BOOM!!!! Financial Meltdown!

[gunrock]

There's only one place all of this will end up - stuff being cheaper again.

Not necessarily. We're in a "perfect storm" at the moment, lots of uncommon and unusual events occurring in short succession. But what we do have to contend with is fuel prices, food and water costs being higher and that treand continuing, and whilst the latter two are affected by the former, I think that the higher cost of gas and electricity (for us in the UK; capcom_suicide will be fine!) is going to have a continual affect on us for the foreseeable future.

[Space Monkey]

.....

[abigsmurf]

Not entirely true. The money exists but it's incredibly obfuscated in loans between banks and investments in commodities, shares and businesses.

Bank A borrows money from bank B so that it has liquid cash it can use to to fund mortgages. It sells 10 mortgages with that money and as they now effectively own 10 homes, they use the value of those homes to fund a loan to bank C. Bank C does the same thing, investing in mortgages and it builds up enough money for Bank A to eventually borrow money from Bank C.

Whilst this is going on, all three banks are making money off of the interest of the mortgages (which is comes out of the homeowner's salaries) and everyone is happy, the three banks are making money and the homeowner has his mortgage. If the mortgage falls through, no money is lost as the homeowner gets his house repossed and the banks get the outstanding balance on the house because there's plenty of equity to cover costs.

However they're making so much money, the smaller banks D, E and F decide to get in on the market, only A,B and C have taken all people with good credit. Banks D, E and F figure that house prices are going to keep rising so that they can lend to basically anyone and it doesn't matter if they keep up with the payments for the mortgage as they'll still have enough equity in their houses.

Banks A, B and C are making lots of money but they want to make more, especially as banks D, E and F are encroaching in their market so they try a novel approach. Rather than set up their own mortgages, they'll 'buy' them. They approach banks D,E,F and offer to buy the mortgages off of them so that, instead of receiving $100,000 over 10 years for a mortgage, they'll receive a single payment off of them of $80,000. D,E,F get to make a profit on the $70,000 the mortgage cost them, A,B,C get to make $20,000 profit over the 10 years of the mortgage. They then use this profit to lend more money to D,E,F so that they can fund more mortgages which they will then buy off of them.

Whilst there's very little physical money flying around throughout these transactions, all 6 banks are making money. That is however, until house prices fall.

House prices fall and suddenly, people no longer have equity. This means when they declare bankrupcy, the bank loses a huge amount of money. Suddenly banks A B and C find themselves running out of liquid funds. They're unable to fund the mortgages of D,E,F and D,E,F become insolvent.

A, B,C even stop lending between themselves as they've millions of mortgages that may never be paid off. With little lending between these banks, their business starts to suffer and they make big losses.

All the money that was floating up in the air suddenly comes crashing down and has to be paid for. A big chunk of the money has already come from houses dropping in value but the rest comes in the value of shares, savings, pensions and over investments. Even at banks who had been lending responsibly, because they have investments tied to the other banks in an obscure way.

Thus we have the situation we have now. Every time a bank collapses, all the debt is has on its shoulders will crash onto the rest of the market which in turn risks other banks collapsing, potentially leading to a big depression.

It's not to be confused with the great depression though. The great depression was caused largely by laymen investing in the market and companies like Ford saturating their markets and finding themselves unable to grow their profits. Here it isn't citizens and business, it's the banks who are at fault.

Hope that's clear and accurate

[funkydan]

Very well explained abs, thank you for that.

I do feel sorry for the 25000 people at Lehman in NY (20000) and London (5000) that lost their jobs yesterday - it's gonna be hard for them all to get work again in the financial sector with them all looking for jobs!

[Red Hogg]

Don't banks make money by lending to customers though? If they stop doing this how do they ever expect to get out of this mess?

[saif]

El Leone, if 5% is not inflation, what is? Remember inflation figures are based on the prices of LOTS of products, not just the fact that the price of cod has gone up.

Reading around on the web, there seems a total lack of sympathy for bankers in this and it is understandable. It seems modern capitalism is based on passing risk on to the public sector and taking profit (with a little bit of joyous tax evasion - yes I said evasion - thrown in) to the private sector. I am sick of the way that the corporate sector is set up to take money from the state again and again and used for selfish means. The US corporate sector has been morally bankrupt for some time and I am sure that the people that have had their lives destroyed by the banks profit motives will allow themselves a little schadenfreude.

[MattyD]

I always understood that banks had a certain amount of worth in real terms (balances in their books, bonds, shares etc) but that they made money by essentially 'making' it out of nothing when they pay you your interest, dole out lones etc.

From my limited understanding of how banks work I thought this is why banks can close down if everyone tries to draw out their cash all at once like happened in the Great Depression and more recently to Northern Rock.

The whole thing disgusts me more than worries me - I find usury in all its forms incredibly immoral and it winds me up to think there are people in the City who take home several times what I earn with my graft in two or three years as a single bonus, just by manipulating and exploiting the financial system and people's confidence in it (for share and commodity prices etc).

I do have some degree of worry closer to home though as my wife works for one of the large corporate investment banks. They aren't in any trouble as far as I know but when top five companies are going to the wall you never know and there's always the worry she might be made redundant.

[funkydan]

Exactly, that's why interest rates are on the rise, in a vain attempt to stop the whole shebang going completely tits-up!

[Mayhem]

El Leone, if 5% is not inflation, what is? Remember inflation figures are based on the prices of LOTS of products, not just the fact that the price of cod has gone up.

He said that the quoted inflation rate is 5% but the "true" or "real" inflation rate is higher than this. It depends what matters to you most... but certainly everything that you may need to maintain a general constant level of wellbeing (food, petrol, heating fuel etc) and various charges levied upon yourself (eg. council tax) have gone up by more than 5% in the last year...

[bangaio]

I used to work in the global debt dept of a US IB where we structured debt - now I am a teacher. It is a lot better.

Seeing the crap that goes around on the news it it no wonder people have no idea what is happening but the off balance sheet stuff makes me laugh. Radio 1 this morning:

"Lehmans went bust because of bad mortgages" Yeah right!

Banks that lend have to set aside capital as required by law. If they only have so much capital they can only issue so much debt sooo.......

An SPV (set up by the arranger not the bank - that would be too grey an area) issues bonds into debt capital markets. Proceeds of bonds buys mortgage pool from bank thus freeing up the capital to issue morer mortgages. The interest people pay on their mortgages pays the bond's interest to the bond holders. Big deals tend to be classed to that the top rank bonds get the paid first but have the lowest interest rate then the next class gat paid but have a slightly higher rate because if people default on their mortgages they have less chance of receiving the interest flow. This was fine until everyone stopped paying their interest on their mortgages in the US so now loads of bond holders don't get paid and the markets that trade off these bonds slows down. Banks don't make as much money - get wary of lending to each other and people then can't borrow so more people stop paying mortgages etc etc etc.

We would "repackage"/"securitise" everything from credit card debt to regular corporate bonds to student loans. If it was debt it would most likely be moved of a lenders balance sheet to an SPV in the cayman islands.

Oh happy days - still sorry for some mates at Lehmans.

[bangaio]

Don't banks make money by lending to customers though? If they stop doing this how do they ever expect to get out of this mess?

Remember Lehmans lends nothing much - they are mainly offering trading/brokerage, advisory (corporate finance) structuring and research. As such they exist to invest and make money along with the ancillary jobs that go with that eg. providing analysis/research on different markets.

[dataDave]

What's next?

World War III. Did you watch Zeitgeist?

Where's Fallows with some craziness??

This is so two weeks ago for me.

I'd personally like to see everybody on the planet unemployed and actually working together in order to sustain ourselves outside of the whole system.

I feel for the (already) starving.

[spagmasterswift]

This is so two weeks ago for me.

I LOLed. Why didn't you warn people, you need to get a sandwich board STAT!!1

By the way this is a really informative thread - well done all!

[Nijo]

This is so two weeks ago for me.

Heh, this is so 12 months ago for me.

http://ntsc-uk.domino.org/showthread.php?t=79432

If AIG dies this week it's gonna get much worse....

[dataDave]

Seriously though, some US people that seem to be full of sense are absolutely ****ting where all this could lead. Have a look on Youtube.