Tuesday, September 23, 2008

When The Shit Hit The Fan

Back in March, Bear Sterns sold themselves to JP Morgan while on the brink of almost certain bankruptcy as we so brilliantly chronicled here at Wheeeeeeeeeeeeeeeere's Luke. It was a financial failure that shocked many and the first failure of a major financial institution since Long Term Capital failed back in the 1990s.

Ah, the good old days.

Over the course of the last few months, and especially the last week the shit has truly hit the fan.

The US Government had to make explicit what was once implicit: they backed up Fanni Mae and Freddie Mac, two private but yet public corporations that had a piece of 70% of all American mortgages and in whom most of the world's nations held significant amounts of bonds.

Their downfall would have brought the world economy to a screeching halt.

And, so, to avoid this we bailed them out at $200 billion apiece.

Then, last week Lehman brothers, bailout-less, went into bankruptcy and Merril Lynch sold themselves to Bank of America to avoid a similary fate.

But the real kicker seemed to be my former employer, American International Group. As they teetered on the brink of failure The Fed initially threatened to let them fall while trying to push Goldman Sachs and JP Morgan to bail them out for what was $40 billion, then $50 billion and then $75 billion dollars.

No dice, said the I-bankers.

The government didn't want to have to guarantee their investments and Goldman and JP Morgan weren't going to take that risk.

AIG is an enormous company that does many things: insurance, aircraft leasing, money management, port owners just name a few and I think no one felt they could have possible done an even remotely reasonable amount of due diligence in a day or two.

And, so, The Fed blinked and bailed out AIG.

Why Bear and AIG and not Lehman?

Well, I think it's because while Bear Sterns and Lehman were both the same thing, Investment Banks, essentially what the difference was no one saw Bear about to fall whereas everyone was sitting around sort of watching Lehman fall apart for six months - lessening the investor panic when the eventually fell whereas a Bear fall would have been much more jarring to the markets.

Now, with AIG, I think the problem was, of course, the 'no-one seriously saw this coming' factor but they were also really just too big to let fail.

At the heart of this whole things are CDOs, or credit default swaps, and if you don't know how they work you can check it out here.

AIG was so big and had so much money in these CDOs, basically, insuring banks against potential defaults that if they were to go under it would have meant that those banks that they insured would then have to account for that increased liability on their balance sheets - showing a lot more debt.

To offset all that debt, they would have had to raise more cash but AIG had something in the neighborhood of $500 billion in of these CDOs - that's a lot of pesos.

To put that much debt back into the market overnight would have been catastrophic because none of these banks are liquid enough to come up with cash that quickly which could have resulted in many more banks going under.

And so, The Fed bailed out AIG.

Basically, the financial sector has turned into a giant Jenga game and everyone was too afraid that to pull out the AIG pegs would make the whole fucking thing fall.

It was not, however, a game saver and while the market continued to dive the undertakers sized and sold short on WaMu, Goldman and the like forcing them to consider selling themselves or face dire consequences.

No one knew where it would stop and that is why The Fed has proposed throwing $700 billion dollars at this problem.

Now, I don't profess to really know how to solve this problem, but first we have to identify the problem and what I think is that there are two problems.

First, with these CDOs, basically what happened was that people writing mortgages were able to sell them off and not 'live' with them so they made their money not on getting paid back but on the up front fees and costs which made it beneficial for them to relax their criteria for giving out mortgages. The companies buying these CDOs were making pretty good coin on them for a long time as well. And of course, Americans wanted bigger and bigger houses.

The thing is, everyone lost touch with reality which is that they housing boom had to end eventually. And it did, in a big way.

So, there's that.

But here's the thing that we don't really want to admit.

The problem really is bigger than AIG and Fannie and Freddie and whoever else may have invested unwisely.

The problem.....(drumroll, please)...is Americans.

(I said it, I said it!)

It's me and most of you.

We live our lives buying shit we can't afford. Wanna go to Vegas? Charge it! That house? Charge it! That car? Those shoes? That expensive dinner? That war in Iraq? Those tax cuts? Charge it! Charge it! Charge it! Charge it! Charge it!

We are a Veruca Salt Nation.

"I want it noooowwww!"

At some point that is going to have to change: we can start following a budget or we're going to go broke.

Now, I'm all for getting out of this serious emergency but along with plugging a hole, we have to go on a fiscal diet.

That maybe means no tax cuts and maybe some raises.

That means losing benefits.

That means driving that toyota for another five years instead of getting that Benz you've beeing dying for.

That means figuring out what the fuck we are, in fact, going to do with Medicare once and for all.

So yes, let's step back from the brink and bail ourselves out but let's not kid ourselves: we are bailing ourselves out on a giant credit card courtesy of the U.S. of A. and we're going to have to pay it back, along with our kids and grandkids and, so, we need to wakeup and realize we don't just need to get our I-Banks in order.

We need to put an end to The Credit Card Culture.


Walt Clyde Frazier said...

Very well said, LJT, thanks for clearing up some stuff.

Here's my question, then: I'm the exception then to the average American. I never rack up credit card debt, only buy shit I can pay off that month (including trips), and have not bought a house yet b/c I wanted enough saved for a huge down payment.

It sounds like the consequences to this situation are that in the future, I'll have to "suffer" economically along with all the irresponsible people who bought shit (including homes) that they truly couldn't afford. Like, "Since Mike and John can't stop talking, I'm giving the whole class extra homework."


rick said...

Walt Cylde...swishing and dishing, I think you are probably right. I like the homework analogy.

ChuckJerry said...

I don't think you'll be suffering as much as others will. And if you've been responsible when everyone else hasn't been, then you can actually take advantage of that.

The Notorious LJT said...

i think it's more like as a rising tide lifts all boats, a lowering tide does the opposite - but, at least you don't have a hole in your own personal boat.