Tuesday, September 16, 2008

saving grapes

Ahh, back in the comfy clothes and taking a nice evening walk to think over the radio show called 'the Giant Pool of Money' I listened to a couple of hours ago. Now I know most of you are too busy to spend much time studying the basics of the current economic difficulties but after I saw the Secretary of the Treasury, Henry Paulson, telling everyone that the 'experts have it all under control' ( ..just move along, folks - nothing to see here), I decided to spend some time paraphrasing that program I mentioned in order to share the essentials with you. I mean who the heck are these 'experts' anyway? Are they the same experts who created the problem and if so, you wouldn't trust them with the milk money. It will take more than one session but I'll do my best to keep to the main points. Here goes with the first part:

According to a very nice lady named Ceyla Pazarbasioglu who is the head of capital market research at the International Monetary Fund the total amount of money in the world is approximately 70 trillion dollars. This refers to the subset of global savings called fixed-income securities which for most of modern history, meant buying really safe investments: things called treasuries and municipal bonds. Boring things. In 2000 the total amount of money in these funds was about 36 billion - an amount it had taken the world hundreds of years to accrue but things changed.

How did the world get twice as much money to invest? Lots of things happened, but the main headline is all sorts of poor countries became kind of rich making TVs and selling us oil: China, India, Abu Dhabi, Saudi Arabia. They made a lot of money and banked it. Suddenly there was twice as much money looking for investments, but there were not twice as many good investments. So, the global army of investment managers all wanted the same thing: a nice low-risk investment that paid some return.

Then along came a not so nice man named Alan Greenspan, who by dropping the interest rates in the US to one percent, essentially told the world's investment bankers they were not going to make any money at all on US treasury bonds for a very long time. Go somewhere else.

So the global pool of money looked around for some low-risk, high-return investment. Among the many things they put their money into was the residential mortgage trading desk in the US. Mortgage interest was 5-9 percent - a heck of a lot better looking than the Fed's one percent - and this money was being paid to banks. The 70 trillion dollar pool was very interested in joining the action but for one problem - individual mortgages are too big a hassle for the global pool of money. Basically, what Wall Street did, was to figure out how to give the global pool of money all the benefits of a mortgage without the bother or the risk.

The chain works as follows: Clarence gets a mortgage from a broker. The broker sells the mortgage to a small bank, the small bank sells the mortgage to a big investment firm on Wall Street.

The firm takes a few thousand mortgages they've bought this way and puts them in one big pile. Now thousands of mortgage checks come in every month - a huge stream of money, which is expected to come in for the next thirty years, the life of a mortgage.

Then they sell shares of that monthly income to investors. Those shares are called mortgage backed securities. And the 70 trillion dollar global pool of money loved them.

We all know this hasn't turned out so well but I'm tired now and a branch is calling (and not a branch bank either). I'll return soon with part 2.

11 comments:

  1. Economics is probably the most important field in our daily lives whether we wish to acknowledge it or not, and that's frustrating because the idea of spending all of my brain's energies on thinking about money makes me want to go into a permanent state of catatonia.

    Music, on the other hand, I could spend lots o' energy on that. Yes, that is a tag for thee.

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  2. ohh gosh, you only got it half right.
    those guys weren't happy earning only 5% on mortgages, so the investment houses divided those pools into tranches, then they divided the tranches into subtranches, and they borrowed money to leverage those investments even further.
    then, because they were borrowing money to purchase pools of already borrowed money, they decided to "insure" the pools by using as collateral the very pools they were insuring (it was a great way to add "liquidity" and generous fee income to their bottom lines).
    then, of course, they'd take the income from their derivative investments and use it as further collateral to borrow even more money to lend to people who were desperate to own a home (after all, most poor people know the differance between haves and have-nots in america is home ownership. they'd do anything to own a home, and who can blame them?)
    how stupid was that? the international monetary fund thinks about one trillion dollars will be lost by the time everything sorts out.
    thank god america's founding fathers built square caskets, or they'd be rolling in their proverbial graves over this.

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  3. randal - It certainly underpins the politics but it is exhausting, I agree.

    sera - So can you stop by to help Crow out when it all gets too much? That was a great breakdown of what these turkeys have been up to the last 6-7 years and I'm very impressed. I need a tranch sandwich.

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  4. This is economics I can sorta get. Susan, you talk my language. I better write to McCain's people and direct him over here. Like me, he doesn't understand economics too well, either.

    I emphatically agree with the milk money part of the post.

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  5. be - The milk money part was original but the post itself is pretty much direct from the first 15 minutes of the radio show I linked to. It's only an hour long and really is the most comprehensible description of what happened and why that I've seen.

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  6. Hi Susan

    You have just exposed the myth of the Greenspan era (1987-2006) whose loose monetary policy (following the dot com bubble bust) and lack of regulation helped sow the seeds for what has happened.

    I notice Henry Paulson is also making all of the running with Ben Bernanke with barely a word from George Bush.

    According to our Reserve Bank Governor Glen Stevens in a speech today~its likely they will come up with a much better system of regulatory control,rather a regultory role that only acts on deficiencies after the events as has dogged administrations.

    Best wishes

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  7. lindsay - I hope they do come up with something better but the devil is in the details and it wouldn't surprise me to see a major devaluation of the dollar. These people have been criminally irresponsible and we face the possibility of the same crowd returning.

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  8. Lol, no joke. What a massive cluster f*** that turned out to be. These people have no idea what they are doing most of the time. And we call them experts why?

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  9. avshar - It appears they're experts in lining their own pockets at the expense of everybody else.

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  10. a tranch sandwich. lol.
    it is an old chinese recipe:
    you eat it and an hour later
    it's gone and you're hungry.
    the secret ingredient? nothing.

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  11. sera - I got a request for T-bill interest in a fortune cookie this week.

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