. Because unlike a friend, they have a lot less reason to actually pay the business back. So, all the companies trying to do it, are basically trying to go after the same safe customers.
Then, a rich guy shows up, and says that he is willing to take all the debts off these businesses hands, on a regular ongoing basis, for $1.10, to every dollar they lent. They think this is a great idea. They won't get as much profit on each loan, but they have no risk at all. It is free money. No idea why this rich guy would want to do this, but it is fantastic, because it means they are guaranteed to get paid, with no risk of losing a dime! So, they take him up on the deal. Back at the rich guy's house, however, he is hard at work. His plan, is to take all these meal loans he bought at $1.10, and package them together, then sell them to his rich buddies, at $1.20 a share of the package of loans, and they get to keep the interest paid to the debts as a steady stream of revenue. That way, he makes ten cents profit for every $1.10 he buys, they get the interest, and none of the risk is his. Of course, no one is going to take his word for the fact that these people are good for the debt, so he talks to a friend of his, who is really well liked, and really well respected. He explains that the genius of the system is that since these aren't individual debts, but thousands of debts bundled together, that even if someone doesn't pay their debt, the actual loss of that single nonpayment, really doesn't hurt the value of the entire portfolio of loans. It is just a drop in the bucket, and still leaves plenty or room for profit over the price he is asking. He points out that, at least until now, almost all of people were paying back their debt, because the lenders were very careful about who they lent to. He also adds that he will pay penny to his friend for every share sold, just to tell people this is a good investment. His friend agrees, and off they go to start selling these debts by the thousands, which they are now calling shares of assets in their portfolio. This goes pretty well, and people are buying them up like mad.
Back at the meal loan companies, it pretty quickly occurs to them that if they have no risk, why would they turn anyone away? They get their money, no matter what, so the more people they loan meal money to, the more money they make, whether those people pay back the money or not. So, they just start handing out meal money. They hand out so much meal money, in fact, that everyone is eating out all the time now. New restaurants are getting built, and there is a huge boom in the food service industry, spurning more people to take out meal loans, because all their friends want to eat out all the time, and they don't want to have to tell their friends they can't afford to go get dinner someplace. In fact, so many people are eating out, that grocery stores have to start shutting down, because no one is eating at home anymore. There is so much demand, that the restaurants all can raise their prices, which of course means even more people have to take out meal loans. This is great for the restaurants, the loan companies, and our rich guy too, because it means a huge growth in the number of shares he can sell. Pretty soon, he is selling millions of them, and making 9 cents on every one, after the penny per share he is giving to his friend, who is vouching for what a good deal they are.
However, some people start to worry that maybe these people won't pay their debt. Luckily, another rich guy steps in, and says that he would be happy to sell them insurance on these assets. If they just pay him 3 cents for every dollar they buy, then he will insure any losses they might have, and pay them the full dollar they are owed. Well, that puts everyone's fears to rest, and they go right back to buying. Now the businesses giving out these loans are making a ton of money, the rich guy selling the millions of 'assets' is making a ton of money, the other rich guy selling the insurance is making a ton of money, and the people eventually buying these 'assets' are happily looking forward to a steady stream of profits coming in from interest as people repay their debts. Unfortunately, after a while, it starts to look like people aren't repaying their debts. In fact, a lot of them aren't. It isn't too big a deal though, because eventually they will pay it, or the insurance will kick in, so they keep buying, because everyone tells them it is guaranteed money, and everyone seems to be getting rich off it. Pretty soon, so many people were buying insurance, and the insurance guy was making so much money, that he even started selling shares in his insurance too. After all, why should he bear the burden of his risk, when no one else in this market is. He can sell off his own potential risk to investors, just like they did with the meal loan risk to begin with. So you have the companies making loans, the rich guy buying and bundling the debts, his friend who is rating the debt, the other rich guy insuring the debt, the people buying the shares of the insurance, and even the restaurants, all making a fortune. The only people not making money in all this, are the people eating out, who are having every meal artificially inflated in price, both by interest, and by the rising prices due to so many people eating out, and the people eventually ending up with the shares of the debt, which isn't getting paid off as often or as quickly as it is supposed to.
Eventually, though, it becomes clear that people really aren't paying of a lot of these loans. Some people, who haven't paid back their first loan, are even getting second loans! The people holding these 'assets' based on these loans, start calling the insurance guy in droves. Except, the insurance guy one day files for bankruptcy, saying that no one could have predicted how many of these loans were bad, and all of a sudden, the entire market for these loans stops dead in its tracks. The people who bought the 'assets,' the insurance guy, the rich guy who is selling the 'assets,' the companies making the loans, and even the restaurants, all grind to a halt, and ask the same question "why are you people eating, if you can't afford it? Why don't you just stop eating?" They all decide that clearly the problem here is all these people under the mistaken impression that they can just eat whenever they are hungry, even if they don't have the money. All the businesses petition the government to pay up all the outstanding debt, because there was no way they could have predicted that people would actually go out to eat, when they couldn't afford to buy a meal, even though that was the entire basis of the entire industry to start with. These fine, upstanding businessmen, bought these disreputable diners' debt, in good faith that they would be able to pay it back, and there is no reason their business should have to suffer, just because these layabouts can't afford to eat. There is no equitable recourse, but to offload these bad debts to the taxpayers, so that the market can stabilize.
And that is where we are today. So, the next time you hear some Wall Street fucko blaming the financial collapse on all those 'deadbeats' who had the audacity to expect a roof over their kid's heads, ask yourself, was it actually borrowing money to get something to eat that caused the problem, or was it the insane and incredible machinations of all the people trying to figure out how to get rich off of you being too broke to afford dinner that really caused the problem? Oh, and before you answer that, please keep in mind that the real life machinations of Wall Street, were several orders of magnitude more complex than my little story. So complex, in fact, that they had to hire Nobel prize winning mathematicians and physicists, just to keep track of the complex financial instruments they created to sell, resell, bet against, and resell again, whether or not you would continue to be able to afford the roof over your head. To put it in the plainest language, the housing market had absolutely nothing to do with the financial collapse. It is the culture of the trading world which is to blame, and the housing market just happened to be the financial instrument that was in vogue at the time. Before that, it was Internet IPOs, and now it is commodities and educational debt. To portray the problem as being in any way the fault of the housing market, is to completely miss the real problem, and the real cause of the collapse.
|Last Updated ( Friday, 20 May 2011 05:46 )|