can you spare $5?

This whole economic mess involving mortgages, from the point of view of the homeowners, the banks that bought the chicken parts or the original financing companies, became much clearer while I was sitting on the couch last night catching up on the NY Times. I read the paper, I watch debates, I follow what’s what online, I’m pretty well informed – but very few articles have been able to condense any of the issues into such a well-defined set of paragraphs. As the bailout package sits on the back porch doing jack-all we have yet to hear anyone inside the Beltway explain what happened within the markets; what brought about the problems we have and/or why it spun out of control. I’ll worry about the solution on another day. Here’s the NY Times staff editorial that made me call out “what the hell is up with tranching and CMOs?” I didn’t actually think or say that but I did some layman’s research on how this crap works and it doesn’t take a rocket scientist – or economic wonk – to see how fiendishly the system was manipulated. Let’s simplify. I’ve got some money that I want to lend. Not only am I gagging to dole it out but I’ve found some folk over in the District who will are willing to buy these loans after I’ve done the legwork – and it’s for enough money that I’ll turn a profit and be done with worrying about deadbeat loan takers while they get to lap up even more money. I gather up my some of my pals – a few are good with money, a few are bad – and I hook them up with some loans: money here, money there. Let’s say I end up loaning money to ten friend, five of which are the type that either never pay back my money, never buy a round at the bar, or simply don’t have the means to ever pay me back. In fact, in my normal day-to-day relationship with them I’d never expect the money to come back, I’d think it a gift. I give them each $1,000 at interest that would return me something like $1,216 from each of them over four years (that’s 4% compounded over 48 months). This little package of gold would be worth, if every one pays me back, about $12,150 in the end. Of course, I know that the chances of my five loser friends paying me back are nil so the profit isn’t really going to be that $2,150. Fortunately, I have a plan. Remember those big money investors in the district? I’m going to sell all $10,000 worth of loans to them for $11,000 and they get to keep that extra $1,250 that will (no doubt!) come flooding in when the loans are paid back. I take my $1,000 for doing the work and head to Verizon Center for a Caps game and a few beers. The next day, I find ten more folks to play my game…ten more the next day….ten more the next day. I’m working five days a week handing out $1,000 loans to any one who can sign their name and I’m making $20,000 month with no risk because I don’t care about collecting these loans – I just sell them on to my sugar daddies in the District who are making (at least on the books or in their minds) about 25% more than I. Free fucking money all around! Yes! Of course, my five loser friends from my Monday transactions aren’t going to pay back the money they owe…ever. The first five good friends pay back their money – about $6,000 – and the other chuckleheads each manage about $500 ($2,500 total) before moving to California and starting medical marijuana farms. My pals in D.C. now have $8,500 on the table to cover the $11,000 they paid me for this “bundle” of loans. I’m going to guess that a 23% loss on that 11K investment isn’t going to go over too well in the boardroom. If they were losing that much on my Monday transaction just wait until my Wednesday crew’s payments dry up. How about six months from now when I’m just signing up folks standing on the platform at Ballston station. Shoot, six months into this escapade I’ve made about $120,000 by just selling all this bad paper to the folks in the golden city who think they’ll make $250,000 on my work. The problem is that I’ll be keeping my money because I won’t be standing near the inferno when the match is lit and the loans go up in a blaze of glory. The loans they paid $120K for will be worth something less than $100K and their little operation goes under.

There’s some math in there but there isn’t much economic instruction required. Is it a very simple example of how the mortgage crisis went to crap? Yes. Is that what was happening? Yup. No one ever imagined that the house of cards would collapse – it’s the Black Swan syndrome. When we look at it now it seems comical that the “smartest guys in the room” would continue to operate while jumping up and down for joy on what was clearly a shallow mooring. But you know what? What I really hate, and what the Times editorial made salient, it this: the ones giving out the loans knew those loans would probably never be paid back. They didn’t care because once they sold them along to another “investor” they were clear of the problem. They were deliberately deceiving both sides in an unregulated market; not only screwing the home buyers, who aren’t totally innocent in this debacle, they were screwing the investors (also not innocents). Picture someone walking into a bar and sucker punching two dudes in the face and then walking away while they mistakenly fight each other. What a fucking bastard.

And so ends Todd’s economic firestorm.

Have a nice day.