America in Decline

Will there ever be a definitive "here is what really happened" tell-all about America and the recession?

The recession in the states was driven by the subprime mortgage crisis. Increased lending to sub-prime candidates lead to increased demand for mortgages which lead to increased demand for housing. This made house prices rise all over the US which turned into a bubble. As house prices rose people who were even more subprime began re-financing their homes in order to 'unlock the equity in your home (remember those commercials)'. These people were conceived as being low risk because if they defaulted their houses would be taken away and sold anyway. All of this was expanded because of the compensation schemes used to sell these mortgages (brokers sold to anyone, as long as they recieved their fee for getting them to sign, and, large bonuses on the bank end for the high profitability of these mortgages).

Now this seems like a risky but ok system. The real key to the crisis and recession was that wall street understood that a lot of these mortgages were crap and that they may default. They bundled all of these subprime mortgages into mortgage backed securities which they sold to investors. Credit agencys were in on it too as they gave these securities AAA (very high) ratings, even though they were subprime.

So banks started unloading all these crap investments off to millions of investors all looking to make a buck. To make things even more complex there was something called credit default swaps which meant banks would provide insurance in the case the values of these securities would start declining, so even if it was risky they would still be insured by banks who would make up the lost value.

Eventually as things started unravling and people started defaulting, these mortgages were already bought and sold so many times no one could keep track of where they were coming from. The housing bubble burst as people were unable to continue selling the houses for insane value increases. Housing prices crashed and people ended up having mortgages worth way more than their house values. So they stop paying the mortgages, and the whole system falls down.

Banks like Fannie Mae had primarily all subprime assets and practically no reserves for any problems that would occur. When the value of their securities started dropping, the banks immediately went bankrupt. But there is much more to this story.

The decrease in housing lead to a HUGE amount of uncertainty which lead to stock market crashes and lead to a tightening of lending. No one was willing to lend money. This contributed to the entire recession. The US gov had to step in and bail out these firms in order to provide liquidity (money supply) to the market in order to prevent and even larger crash.

That is 'basically' what happened. But there are so many more parts to it and so many players that really it was a freight train without brakes.

They were doing the same thing in Canada after 2006 when the government allowed foreign banks to play in the mortgage market. They saw that they were doing the exact same thing as in the states, lending to subprime candidates and the conservatives put a stop to it in 2008. This is what prevent Canada from getting hit as hard as the US, but really its conservatives fault for allowing it in the first place. Canadian banks are much more conservative. But during 2008 when they put a stop to it there was approx 50 billion in subprime mortgages out there in the market, most banks faced 50% drops in their value/share price.

There are many books and articles on this subject that explain the full story if you are interested.

It started with bank deregulation, which led to a change in the mortgage industry.

It used to be that if a bank handed you a mortgage and you defaulted on it, it was the bank's loss. That made them careful about loaning money.

Now suddenly those mortgages were bundled up and turned into investment bonds. Now it was the investors who were on the line for any losses. Now there was a complete disconnect between those handing out the mortgages, and the risk.

Which naturally led to "liar loans", where the industry as a whole urged people to lie about their finances to get a loan. The banks doing it had nothing to lose.

But here's where things got crazy: The investment banking system created a *demand* for the riskiest subprime-backed bonds, because they were worth betting against.

And when there weren't enough bad mortgages, the banks created them - a hundred times over - out of thin air. THAT was the main problem, and a big reason why the mortgage holders couldn't be bailed out. Too many of them existed only on paper. And it wasn't even illegal.

Of course there weren't enough investors willing to make such high-risk investments. No problem: The folks who should have warned the investors - bond rating companies like Standard & Poors - were instead in on the scam. (Just like Arthur Anderson was in on Enron's scams rather than acting as an impartial outside auditor for investors.) High-risk, doomed bonds were rated as low risk.

Once it all collapsed, banks suddenly got really conservative with their lending practices. And now people couldn't get car loans. Chrysler and GM, in bad shape to begin with, couldn't sell cars. And that was the end for them.

To make things worse, the banks ripped off the very investors holding the US national debt.

All of which led to a jaw-dropping video from the end of 2008, about what happened next in mid-September 2008. (Start 2 minutes in.)

Hope this helps!

^ Very good post.

I found this program to be particularly informative of what has transpired.

http://www.pbs.org/wgbh/pages/frontline/money-power-wall-street/

And yes, I did waste 4 hours watching all this! lol

Yes the Money/Power/Wall Street doc on Frontline was too much chatter about derivatives which very very few can even understand.

Meltdown on Frontline was very good. CBC doc zone did something similar.

The book and film : 2 Big Too Fail was worth watching.

If I personally had to describe the reason for 2008 crisis in one word.. DEREGULATION

Our regulated banking system likely saved us from what they are still dealing with down south.

I almost forgot "Inside Job".. which I believe won the Academy Award.

justmythoughts wrote:If I personally had to describe the reason for 2008 crisis in one word.. DEREGULATION

As Greenspan stated, "Those of us who have looked to the self-interest of lending institutions to protect shareholder's equity -- myself especially -- are in a state of shocked disbelief."

Gee, you think he'd have learned a lesson from Enron and WorldCom - again with private but "independent" auditors like Arthur Anderson in on the fraud.

justmythoughts wrote:I almost forgot "Inside Job".. which I believe won the Academy Award.

A very good film. But I don't think they touched on how the market found a legal way to "synthesize" more bad mortgages to bet against. They would create bonds identical to the real ones, a hundred times over, with no actual homebuyers or borrowers. Which is why the losses were so much greater than the loans.

As well, it's important to note that this entire market was essentially a private market that was hidden from regulators (no legal authority basically)

Plus, we still don't know much about the deals that were made, as many to most had non-disclosure clauses built in (again, unregulated, so no rules means you can legally have all the clauses you want)

A good article on the results published by CCPA report last week:

http://business.financialpost.com/2012/04/30/canadas-secret-bank-bailout/

JT Estoban wrote:A good article on the results published by CCPA report last week:

http://business.financialpost.com/2012/04/30/canadas-secret-bank-bailout/

As a further measure to increase liquidity in the system, Ottawa introduced its Insured Mortgage Purchase Program in early 2009 under which it bought $69-billion of CMHC insured mortgages from the banks.

As the title asks, "Was Canadian banks’ ‘secret’ bailout really a secret?" I remember posting about it on another forum at the time, after reading about it at the time. It was not in any way a secret.

Those mortgages the government bought up were NOT troubled mortgages. Canada wasn't having that crisis.

But NOT having a bailout or government intervention - when everyone else was having them - created a DIFFERENT crisis: Canadian banks were having trouble competing internationally because they didn’t have the new US and European government-backed guarantees for everything they did.

So the Canadian government started insuring mortgages to level the playing field. Again, those were sound mortgages. It also loaned the banks money, with the bank’s non-mortgage loans as collateral.

RogerStrong wrote:

justmythoughts wrote:If I personally had to describe the reason for 2008 crisis in one word.. DEREGULATION

As Greenspan stated, "Those of us who have looked to the self-interest of lending institutions to protect shareholder's equity -- myself especially -- are in a state of shocked disbelief."

Gee, you think he'd have learned a lesson from Enron and WorldCom - again with private but "independent" auditors like Arthur Anderson in on the fraud.

justmythoughts wrote:I almost forgot "Inside Job".. which I believe won the Academy Award.

A very good film. But I don't think they touched on how the market found a legal way to "synthesize" more bad mortgages to bet against. They would create bonds identical to the real ones, a hundred times over, with no actual homebuyers or borrowers. Which is why the losses were so much greater than the loans.

Agreed. One of the docs. I watched (can't remember which one) touched on the subject. They used the analogy where a homeowner (let's call him Bob) purchases fire insurance against the loss of his house.

Meanwhile, every other homeowner on the street also purchased the same insurance on Bob's house. Bob's loses house..... Insurance company (AIG) has to pay out damages to not only Bob but everyone else on the street.