Sunday, September 28, 2008

The Financial Crisis

I received this from a friend of mine in Penn. It makes a lot of sense.

As the financial markets tumbled recently, the average American wondered: "What happened?" "Is my money safe?" "How do I pronounce the second 'N' in Bernanke's name?" It's time for simple explanations.

Every American knows this relates to the housing crisis. Real estate always guaranteed a return because it's the only investment with the word "real" in it. The average home purchased in 1970, was worth 87,000 times that in 2006 (though not quite as much today).

The Fed lowered interest rates in the 90s because they liked to mess with the economy. You could buy more money with less money. Money became cheaper. Money was so cheap, it could take itself out to a fancy dinner and still have money to see a show. Banks loaned money to virtually anyone. Suddenly people who could couldn't afford a non-fat vente caramel machiatto were buying McMansions.

Why were banks lending money to people who couldn't afford it? Why weren't banks lending to people who couldn't afford it!? People who can't afford things are the best people to loan to because they're stupid. They don't even know what the letters "APR" stand for. Banks started making, not millions, bazillions (with a "b").

Banks also loaned money to each other to keep the market "liquid." Let's say, I'm Sally Citibank and I have lots of money tied up with those stupid people and I need liquidity. Picture a viscous fluid, like motor oil, poured all over a pile of money. Now picture that money and motor oil being shoved through a pipe and someone on the other end receiving the dollars and oil. The person receiving has to clean the money. Not launder it, just get the oil off it. Actually, this is not a good metaphor, so hold that thought.

Meantime the numerological necromancers on Wall Street devised credit-derivative fault-line swap-meets and everybody wanted in on the deal. No one really understood these instruments or why there were so many hyphens or even why the word "swap" sounds dirty.

This went on for some time while the U.S. government sat by like a parent asleep on the couch while their two year old plays with matches, broken glass and liquid bleach. Ultimately, those people who couldn't afford anything turned out to be smart. When they couldn't pay their bills they did something no one expected: they didn't pay their bills.

Everybody started calling everybody asking for money. No one knew where the stupid people went. Their houses went on the market. No one wanted those houses because stupid people lived in them. Values plummeted. People panicked. The market applied Head-on directly the its collective forehead.

See, the market is like a see-saw with the really fat kid on one end and a bunch of smaller kids on the other side stuck in the air. When the fat kid gets off the see-saw and lets his side go, what happens? The greatest minds of Wall Street had no idea.

No one had ever thought the fat kid would get off his side. They thought if they just kept feeding him and kept his legs from cramping, he'd never get off. No one thought the fat kid might get bored. The fat kid went home and the smaller kids went home too and some sat in their room drawing nasty pictures of the fat kid.

It was up to the government to step in and say, "What the hell is going on here!? Why are you drawing those pictures? Why aren't you getting more exercise instead of sitting on a see-saw and eating. Who poured motor oil on this big pile of money?"

The government is in a unique position because it can print money. The government can also regulate the markets by borrowing from itself with a low teaser rate then not pay itself back and then default on the loan and finally raise taxes.

Who pays for this? The American Taxpayer. Luckily, the American Taxpayer doesn't really exist. Taxpayers are like extras in the movies. They do nothing important and just walk around in the background.

We haven't answered all of the questions and there will be more uncertainty. "How can this be prevented? Will this happen again? Where can I learn to print money?" For the moment, the answer is clear: remain calm, stay informed and don't say you don't understand. It's all very simple.

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