LONGECITY

We are told that what precipitated the current economic/financial crisis are house foreclosures. Mainly houses that were acquired with
sub-prime mortgages. We are all very unhappy. It would provide some relieve if we could identify the main culprits. Then we can tar and
feather them.
How did it all start? Well, depends. If we go far enough in time we can blame Linda Tripp. Hadn't she given the Clinton-Lewinsky tapes to
to Kenneth Starr Gore would have been the president the last 8 years. No Iraq war and may be no financial melt down. Joe Lieberman will be running
for president now? Argh!
Accepting history and looking at the recent past I cooked up an example.
Joe and Mary are lower middle class renting an apartment for $500/month. They saved 10 grand and decided to buy a house. They tell
the real estate agent they are thinking of a 80 grand house paying up to $500 mortgage.
Howard, the real estate agent shows them a house for that price. and
points out it's not very nice. He can get them a much better house they can afford.
The $170,000 house is really much nicer and they like it. Howard takes them to Steve, a mortgage broker. Mortgage is only $480/month. Joe and
Mary sign the papers and the $10,000 covers Howard's fee and closing costs from which Steve takes his commission.
Problem is that everything hinged on a teaser interest rate. After a few months the real rate kicked in, 7.5% (sub-prime rate). Mortgage payments went up to $1,190/month.
Joe and Mary couldn't afford these payments. They tried to sell the house. House prices took a dive and they were told they couldn't get
more than $125,000. They had to walk away and the house was foreclosed. Joe and Mary lost the money spent in renovating the house
as well as their good credit.
The local bank allowed all of this because it could sell a bunch of mortgages like that to a
bigger Bank (B). B bundled the mortgages into Collateralized Debt Obligations (CDO). These toxic instruments were traded because they
were insured by Credit Default Swaps (CDS) issued by institutions like Lehman Bros. Completely unregulated so nobody knows how to value them.
So who is to blame? There is plenty of blame to go around. Joe and Mary should have read the fine print and figure out what they were getting into.
Howard and Steve just wanted to get their commission and didn't give a damn about anything else. Bankers and financiers manufactured the CDOs
and CDSs as a way of making lots of money faster.
If you are a liberal you accept Joe and Mary were at fault but feel sorry for them. You believe the blame gets magnified as you go up the
feeding chain.
If you are a far right conservative you are searching for Joe and Mary to teach them a lesson.

We are told that what precipitated the current economic/financial crisis are house foreclosures. Mainly houses that were acquired with
sub-prime mortgages. We are all very unhappy. It would provide some relieve if we could identify the main culprits. Then we can tar and
feather them.
How did it all start? Well, depends. If we go far enough in time we can blame Linda Tripp. Hadn't she given the Clinton-Lewinsky tapes to
to Kenneth Starr Gore would have been the president the last 8 years. No Iraq war and may be no financial melt down. Joe Lieberman will be running
for president now? Argh!
Accepting history and looking at the recent past I cooked up an example.
Joe and Mary are lower middle class renting an apartment for $500/month. They saved 10 grand and decided to buy a house. They tell
the real estate agent they are thinking of a 80 grand house paying up to $500 mortgage.
Howard, the real estate agent shows them a house for that price. and
points out it's not very nice. He can get them a much better house they can afford.
The $170,000 house is really much nicer and they like it. Howard takes them to Steve, a mortgage broker. Mortgage is only $480/month. Joe and
Mary sign the papers and the $10,000 covers Howard's fee and closing costs from which Steve takes his commission.
Problem is that everything hinged on a teaser interest rate. After a few months the real rate kicked in, 7.5% (sub-prime rate). Mortgage payments went up to $1,190/month.
Joe and Mary couldn't afford these payments. They tried to sell the house. House prices took a dive and they were told they couldn't get
more than $125,000. They had to walk away and the house was foreclosed. Joe and Mary lost the money spent in renovating the house
as well as their good credit.
The local bank allowed all of this because it could sell a bunch of mortgages like that to a
bigger Bank (B). B bundled the mortgages into Collateralized Debt Obligations (CDO). These toxic instruments were traded because they
were insured by Credit Default Swaps (CDS) issued by institutions like Lehman Bros. Completely unregulated so nobody knows how to value them.
So who is to blame? There is plenty of blame to go around. Joe and Mary should have read the fine print and figure out what they were getting into.
Howard and Steve just wanted to get their commission and didn't give a damn about anything else. Bankers and financiers manufactured the CDOs
and CDSs as a way of making lots of money faster.
If you are a liberal you accept Joe and Mary were at fault but feel sorry for them. You believe the blame gets magnified as you go up the
feeding chain.
If you are a far right conservative you are searching for Joe and Mary to teach them a lesson.

That's only part of the story. The CDSs that they had on these loans were stacked up to 30 layers deep. So basically you end up with X actual assets with 30X leverage applied to it. This is why a small change in the number of people who can pay their mortgage results in a huge gaping hole getting blown in the financial system. This is where the counter party risk you hear about in the news comes in. If someone on the other end of the CDS goes under, that breaks the chain in these things. If bank A goes under then he can't pay bank B, which then can't pay bank C and so forth through all the layers of CDS piled up on those assets. If it wasn't for all the leverage being applied to the actual assets the "sub prime" mess wouldn't be that big of a deal. This is where the lack of regulation comes in. These CDS instruments are basically unregulated bets between banks. Initially they were a way to hedge, but then they figured out they could just keep piling them on for more profit. These instruments should never have been allowed to exist in the first place.

We are told that what precipitated the current economic/financial crisis are house foreclosures. Mainly houses that were acquired with
sub-prime mortgages. We are all very unhappy. It would provide some relieve if we could identify the main culprits. Then we can tar and
feather them.
How did it all start? Well, depends. If we go far enough in time we can blame Linda Tripp. Hadn't she given the Clinton-Lewinsky tapes to
to Kenneth Starr Gore would have been the president the last 8 years. No Iraq war and may be no financial melt down. Joe Lieberman will be running
for president now? Argh!
Accepting history and looking at the recent past I cooked up an example.
Joe and Mary are lower middle class renting an apartment for $500/month. They saved 10 grand and decided to buy a house. They tell
the real estate agent they are thinking of a 80 grand house paying up to $500 mortgage.
Howard, the real estate agent shows them a house for that price. and
points out it's not very nice. He can get them a much better house they can afford.
The $170,000 house is really much nicer and they like it. Howard takes them to Steve, a mortgage broker. Mortgage is only $480/month. Joe and
Mary sign the papers and the $10,000 covers Howard's fee and closing costs from which Steve takes his commission.
Problem is that everything hinged on a teaser interest rate. After a few months the real rate kicked in, 7.5% (sub-prime rate). Mortgage payments went up to $1,190/month.
Joe and Mary couldn't afford these payments. They tried to sell the house. House prices took a dive and they were told they couldn't get
more than $125,000. They had to walk away and the house was foreclosed. Joe and Mary lost the money spent in renovating the house
as well as their good credit.
The local bank allowed all of this because it could sell a bunch of mortgages like that to a
bigger Bank (B). B bundled the mortgages into Collateralized Debt Obligations (CDO). These toxic instruments were traded because they
were insured by Credit Default Swaps (CDS) issued by institutions like Lehman Bros. Completely unregulated so nobody knows how to value them.
So who is to blame? There is plenty of blame to go around. Joe and Mary should have read the fine print and figure out what they were getting into.
Howard and Steve just wanted to get their commission and didn't give a damn about anything else. Bankers and financiers manufactured the CDOs
and CDSs as a way of making lots of money faster.
If you are a liberal you accept Joe and Mary were at fault but feel sorry for them. You believe the blame gets magnified as you go up the
feeding chain.
If you are a far right conservative you are searching for Joe and Mary to teach them a lesson.

That's only part of the story. The CDSs that they had on these loans were stacked up to 30 layers deep. So basically you end up with X actual assets with 30X leverage applied to it. This is why a small change in the number of people who can pay their mortgage results in a huge gaping hole getting blown in the financial system. This is where the counter party risk you hear about in the news comes in. If someone on the other end of the CDS goes under, that breaks the chain in these things. If bank A goes under then he can't pay bank B, which then can't pay bank C and so forth through all the layers of CDS piled up on those assets. If it wasn't for all the leverage being applied to the actual assets the "sub prime" mess wouldn't be that big of a deal. This is where the lack of regulation comes in. These CDS instruments are basically unregulated bets between banks. Initially they were a way to hedge, but then they figured out they could just keep piling them on for more profit. These instruments should never have been allowed to exist in the first place.

I'm not in the mortgage business nor in finance. Since I'll be affected by this bailout as much as everybody else, I tried to figure
out what happened.
You seem to know much more, so I appreciate your corrections and further explanations.
Shortly after Paulson presented his original proposal with the implication that the sub-prime mortgage market was the main cause of
the problem, I sent a note to several politicians. Never got a reply.
I was thinking why not help distressed owner pay their bank mortgage in exchange of an additional government mortgage. With the agreement that
the government will be first in line if there is a foreclosure. I figure that would cost less than the 700 billion. Then, financial institutions wont be able to blame things on the
sub-prime market. And it will buy time during which Congress will pass laws forcing financial institution to disentangle CDS and other such garbage.
Now I'm trying to find out how much money is locked up in the distressed housing market, and what monthly disbursement would alleviate the
situation. I don't know where to look.
It's useless to try to comment on the merits of a bailout proposal without knowing what the real problem is.
Edited by inawe, 30 September 2008 - 10:13 PM.

The excuse for issuing CDSs was to provide insurance for the CDOs. In principle in a CDO package there can be mortgages and other type of
instruments. So we might not just be talking about mortgage related paper. Now, CDS related world market is 62 trillion. So how much junk is in
the institutions Paulson wants to help? Does he have any idea?
As for the credit crunch. If WAMU needed credit from JP Morgan to survive. Why save it if it could take it over when it's about to fail?