In a very cool conversation we had a little while back,
@jim explained, using easy analogies and simplified scenarios, the current big financial crisis in the US. It made things very clear and made a lot of sense to financially-disoriented me. Thus, I think posting it might make someone's day a bit easier!
Here's
@jim's Current Finance: 101 (Made Simple)
@jim linked this news: 
My Question: So a very quick question -> Is this one line summary correct? The companies that give out money as credit to people suddenly buckled and imploded. They couldn't give out money or mortgages any more because people were not paying back and now the credit-giving companies are in debt themselves and the Government has stepped in to lend them money in return for their now-worthless shares (and stakes)? And the Government will probably extract the money they lent to these credit companies from taxes. The taxes would go up and people who have good credit would end up paying the higher taxes and not get any low-interest mortgages any more just because of irresponsible people who didn't pay their credit card bills and mortgages in the first place?
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Sidenote: Yeah, I know. That's not really a one-liner. Deal with it! If you want to learn, you gotta ask!)
@jim's Answer: Yeah, two parts. One: basically they were set up to process huge inflows and outflows of cash, and once that dried up they ran out of steam to operate. Two: AIG owned a ton of financial securities that were two steps removed from actual mortgages, and were thought to be super safe, but the whole mortgage industry shifted underneath them and so these supposedly safe things are now worthless. So, the first things means they desperately need money to operate day to day, and two means that they are no longer in a position to borrow money because what they own is worthless.
My Question: Why not let them file for bankruptcy? Would that have affected anything?
@jim's Answer: Well, not quite bankruptcy, it seems like it was illiquidity. They do have TONS of assets. But they need money, not assets to operate. They own lots of stuff, besides mortgages.
But consider it this way: If, every day, they need to take in $10 billion because they have to pay out $10 billion, but they own $100 billion worth of stuff, you'd think they'd be fine. But, if they stumble one day and don't have money, and they can't borrow money to pay what they have to that day, all of a sudden no one trusts them. So then, the next day it becomes 10 times hard to make the cash flow correctly. So they have lots of 'things' but they need cold hard cash, not things to operate. So the US is now taking 80% of AIG's 'things', in exchange for giving it virtually unlimited loans to operate with as cash day to day. The thought is, once people trust AIG now that the US is backing them, is that everything outside AIG will go back to normal. Yesterday, someone might think 'I don't want to trust them with my money' which led AIG to say 'I can't afford to give money to this person I owe it to', but tomorrow, with the gov't involved, we'll all go back to trusting AIG and things will be fine.
My Question: Is that a good thing, per se? I mean its better that the government own things... is it not? But come to think of it, its somewhat against a capitalistic tendency. In a strange way, this is a somewhat socialist outcome to justify a capitalistic venture eg. AIG
@jim's Answer: I don't buy it. We're basically socializing the wrong parts of our economy and doing it in panic-mode instead of well considered. The other thing to consider is punishment or the technical term is "moral hazard". If the US bails out these companies after doing really risky things, it makes other companies feel OK doing it to. You really, in a free market, want to let companies that do risky things fail completely so that they become lessons to the surviving companies. So - we're halfway socializing Wallstreet, but not really punishing the greedy bastards, and totally neglecting industries that would function much smoother if socialized (like healthcare and the like). It's going to get worse, I think. Some big banks are still out there teetering. Washington Mutual is next to go, from what I gather.
My comment: HEY!!! Does Bush or any "government" insiders own big time stakes or "former" executive posts in AIG?? Like they do in oil companies?? That would make all of this 80% lending a total-anti-socialist sneaky capitalistic personal-selfish-gain thing to do!
@jim's Answer: Not sure ;)
My comment: As you pointed out, they are being, (and rather uncharacteristically so) rather generous to this company after all.
@jim's Answer: They sort of have to, it's a mess. I think they should've taken 100% is my beef. But AIG is a company that helps other companies do financial stuff. If AIG fails badly, it basically kicks all the banks when they're already down on the ground having heart attacks.The penultimate cause of all this was actually the mortgage/credit deregulation that allowed anyone to buy a house for no money down, and that's been going on for 7 years or so. It's going to take another equal sort of period to set things right.
Basically, the banks found a way to take ways of making money, and repackaging them into other ways of making money, and selling those other ways to other people. So you'd sell John a mortgage, then sell Sally something that says she's buying the risk on John's mortgage, and then sell Fred the right to the risk of Sally not paying for John's defaulted mortgage in case John defaulted (seriously). And then everyone let John buy a house for nothing, and were shocked when he couldn't pay his mortgage. And once enough people at the base can't pay their mortgages it just destroys the whole chain of made-up financial stuff that's built on top of it.
My Comment: Wow. That's crazy! So people knew what they were getting themselves into - Or Sally and Fred knew that they were indirectly dependent on some stranger John? Was this explicitly understood?
@jim's Answer: Yes, the banker says. "Hey Sally, mortgages are pretty safe! we could always just reposses the house! So, if you want to make $100 a week, why don't you say you'll pay for these mortgages should everything go south? I mean, that's never going to happen!" and so Sally signs up, thinking it's a good way to make money.
Only in this case, it's not someone named Sally - these sorts of things were sold to companies and pensions, not any particular person. And they weren't sold in individual mortgages, but instead, thousands of mortgages would be packed up together, and the risk on the whole lot of mortgages sold. If you put your money in a bank, you could get 3% interest, but if you put your money in escrow (essentially, sort of) to guarantee these mortgages, you could make 6%, BUT if things go wrong you lose your deposit. (making up numbers a bit here to illustrate) Sort of like that.
In my post (
@jim #45689) that's what I was talking about: 'derivatives', basicallly they're things you can buy or sell based on things that can be bought and sold. So, instead of buying gold today, I can buy the right to buy gold 6 months from today at a specific price. Or, various layers and combinations of contracts. It gets really crazy.
This kind of financial stuff can be very useful and essential - don't get me wrong. It's when you put up like 8 layers of add'l stuff on top of it that it gets dicey. So, being able to buy a contract to buy gold in the future? Perfectly useful. Some of the other stuff is just operating on faith and in herds.
My comment: Humanity has all these pithy sayings and proverbs but the minute a situation or question gets twisted around a bit, we walk right in and make the same mistakes over and over and build castles all over the clouds and count chickens before they hatch all the time
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One more sidenote: Oh and I forgot to say this but thought about this later: Talk about chasing all the birds in the bushes and ignoring the ones in hand.)
Moral of the conversation No.1: It's always better to hang out at
(e:strip) and chat than hang out at other websites or not hang out at all.
Moral of the conversation No.2: @jim always has **the scoop** on things. If things are not making sense, he is **the go-to-bloke**!
