My take on why the financial world exploded

[pinoyhero]

I'll try to keep this short but wanted to get some thoughts.

The reason why the financial world exploded was because people got overly comfortable with the idea that there was free money lying around. By that I mean that there was a risk free way to make more than the risk free rate of something sub 5%.

People quit actually researching where their money went and just blindly rammed it into stocks/real estate or other historically higher than risk free return investments and assumed the trends would continue. There is no "free lunch", no arbitrage in efficient markets. The reason for this is that if there were then the market (including the teams of PhD quants and proven investment giants) would correct those anamolies. Something was paying a 7% or 20% or 30% return because it carried more risk than the GIC or other more risk-free investment. Poeple forgot about that, they didn't bother researching where they were putting their money and are now seeing the downside of the additional risk taken.

Problem was that with people just throwing money at investments, those that run the investments are free to do as they please and report as poorly as they were because the market is signalling that everything they are doing is fine.

[The Cosworth]

Originally posted by pinoyhero
I'll try to keep this short but wanted to get some thoughts.

The reason why the financial world exploded was because people got overly comfortable with the idea that there was free money lying around. By that I mean that there was a risk free way to make more than the risk free rate of something sub 5%.

People quit actually researching where their money went and just blindly rammed it into stocks/real estate or other historically higher than risk free return investments and assumed the trends would continue. There is no "free lunch", no arbitrage in efficient markets. The reason for this is that if there were then the market (including the teams of PhD quants and proven investment giants) would correct those anamolies. Something was paying a 7% or 20% or 30% return because it carried more risk than the GIC or other more risk-free investment. Poeple forgot about that, they didn't bother researching where they were putting their money and are now seeing the downside of the additional risk taken.

haha, I was thinking about this yesterday and I had the same sort of thought proces.


One thing I can see also is that people are panicking. In NA the majority of the population is going to retire soon, and most have their savings invested in some sort of market that has taken a beating. So what do people do? They pull out their money (either literally or through their fund manager), which devalues the fund because the next largest group of population (our age) isn't really investing in this environment. This causes the markets to plummet further NATURALLY.

Personally everyone who is calling global conspiracy are missing the obvious I think.

[ChappedLips]

Thew media is also fueling the fire, everyday you switch on the news or look at the paper its doom and gloom.

[e36bmw///]

nm

[01RedDX]

.

[broken_legs]

Originally posted by e36bmw///
i think short selling had a lot to do with it too

The LACK of short selling is why there hasn't been a 'rip your face off' rally and the markets have continued to decline.

See Short Squeeze.


Short selling of financial stocks was banned by the SEC.

[old&slow]

Originally posted by ChappedLips
Thew media is also fueling the fire, everyday you switch on the news or look at the paper its doom and gloom.

You mean like this? Excerpt:

http://news.bbc.co.uk/2/hi/business/7665515.stm

The world financial system is teetering on the "brink of systemic meltdown", the head of the International Monetary Fund (IMF) has warned in Washington.

Dominique Strauss-Kahn said the crisis was being fanned by fears over debt-ridden banks but added rich nations had so far failed to restore confidence.

He spoke after talks with US President George W Bush, Group of Seven (G7) finance ministers and the World Bank.

Mr Bush said the global economic crisis needed a united international response.

Speaking in the US capital on Saturday, Mr Strauss-Kahn said: "Intensifying solvency concerns about a number of the largest US-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown."

George Bush says the US will lead the response to the crisis

The IMF chief was joined at the White House by finance ministers from the G7 most-industrialised nations (the US, Canada, France, Germany, Britain, Italy and Japan), as well as World Bank President Robert Zoellick.

Following talks with the economic leaders, Mr Bush said: "We must ensure the actions of one country do not contradict or undermine the actions of another.

"In an interconnected world, no nation will gain by driving down the fortunes of another. We are in this together. We will come through it together."

[benyl]

This is the echo of the Dot com bubble. In order to kick start the economy, the Fed set interest rates super low to keep people spending.

The "pursuit of happiness" became "I want a 3000 sq ft house, a BMW and to live the 90210 lifestyle."

How do I that when I make $30 / hour?

Easy, it is called credit. Credit was too easy to get and now we are in this mess.

De-regulation and the acceptance of subprime mortgages were next.

[rc2002]

Originally posted by 01RedDX
Human greed

That pretty much sums it all up.


I agree with Benyl. The easy credit was the driving factor behind the whole mess. They knew this was going to happen (exactly what happened in Japan) but thought it was worth it to kick start their economy out of recession after the dot com bubble burst.

If they let the economy revive itself after the dot com bubble instead of making money so readily available to everyone then this current bear market wouldn't be so severe.

[googe]

yep, proof that deregulated, unchecked FREE MARKET doesn't work ;)

[ExtraSlow]

Originally posted by googe
yep, proof that deregulated, unchecked FREE MARKET doesn't work ;)
Looks like it's working fine to me. Market goes up, market goes down. That's how it's supposed to work.

[pinoyhero]

Originally posted by 01RedDX


But investors are only one part of the problem.

You should also blame:

- The banks and lenders for using careless management and administration practices.

- The government, for failing to provide proper regulation and oversight for their own puppet institutions.

- Human greed

Agreed, the bank made the same nistake though ... lend to anyone because worst comes to worst you get their house which is going up in value so regardless you safe right? Wrong.

The govt. can't shoulder all the blame, they didn't force anyone to invest, people just blindy do.

Greed is exactly what I'm talking about.

[pinoyhero]

Originally posted by ExtraSlow

Looks like it's working fine to me. Market goes up, market goes down. That's how it's supposed to work.

Can't agree more, there's no fre money, a 10% mut fund that always returns 7% more than risk free pays more than risk free because it has risk.

[benyl]

did you know that when Daimler Benz and Chrysler merged, chrysler's CEO made 9.8 million a year? The boar of Daimler, which was 10 people, had a total salary of $11 million between all of them.

That is greed. Especially when CEOs get bonuses even when the company loses money. How the he'll does the CEO of washingon mutual, who only worked for 3 weeks walk away with $18 million. We,in north America don't reward performance, we reward greed.

[broken_legs]

This is how I understand things went down:

1.) Fed Drops interest rates to ridiculous levels to stimulate economy
2.) Commercial and investment bank regulations are repealed allowing them to invest up to 40 to 1 margin. Historically banks had to stay at 15 to 1, I believe.
3.) Predatory Lending policies and so called liar loans become common place thanks to abuse of mortgage lending rules and greed all along the chain from mortgage brokers, to banking executives.
4.) Some smart people on wall street figured out that they could package all of these liar loans into bundles of "safe investments"
5.) Investment banks take advantage of these new so called safe investments at 40 to 1 leverage making massive profits.
6.) Credit and Bond rating agencies somehow manage to give these ridiculous CDO bundles AAA credit ratings.
7.) Insurance companies offer insurance on these new instruments at pennies on the dollar. This means that the lender has no credit risk if the loan defaults. The insurance companies assumed this was a solid investment and didnt charge a high enough rate, so when things defaulted they were left high and dry.
8.) Credit Default Swaps were invented as a derivative of credit. It's basically a contract that lets the owner of debt hedge against a default. ie the credit defaults and the CDS contract goes up in value thus canceling the downside of holding the bad debt.
9.) The CDS market is abused and soon becomes an arena of speculation among hedge funds and other invetment banks. The CDS market in the US becomes valued at 15 TRILLION dollars
10.) Inevitably, home loans start to default. The massive leverage applied to these CDS and CDO vehicles creates unthinkable losses to investment banks.
11.) Rating agencies start cutting credit ratings reducing trust among banks
12.) Mark to Market rules require banks to mark down their mortgage portfolios causing massive losses of equity and more credit downgrades.
13.) Banks start failing. Trust is lost amongst intitutions and interbank lending rates go sky high. Credit dries up teh federal reserve intervenese, the governemtn socializes banks and mortgage insurers
14.) House of cards collapses

[googe]

Originally posted by ExtraSlow

Looks like it's working fine to me. Market goes up, market goes down. That's how it's supposed to work.



Originally posted by pinoyhero


Can't agree more, there's no fre money, a 10% mut fund that always returns 7% more than risk free pays more than risk free because it has risk.

anything the causes widespread hardship, recession, depression, or a crash of any sort, is synonymous with something that "didn't work." by your logic, if it went up and stayed up, that would be "not working" then?

haha, forget it actually, anyone that says an economy that requires spending a trillion dollars to bail out a country (and it continues to crash in spite of the effort) is still "working fine" is certainly not capable of rational thought :nut:

you can't call this anything short of economic failure and hope to maintain a shred of credibility.


in unregulated free markets, the people get fucked...hard. and that's just what happened.

who caused it is irrelevant - it didn't work, plain and simple.

take a lesson from Jim Flaherty, canada's finance minister, to see why he used strict regulation to avoid the obvious path to doom that the US hit.

http://money.canoe.ca/News/Economy/2008/10/08/7017666-cp.html

[googe]

Originally posted by benyl
We, as humans, don't reward performance, we reward ourselves.

fixed :D


Funny thing I noticed when I moved down here...people in Alberta talk about how people are borrowing beyond their means and it's a huge dangerous situation. I thought it was more or less similar to the states, but it's pretty shocking actually. The questionable loans up there are *nothing* compared to what's been going on. I know a mortgage broker in Canada, and for all intents and purposes, he's a pretty average guy. He has a college education, does his 9-5, makes a healthy but modest living.

I came down here and made friends with a guy, who shortly after, got a job as a mortgage broker. He has no education, is a massive party animal, gets $20,000 commission cheques every 6 weeks or so, blows through it as fast as he can on partying, buying rounds of drinks for everyone...not because he's pretending to be a baller, dude is down to earth, generous, and...regards money as completely disposable. Sleeps on someones couch, and really just doesn't care. His office is full of people like him. He said anyone can work there as long as they can sell. Don't need the first clue about finance or even how to use a calculator. Sounded right out of the movie Boiler Room. Everything changed a few weeks ago though, now he's working for minimum wage and the brokerage disappeared into the night.

Chances are, the first guy I met when I was down here, wasn't the only one working at a place like this. If it took me that long to encounter one, I'm sure the entire country is full of them.

Haha, what it comes down to is, more often than not, if you give someone a legal way to take your money, they'll take it. That's what deregulation is.


I still have a charge on my energy bill to recoup the costs that the state of California went into massive debt for during the Enron scam. In case any are unaware...Enron made the largest campaign contributions to 1 specific Sentaor (a republican obviously). That Senator was able to pass legislation to deregulate energy. Enron's profits went from $12 billion in a quarter to $48 billion instantly, and they state couldn't "afford" power. The entire state of California went DARK 38 times with rolling blackouts.

It's the same thing every time. Someone calls for regulation because they know it's an absolute necessity. The handful of executives and politicians making a killing by exploiting everyone step up and convince the public that would be "communism" or "socialism", and commies are bad! Vote no! The sheep that don't know any better, but know that they're supposed to hate communists, vote no. Usually it's democrats that manage to reasonably keep a lid on things for a short time, then the republicans come along, rape and pillage everything for a good while, people realize how bad they got fucked, a democrat comes and starts saving what little is left and stabilizes things, and half the general public forgets the lesson and republicans come back and fuck it all up again.

Surprise, 8 years of Bush and Cheney running everything deep into the ground, now everyone realizes they need Obama to come clean up the mess.

[pinoyhero]

Originally posted by benyl
did you know that when Daimler Benz and Chrysler merged, chrysler's CEO made 9.8 million a year? The boar of Daimler, which was 10 people, had a total salary of $11 million between all of them.

That is greed. Especially when CEOs get bonuses even when the company loses money. How the he'll does the CEO of washingon mutual, who only worked for 3 weeks walk away with $18 million. We,in north America don't reward performance, we reward greed.

You know why this happens? Because the investor lets it happen, if the market thought this was wrong then they should not have been buying/holding the companies' stock. By not selling and sending the market signal, they are effectively saying that this is fine.

[liquid1010]

Originally posted by broken_legs
This is how I understand things went down:

1.) Fed Drops interest rates to ridiculous levels to stimulate economy
2.) Commercial and investment bank regulations are repealed allowing them to invest up to 40 to 1 margin. Historically banks had to stay at 15 to 1, I believe.
3.) Predatory Lending policies and so called liar loans become common place thanks to abuse of mortgage lending rules and greed all along the chain from mortgage brokers, to banking executives.
4.) Some smart people on wall street figured out that they could package all of these liar loans into bundles of "safe investments"
5.) Investment banks take advantage of these new so called safe investments at 40 to 1 leverage making massive profits.
6.) Credit and Bond rating agencies somehow manage to give these ridiculous CDO bundles AAA credit ratings.
7.) Insurance companies offer insurance on these new instruments at pennies on the dollar. This means that the lender has no credit risk if the loan defaults. The insurance companies assumed this was a solid investment and didnt charge a high enough rate, so when things defaulted they were left high and dry.
8.) Credit Default Swaps were invented as a derivative of credit. It's basically a contract that lets the owner of debt hedge against a default. ie the credit defaults and the CDS contract goes up in value thus canceling the downside of holding the bad debt.
9.) The CDS market is abused and soon becomes an arena of speculation among hedge funds and other invetment banks. The CDS market in the US becomes valued at 15 TRILLION dollars
10.) Inevitably, home loans start to default. The massive leverage applied to these CDS and CDO vehicles creates unthinkable losses to investment banks.
11.) Rating agencies start cutting credit ratings reducing trust among banks
12.) Mark to Market rules require banks to mark down their mortgage portfolios causing massive losses of equity and more credit downgrades.
13.) Banks start failing. Trust is lost amongst intitutions and interbank lending rates go sky high. Credit dries up teh federal reserve intervenese, the governemtn socializes banks and mortgage insurers
14.) House of cards collapses

That pretty much sums it up... good post. What's your background?

[Antonito]

Originally posted by pinoyhero


You know why this happens? Because the investor lets it happen, if the market thought this was wrong then they should not have been buying/holding the companies' stock. By not selling and sending the market signal, they are effectively saying that this is fine.

And another example of the market and the invisible hand being incompetent

[Mys73ri0]

Originally posted by Antonito


And another example of the market and the invisible hand being incompetent

everyone who says this is the fault of 'free market' and the 'invisible hand' is wrong... there has been tonnes of government interventions in this whole thing for a long time now...

Read up on Fannie Mae, and Freddie Mac

http://en.wikipedia.org/wiki/Fannie_Mae

http://en.wikipedia.org/wiki/Freddie_Mac

nice post broken legs - i'm curious what your background is as well...

[ExtraSlow]

Originally posted by googe
in unregulated free markets, the greedy, impatient and lazy people get fucked...hard. and that's just what happened.

Fixed.

Aww fuck it, I can't "maintain a shred of credibility."

[01RedDX]

.

[broken_legs]

Originally posted by liquid1010


That pretty much sums it up... good post. What's your background?



Thanks.


Oilfield Scum :thumbsup:

[Mys73ri0]

Originally posted by 01RedDX

I don't understand what you're getting at here... just because they are government-sponsored doesn't mean there was any kind of actual regulatory intervention.
The US department of housing and something was responsible for setting the 'goals' that both Freddie and Fanny had to meet. Unless I'm completely misunderstood everything - they were forced to buy risky mortgages from low to mid income families because it was what the government wanted.

straight from the article I quoted

In 1999, Fannie Mae came under intense pressure from the Clinton administration to ease its credit requirements on mortgages it is willing to purchase in order to encourage lenders to extend more mortgages to borrowers with low to moderate income and improve rates of home ownership among those groups. Shareholders also pressured Fannie Mae to purchase mortgages below its conventional credit standards in order to maintain its record profits.[7] In 2000, due to a re-assessment of the housing market by HUD, anti-predatory lending rules were put into place that disallowed risky, high-cost loans from being credited toward affordable housing goals. In 2004, these rules were dropped and high-risk loans were again counted toward affordable housing goals.[8]
Unfortunately I can't any 'official' US sites that list HUD's affordable housing mortgage program but this article has some information on it.
http://sweetness-light.com/archive/2004-hud-ups-goals-for-fannie-freddie

[googe]

ItedhWk7jBA

[Eleanor]

Originally posted by googe
yep, proof that deregulated, unchecked FREE MARKET doesn't work ;)
Easy comerade, "Better dead than red" :D

[aram1000]

Originally posted by broken_legs
This is how I understand things went down:

1.) Fed Drops interest rates to ridiculous levels to stimulate economy
2.) Commercial and investment bank regulations are repealed allowing them to invest up to 40 to 1 margin. Historically banks had to stay at 15 to 1, I believe.
3.) Predatory Lending policies and so called liar loans become common place thanks to abuse of mortgage lending rules and greed all along the chain from mortgage brokers, to banking executives.
4.) Some smart people on wall street figured out that they could package all of these liar loans into bundles of "safe investments"
5.) Investment banks take advantage of these new so called safe investments at 40 to 1 leverage making massive profits.
6.) Credit and Bond rating agencies somehow manage to give these ridiculous CDO bundles AAA credit ratings.
7.) Insurance companies offer insurance on these new instruments at pennies on the dollar. This means that the lender has no credit risk if the loan defaults. The insurance companies assumed this was a solid investment and didnt charge a high enough rate, so when things defaulted they were left high and dry.
8.) Credit Default Swaps were invented as a derivative of credit. It's basically a contract that lets the owner of debt hedge against a default. ie the credit defaults and the CDS contract goes up in value thus canceling the downside of holding the bad debt.
9.) The CDS market is abused and soon becomes an arena of speculation among hedge funds and other invetment banks. The CDS market in the US becomes valued at 15 TRILLION dollars
10.) Inevitably, home loans start to default. The massive leverage applied to these CDS and CDO vehicles creates unthinkable losses to investment banks.
11.) Rating agencies start cutting credit ratings reducing trust among banks
12.) Mark to Market rules require banks to mark down their mortgage portfolios causing massive losses of equity and more credit downgrades.
13.) Banks start failing. Trust is lost amongst intitutions and interbank lending rates go sky high. Credit dries up teh federal reserve intervenese, the governemtn socializes banks and mortgage insurers
14.) House of cards collapses

Very good synopsis on what has gone on, hopefully we can learn from these hard lessons and not let history repeat itself, though human greed can be a hard beast to tame

[Xtrema]

Originally posted by aram1000


Very good synopsis on what has gone on, hopefully we can learn from these hard lessons and not let history repeat itself, though human greed can be a hard beast to tame

Never. There will always something creative to by pass rules and regulation. And those people who comes up with it will get paid big $$$$.

[ExtremeSi]

For once I actually feel good about being a student and having no debt other than student loan debt! I'm getting a little worried about the job market when I graduate next year though...