What Really Triggered the Financial Crisis?

[Joanne98]

The Shadow Banking System Blew Up

By MIKE WHITNEY

Most people still don't know what caused the financial crisis. They know it had something to do with subprime mortgages and Lehman Bros, but beyond that, it gets rather hazy. Unfortunately, Congress appears to be in the dark too, which is why their attempt to regulate the system is bound to fail and pave the way for another crisis in the next few years.

The real source of the the last crisis is a design-flaw in the architecture of the modern banking system. This sounds more complicated than it really is.

You see, credit, which used to be strictly regulated--since it allows banks to create money out of thin air--has become a franchise which is shunted off to hedge funds, insurance companies, pension funds and other so-called shadow banks which are able to take advantage of loopholes in the system and create gigantic amounts leverage without any regulatory supervision.

At one time, when a bank made a loan, they made sure that the applicant had a job, steady income, collateral, and a good credit history. That's because the banks knew they would be holding the loans to maturity and any loss on the loan would impact their profitability. That's the only way that it's safe to allow private industry (aka--the bank) to create credit. The financial crisis proves that unregulated credit-generation is every bit as lethal as a neutron bomb, which kills everyone in the vicinity, but leaves the buildings still standing. The credit-mechanism cannot be handed over to unregulated speculators without putting the entire economy at risk.

The new system works differently. Now the banks are largely middle-men who originate the mortgages, (or other loans) chop them up into bits and pieces in their off-balance sheet operations, and sell them to investors in the secondary market. The process is called securitization and it magically transforms one man's liability (the loan) into another man's asset.(the security) But don't be fooled. The debt is the same as if it was still sitting on the bank’s balance sheet instead of some oddball structured-debt instrument, like a mortgage backed security (MBS) or a collateral debt obligation (CDO). What's really changed is the ability to generate credit has shifted from highly-regulated depository institutions to fly-by-night speculators whose only interest is to maximize leverage, create another bubble, and cash in before the mighty zeppelin crashes to earth.

http://www.counterpunch.org/whitney04272010.html

[Demeter]

1. In a Word: Fraud

Specifically, control fraud. Investors were given worthless "securities" for their hard-earned, diligently saved cash. Then the fraudsters took their loot and speculated in commodities, leading to massive wealth loss and simultaneous inflation. And they bought politicians, judges, and mercenary armies.

The Asians, having refused to participate in their own fleecing, are sitting pretty, and still keeping the fraudsters out and under strict control. Would that Obama would learn from China and India the real lessons of life: fool me once, shame on you...

[ixion]

3. Indeed. It was Fraud, pure and simple

Starting with Bush's proclamation of creating an "ownership society".

[CoffeeCat]

2. And there is pressure to conform..

I'll never forget when Hank Paulson talked about the big meeting he had with the
major banks--the night before the bailout funds were distributed. On "Frontline"
Paulson actually said that there was "yelling and screaming" in the room because
one or two banks didn't want to participate.

One of those banks was Wells Fargo. They didn't want the bailout funds. I don't
know what was said, or the mechanics of what went down--but it is clear that Wells
Fargo didn't want or need that government bailout, but they were forced to participate
and take those funds.

These banks--in collusion with our government--are one big crime syndicate.

[naaman fletcher]

4. Theoretically..

The fact that the credit risk was transferred to investors was not that big of a deal, as the ratings agencies where there to do close inspections of the credit pools to make sure that the banks were not in fact easing credit standards and passing the risk off to someone else. However, things don't always work in real life as they do in theory. In this case:

1. The real estate agents, appraisers, and mortgage originators all resorted to massive fraud to increase their order flow.
2. The ratings agencies became corrupted and didn't do their jobs for fear of losing the revenue stream from the banks.
3. Many of the investors didn't care because as long as the party went on they would get their big bonuses, with the ultimate investors (you and me, and everyone else with a pension, 401K, etc) holding the bag.
4. We investors ultimately didn't care, as proven by the fact that if the bond fund in our 401K underperformed slightly for a single quarter we would move our assets out of it and into a fund that performed better (by taking part in the bubble).

So the depressing conclusion is of course that the vast majority of us are not rational in the traditional classical economics sense, as we do not properly weigh long-term vs. short-term decision making.

[Igel]

6. Yes, but it was a peculiar type of fraud.

One in which we the consumer decided that we liked the inflated appraisals, risky interest-rate terms, and exaggerated amounts we were offered. In which we liked having the banks, appraisers, and real estate agents tell us we could afford stuff, and were proud that those formerly judged to be risky bets for loaning money to were getting money for houses.

It's a fraud that not only we liked, but we actually all but demanded. And then in 2008 we said, "No! You need to make credit requirements stricter for the consumer to stop this."

Four months later, in early 2009, we were again screaming, "You need to make more loans and relax credit requirements." Immediate problem passed, the demographics of who FICO judged to be good credit risks were again obvious, and the reaction was the same as a decade before.

Indeed. Irrational consumers, bankers, mortgage originators--and then we're asked to assume that of all Americans, that politicians and would-be regulators are strictly rational.

And you know what? We tend to believe them. Because we, after all, have a proven track record of rationality. As evidenced by the fact that the entire market for CDOs wouldn't have happened if not for bloated loans and excessive defaults because, originally, too many bad risks and irrational--or at least "very short-term thinking consumers"--were given loans.

:crazy:

[starroute]

5. I still don't understand the creating money out of thin air part

It seems as though there's more wealth on the books than our entire planet is worth.

If those ill-natured aliens that Stephen Hawking worries about showed up, we'd have to tell them that they could have the planet and everything on it, but only by paying 10 or 100 times its actual value to a bunch of speculators.

And that makes no sense to me at all.

[blue97keet]

7. The food chain is too too long

The securitization process promotes risky lending at the bottom of the food chain, blind investing at the top, and too many predators taking their bite out of the middle (packaging, slicing and rating BBB to AAA.)

[troubledamerican]

8. Vanity Fair: The Controlled Collapse of Bear Stearns As Practice Run For 10/08

http://www.vanityfair.com/politics/features/2008/08/bear_stearns200808

http://spitfirelist.com/for-the-record/ftr641-were-we-controlled-part-ii-the-collapse-of-bear-stearns/

http://www.theatlantic.com/magazine/archive/2009/05/the-quiet-coup/7364/

http://spitfirelist.com/for-the-record/ftr-658-update-on-the-meltdown/

http://spitfirelist.com/for-the-record/ftr-651-the-engineer-has-wrecked-the-train/

http://spitfirelist.com/for-the-record/ftr-650-analyzing-the-causes-of-the-crash-interview-with-lucy-komisar/