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.