September 17, 2018
The Great Recession
2008 - Not Only a Bank Odyssey*
2008 - Not Only a Bank Odyssey*
SEPTEMBER 17TH , 2 0 1 8
Client (C): Can you explain to me what happened in 2008, the Great Recession?
Advisor (A): That was ten years ago, why are you asking me now?
C: You gotta know the future so you don’t repeat the past.
A: Who are you, Yogi Berra?
A: Never mind. We are going to talk about seven events: 1) Some Guys in Congress; 2) The Big Guys at Fannie Mae; 3) Mortgage Backed Securities (MBS); 4) The Three Rating Agencies; 5) Breaking the Buck; 6) Liquidity Crisis and; 7) TARP (Troubled Asset Relief Program). Got it?
A: Anyway, this all started with the government in 1992, when Some Guy in Congress…
C: NOT FROM THAT CESSPOOL AGAIN.
A: Please be considerate of our readers. Some Guy in Congress wanted everyone to own a house, so Congress made it easier for people with less income and poorer credit to get a mortgage, which was called a sub-prime loan.
C: A noble cause.
A: Yes, then starting in 1995, The Big Guys at Fannie Mae...
C: The tushie guys?
A: Will you please behave? This is G-Rated. The Big Guys at Fannie Mae, the government agency that buys and sells mortgages, knew that the more mortgages they wrote, the bigger the bonsuses they could give to themselves.
C: So those idiots in Congress basically gave the big guys at Fannie Mae the ability to write tons more mortgages? And then then those guys bought themselves big fancy yachts?
A: Yes, then for the next twelve years, the banks…
C: NOT THE BANKS AGAIN.
A: Yes, the banks took the better mortgages and the poorer mortgages and they bundled all the mortgages into one big mortgage, or bond, called a Mortgage Backed Security, or MBS.
C: I know I’m slow, but I’m trying. A hundred mortgages became one mortgage?
A: Yes, then the Three Rating Agencies…
C: Like the Three Little Pigs?
A: You just can’t help yourself, can you? The three rating agencies - Moody’s, S&P and Fitch - looked at the bundle and said: Better mortgages and poorer mortgages? Mortgages from different states? Condo mortgages, house mortages, apartment mortgages? Put all these together and diversify and what could go wrong? We’ll give this MBS our best rating, AAA. But guess what, the value of those diversified properties all went down together. The diversification didn't work.
C: So the rating agencies thought that if you take one mortgage from column A, another from column B, a third from column C, etc., you'd end up with a fancy AAA dinner from a fancy restaurant? But instead they wound up with a three course dinner of Spam?
A: In a manner of speaking, yes.
C: By the way, I thought that only good companies like Microsoft have a AAA rating. How come an MBS with some lousy mortgages gets the same rating as Microsoft?
A: MIcrosoft, unlike an MBS, is a company that has excellent assets and not a lot of debt. They had earned their AAA rating. No one is really sure why the MBSs' also got AAA ratings, although the rating agencies do get paid by the company that wants the rating.
C: Wait a second, doesn't that mean that the rating agencies have an incentive to give a higher rating so that they can get more business?
A: It almost sounds like a rigged game. Unfortunately, it still continues today.
C: Hey, I want in. I'll be the fourth agency and take my share of the cut.
A: It's not that easy. Congress...
C: NOT THOSE LUNATICS AGAIN.
A: Congress decides which agencies can be a nationally recognized statistical rating organization (NRSRO), and only these can rate securities. Until 2006, the government had made room for only those three at the table.
C: Like three card monte. You just reminded me. I got one of those mortgages to buy me a lake house. The bank gave me five hundred thousand smackaroonies.
A: You make $40,000 per year. How could you possibly have gotten that mortgage?
C: I told the guy I made $1m and there was no income verification. Ha Ha.
A: You lied? How come he gave you the mortgage?
C: He wanted the commission. But then guess what? The lake dried up and started to smell.
A: So what did you do?
C: I walked away from the house, the lake, the mortgage, hasta la vista. The mortgage was "underwater" (get it?); it was worth more than the house. I couldn't afford it anyway, so who cared? All my neighbors walked away as well.
A: Right, so everyone started to walk away. Did the banks tell anyone they had bad mortgages that no one was paying?
C: YOU MEAN THE BANKS LIED?
A: We’ll get to that in a moment.
Around the same time, there was a fund, the Reserve Primary Fund, that sold money markets, which are funds where one unit equals $1, or one buck.
C: I know those. I once had $10,000 in a money market fund. I got paid 2%, and after one year I had $10,200.
A: Right, the money market invests in something safe, like an investment grade bond, so that they can pay you your interest and pay you back your principal.
C: Right o bro, because if I didn't get my money back I'd a been pee ooodd.
A: Well guess what? The Reserve Primary Fund bought bonds of Lehman Brothers, which they thought were safe but actually weren't because Lehman owned bad MBSs. And when Lehman Brothers went bankrupt, the truth came out that the bonds were worth less than they had said, and the value of a unit of a money market was actually worth less than $1. That was called breaking the buck.
C: YOU MEAN I COULD HAVE LOST MONEY IN A MONEY MARKET?
A: Yes, a money market is a fund, like other stocks and bonds funds, and some people did lose money.
Now back to the banks. Banks usually lend money overnight to each other to pay their bills, but by 2008 they were all lying to each other, and they got caught, and they also freaked out about this breaking the buck thing, so they stopped lending to each other. This created a liquidity crisis.
C: So who cares if the banks lied? I lied and got a $500,000 mortgage.
A: That’s kind of the point. The banks lend to each other based upon the truth. If your property was worth $500,000 and is now worth $400,000 and your mortgage is still $500,000, now the morgtage is "underwater". The banks have to write down the value of the mortgage from $500,000 to $400,000, but they will have a harder time selling an underwater mortgage, which is worth less than the property, so this becomes an illiquid asset. If they lie and don’t tell anyone that the asset is now worth less and someone finds out, they won’t get any more money. That is why lying can lead to not lending.
C: I pinky swear never to lie again.
A: I’ll believe that when I see it. Now everyone was screaming for the government to help, to provide liquidity.
C: Help from the government? I want term limits.
A: So then the government said “We’ll give you $250b and you’ll give us all your bad, illiquid mortgage backed securities.
C: THEY DID WHAT???
A: There were some banks that had a lot of MBSs and some that had very little, but the government didn't want anyone to know which banks were good and which ones were bad, because they were afraid that people would start taking their money out from all the bad ones. So the government said to the banks: "You're all taking the money whether you like it or not." That was TARP, or Troubled Asset Relief Program.
C: But the banks were the ones who lied to each other, and to us.
A: That’s pretty pathetic, isn’t it?
C: So why would the government just give them money?
A: The banks need to keeping lending money so you can finance a new car. If the banks don’t have money, you can’t borrow.
C: So what happened to the big honchos who ran the banks? They were a big part of the problem.
A: At the end of the year they got big million-dollar bonuses.
C: Why didn’t the government just put them in front of a firing squad, along with the cesspool guy, the tushie guys and the pig guys?
A: A lot of people have asked that same question.
C: Can I ask you one more thing?
C: What did the banks do with the $250b?
A: They bought all the homes around the dried lakes at dirt cheap prices, bundled them into new mortgage backed securities and sold them all over again.
C: What a racket.
A topic suggested to me by the guy who coined the phrase “Greed is Good”.
What suggestion do you have for a blog post?
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