Wall St, FUBAR ! 2

Now that the dust is settling (hopefully) and capitol hill is busy in finalizing the mother of all bailouts, I'll try to explore the causes for the crisis.

As I see it, these're the causes.

Insanely low interest rates from 2004 to 2006
Sub prime Lending
Predatory Lending
Derivatives
Lack of Regulation

and the Housing bubble burst.

Low Interest Rates
Post 9/11 Fed decreased the rate consistently. And from Jun '03 to Jun'04 the rate is 1%. Alan Greenspan advocated that rate cut would help the Housing. But too much cash flow to bankers made'em look out for more people to lend their easy money.

Sub prime Lending
Sub prime is jargon for people with bad or avg credit history. Usually this group wouldn't be eligible for housing loans. But as there is too much money to lend, realtors and mortgage bankers lend the money to this group.

A couple making 75G per year bought a 450G home without a down payment in SoCal. No income verification! How is this possible? Here comes the different types of Mortgage Products. ARM (Adjustable Rate Mortgage) is one of them. With this kinda mortgage, lenders can pick their payments for the first 3 years. Obviously people paid interest only for the first 3 years. And then the Bankers used all the Predatory Lending practices.

Predatory Lending
So Bankers convinced this public that they can refi or sell their house after 3 years if they can't afford the payment. But apparently they're not informed that they can't refi the home before 3 years. So after 3 years the teaser rates ended and the real payments kicked in. As many people didn't pay any Principal in the first 3 years, you can imagine how much the monthly payments would go up. Now this public couldn't get their homes refinanced coz of the credit crunch, new lending standards and the phenomenal loss of house values. Even though the borrowers are really foolish, Mortgage lenders had intentionally hidden these details in their paper work.

Derivatives
As there is risk in all the sub prime loans, these loans we're sliced and repackaged as Derivatives ans sold all over the world. this reduces the risk to lending firm. The problem here is that no one really knows, which toxic loan effects a derivative. When Fed was trying to convince Goldman Sachs and Morgan Stanley AIG, they couldn't figure out how many toxic derivatives are in AIG books and how they would be affected.
And they backed out. Warren Buffer once called'em Weapons of Mass Destruction. Here's a pic which shows how loans are packaged into Derivatives. (Courtesy wikipedia)

These Derivatives are the main reason for Bankruptcy of walls st firms. As the housing foreclosures are increasing, these derivatives are losing their value. Panic on the wall st brought down the share value. It's just another illustration of Domino effect.

Lack of Regulation
Every year Wall st contributes millions of dollars to the both parties. In return they get no regulation or regulation of no use. This is the Free Market capitalism at it's best. When the street is making profit, they lobbied for lower taxes on Capital gains and got the 15% tax rate and tax cuts. Now they got the bail outs. AIG is just an insurance company. But it got involved into Derivatives trading and insurance. Reason, no regulation.

Dick Fuld, CEO of Lehman Bros got 180 Mil in compensation last year. CEOs of Freddie Mac and Fannie Mae got the golden parachutes on their compensation package already. Thank God, Fed fired'em already and the chances that they'll get any severance package are very low. I saw Henry Paulson's and Bloomberg's take on CEO pay on Meet the Press this morning. watch it here

Like all good things, Housing Bubble came to an end in 2007. Home Prices're in Free fall mode. Bankruptcy of sub prime mortgage companies signaled the incoming financial storm. Apparently we saw that very late.

Some one on wikipedia, put all this mess into a good pic.


Peace.