Sub Prime.The Idiots Guide

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W200

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Good Afternoon.
As a casual observer of world financial affairs I am totally lost when trying to understand what is happening at the moment.
Please indulge me here as I have no financial training whatsoever and am just curious.
Ok. On any given day billions of dollars , yen, pounds etc swirl around the world in the various financial markets .
America contributes a percentage of these markets .
The American mortgage market contributes a percentage of the total American market.
The American sub prime market contributes a percentage of the mortgage market.
A percentage of the sub prime market has difficulty with repayments.
Now can somebody explain in laymans terms why this ,by now small percentage of the overall market is having such an effect worldwide.
I understand that there may not be an " idiots guide " to all of this as it is extremely complicated.
W200
 
There is also this youtube video from last September, I believe:
http://www.youtube.com/watch?v=mzJmTCYmo9g

The important thing to remember about the credit crunch is that it is not just about subprime. It is about the bursting of a credit bubble. The immediate result has been the bursting of the house price bubble in the US. The canary in the coalmine is sub-prime - it is the first class of assets to blow up. The next in the US will be Alt-A (reset mortgages), near prime and prime. That's on the residential side. The commercial side will also tank. These mortgages were packaged into securities and sold worldwide (but mostly in America) as RMBS and CMBS (Residential and Commerical Mortgage Back Securities). Also sold were auto-loans, credit card loans, student loans and any other loans.

Many banks, insurance companies and pension funds both these Asset Backed Securities and have been writing down their value. Er, and going bust.
 
Ok - a couple of things I don't understand.

firstly
it seems that all financial companies were involved in this game of selling off these packaged mortgages.

Who was buying these?
Like - could me or you have walked in off the street and buy one of these products?

if we did, how did it work?
e.g. Would we pay in some nominal sum and get monthly returns for 2 years?
Or for the lifetime of the mortgage or what?
if we did pay some nominal sum, then what was done with this?

Basically If i was interested in buying one of these products what would the bullet points on the leaflet say to convince me?

Secondly
Just to clarify - this scheme was completely dependent on house prices rising and people being able to pay off their monthly mortgage repayments yes?

This doesn't seem to make sense.
Surely some of these financial institutions must have seen some danger?

Surely some guy at some meeting put his hand up and siad what if house prices fall?
As in - the notion of house crashes is not a new one.
Was there not every reason to suggest it woudl eventually happen?

Something doesn't add up here in my mind.
Can someone explain please what there institutions were thinking at the time. Presumbaly they were operating on some logic at the time ?What was this logic?

Thirdly
Irish banks fortunately did not buy into these mortgage backed securities (imagine where the share price would be had they done so ! Yikes !!)

Why did irish banks not buy into them?
Is it that they were clever enough to spot the potential trouble ahead?
Or was it because of some other reason?
 
Quertytop I'm with you on this, but I think it was all greed and the money boys just magically created these new 'products' and sold them as investments, put glitzy names on them to bamboozel us and some people ended up buying them. What I don't understand is where people are making the money on it. Is it the guy selling the mortgage getting his commission, then the guy selling the mortgages etc etc etc. Where do the one's at the top get their cut, is it these million dollar bonus' they get in the 'city' or large pension funds etc. And now these guys are out on the street but they have their own money safely tucked away. I think the big institutions have the likes of Nick Leeson and the guy in France trained to take high risk/ high gamble bets and then when things go wrong they throw these guys to the wolves. Some of the gambles work but occassionally they don't. Even now with the crisis people are making money on it. I asked yesterday on AAM (think it was deleted) who is currently making money on this crisis, is it for examply Lloyds taking over another bank cheaply or what?
 
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Yes - there are definitely areas I am not sure of.

Another question - are AIG not the main culprits here in the whole credit crunch?
As in - had they not insured these securities in the first place would they have been worthless before they even got started?

Could you not argue that while what the investment banks were doing dodgy stuff, could they not use the argument that at least they were insured so therefore the worst case scenario wouldn't be too bad for anyone investing in these products?

How did AIG get it so wrong?
Did they simply not assess it correctly ?

Also - were there any other insurance companies involved in insuring these products ? Or were AIG the main guys doing it ?

Is there anyone on this forum that is a credit cruch expert that could shed some light on the whole thing please.
 
No. AIG were a player in the market. They weren't the main player and they didn't invent the market. You'll have to look elsewhere for blame (my bullseye would be aimed on regulators and rating agencies. The biggest names in the ABS insurance market were MBIA and Ambac and a few others (like FGIC).

The securities would have been worth less (would have had a lower rating and required a higher interest payment to cover the greater risk of losses), but the model that was being used to assess maximum loan losses was wrong. It only had a few years of historical data. It didn't believe that US prices could go down by very much in an area or that nationally prices could go down at all. So the problem would still have existed for the banks that bought the ABS, the insurance companies wouldn't have gone bust is the difference.

Could you not argue that while what the investment banks were doing dodgy stuff, could they not use the argument that at least they were insured so therefore the worst case scenario wouldn't be too bad for anyone investing in these products?
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That's why they did it - to get the insurance to cover their investments and ensure that they had a AAA rating. The problem comes from the fact that this insurance has no substance behind it. It is like getting insurance on US government debt - if you ever need to call it in, nobody will have any money to pay you. That was neither priced into the insurance nor priced into the rating that the rating agencies gave.

How did AIG get it so wrong?
Did they simply not assess it correctly ?
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Yes. The question is whether this was willful stupidity or common or garden stupidity - did they know it would never work or were they just doing what all the big boys were doing and didn't realise it was wrong.

Also - were there any other insurance companies involved in insuring these products ? Or were AIG the main guys doing it ?
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See above - MBIA and Ambac were the biggest ABS insurers.

Is there anyone on this forum that is a credit cruch expert that could shed some light on the whole thing please.
Click to expand...
Not an expert by any means, but there is a lot of info out there on the web. Sadly, it's not really talked about that much in the blogosphere because it's now a known known and the known unknown has moved on to CDS (Credit Derivative Swaps).

Remember aswell about AIG, it was playing both sides of the game. It was insuring against the fall in value of ABS through one division, but was buying ABS to hold as security against insurance policies in another division. It was essentially insuring itself against a loss!
 
Ok - cheers for the response.

I'm sure I'll have more questions as I think of them.
 
Don't worry about it. The good old American taxpayer is going to save everyone! The crisis is over.
 
Sunny said:
Don't worry about it. The good old American taxpayer is going to save everyone! The crisis is over.
Click to expand...

I think you're quite wrong there. We are now at the mercy of the Chinese. ...."China is the US of this century. The initial stages of last year’s credit crunch were managed so apparently painlessly because sovereign wealth funds (SWF) from the Middle East, but above all from China, were willing to step in and recapitalise the debt of US and European institutions. The pivotal moment in today’s events came when the Chinese SWF China Investment Company (CIC) was unwilling to go further in its exploration of buying Lehman Brothers. Its turning back will be held up in the future as a moment when history could have turned in a different direction."....
www.project-syndicate.org
 

Why was I quite wrong?

I was talking about the annoucement today that the US government and FED are looking to take all the toxic waste off the banks and probably putting hundreds of billions if not a couple of trillion of taxpayers money at risk.
 
Strathspey said:
"sovereign wealth funds (SWF) from the Middle East, but above all from China, were willing to step in and recapitalise the debt of US and European institutions."http://www.project-syndicate.org
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This makes no sense at all. I only remember a single chinese investment in a US investment bank (CICs 5 bn investment for a 9.9 stake in Morgan Stanley). There were more investments from arab and Singaporean investment funds (both in size and quantity). As far as I can see there has been no chinese investment in European banks.

What China has been doing is recycling dollars (from Chinese exports) into US Treasuries and into GSE debt. One of the reasons that has been put forward for the nationalisation of the GSEs is to maintain the value of those large Chinese (and other foreign) investments. But none of this is in the sense of recapitalisation.

In any case, the nationalisation of the GSEs and the concomitant stop on preferred share coupon payments has made it practically impossible for banks to issue preferred shares to be recapitalised. The failure of take-up the HBOS common share issue shows there is little appetite to buy those either. So the alternative is to waive foreign ownership rules and allow sales of controlling stakes. This is not a recapitalisation, this is a takeover as an alternative to nationalisation.
 
Let's go back to the beginning - how come mortgages were allowed to be given to people who patently could not make repayments? Does a regulator not monitor this? Isn't that what regulators are for? Or are banks a law onto themselves?

Thought of another question: who is going to be punished for this mess?
 
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Thanks for all the interesting, intelligent, and humorous comment on this subject. However as I said in my original mail it is astonishing that a problem with a small percentage of the American mortgage market can have such worldwide implications.
Sounds like the pebble in the mill pond ripple effect or that pesky butterfly starting the hurricane by flapping his wings in the Amazon.
 
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