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Please explain the state of the economy.

edited September 2008 in Everything Else
Ok. I'll be the first to admit that I'm not a hundred percent sure why the economy is going down the tubes. I know that Freddie Mac and Fannie Mae have pretty much imploded, but I don't know why (other than that a lot of people have been defaulting on loans). Why are so many people abandoning their loans? Why did both of these companies fall apart so fast? Is it just coincidence that they both died at the same time, or is there a reason?

I'm not entirely financially inept, but I don't know much about the stock market beyond the elementary basics (buy low, sell high, splits are usually good, stay the hell away from Nortel). Can someone break it down, or point me at an article that will do the same?
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  • edited September 2008
    The short answer:

    A lot of banks made a lot of loans for houses to a lot of people, many of whom probably shouldn't have qualified for a home loan.

    A lot of these loans won't be paid back.

    The houses bought with these loans aren't worth as much as was paid for them.

    Banks can't make any good loans because they have used all their "loaning ability" on bad loans, which will lose money one way or another.

    More people took out loans to buy these loans from banks. These investments are bad, and bought with borrowed money.

    When our entire economy is based on credit, this is very bad.

    The current double edged sword is that if the treasury (ie. the taxpayer) buys all these loans, we will have to print more money to do it. More money in the economy leads to inflation.

    If we don't buy these loans, banks won't be able to loan money as usual. This would cause a slow down in the economy.


    I can write out the long answer if you want.
    Post edited by BadDeacon on
  • That's definitely a start, but the thing I'm really curious about is why there's such a huge crisis all of a sudden. It seems like everything was fine and dandy, and then BOOM! Two mortgage powerhouses are down the tubes and the fiscal apocalypse is nigh. Is there a reason why it's all coming to fruition at mach 10?
  • That's definitely a start, but the thing I'm really curious about is why there's such a huge crisis all of a sudden. It seems like everything was fine and dandy, and then BOOM! Two mortgage powerhouses are down the tubes and the fiscal apocalypse is nigh. Is there a reason why it's all coming to fruition at mach 10?
    Well, as some started to default on mortgages, other banks bought the bad debt. The debt kept going bad, and the whole situation kept escalating. It's a katamari, basically.
  • edited September 2008
    That's definitely a start, but the thing I'm really curious about is why there's such a huge crisis all of a sudden. It seems like everything was fine and dandy, and then BOOM! Two mortgage powerhouses are down the tubes and the fiscal apocalypse is nigh. Is there a reason why it's all coming to fruition at mach 10?
    Read the "Are we heading for another depression?" thread. Things haven't been going fine and dandy for quite a while now. Of course, the first article in that thread was called "alarmist", and so not very many people paid attention.
    Post edited by HungryJoe on
  • What it seems like to me is that the financial system is inflated artificially high. More and more of the supports are being pulled out from underneath it, and it is getting less and less stable.

    If you have only been watching where the financial system is, then yes, it does seem a bit sudden. If you have been watching the supports of the system for a while, you can see that it has been falling apart for a while.

    October should be a very interesting month.
  • Banks have too much debt, they are closing, the government is taking out more loans to help them back up, we can never piss off China again.
  • The default rate is less than 10%, but the lenders sold them on to Fannie Mae (FNMA) and Freddie Mac (FHLMC) to be repackaged as mortgage backed securites. The problem is that the small section bad mortgages are poisoning the whole MBS investment pool, leading to a lack of confidence in the securities. No one wants to buy a security that is going to lose them money so they lose value and the banks that have used them to meet their asset to lending ratio requirements have to stop lending or in extreme cases raise cash some other way. That is what happened to AIG and the investment banks leading to them needing to get bought by someone with a stronger asset base (The Federal Govt in AIG's case) or going bankrupt. It's a self feeding loop as long as a significant portion of mortgages are defaulting. The result is that the whole financial system grinds to a halt, with no one being willing or able to extend credit - no car loans, no business credit, etc and growth comes to a complete halt leading to a recession or depression depending on how long it takes until credit starts flowing again - ie the risk of lending is out weighed by the potential reward. Japan went thru a similar situation in the early 1990's and their economy is just now getting going again. The Nikkei index was at 38000 in Dec of 1989, today it closed at just over 12000. That would be as if the DJIA went from it's current level of about 11000 to 5000.

    This has been building for 15 years or so, since the rules for FNMA/FHLMC were changed in the mid 90's to allow them to buy non AAA rated mortgages also known as sub prime mortgages. Until that happened, banks were very reluctant to issue sub prime loans since they individually would be responsible for any losses.
  • If you haven't already, listen to the This American Life episode on the housing crisis (a free streaming version is available here). It was extremely informative and basically summarizes why the mortgage crisis happened (it being a major cause of the current economic crisis).
  • edited September 2008
    The short answer:

    A lot of banks made a lot of loans for houses to a lot of people, many of whom probably shouldn't have qualified for a home loan.

    A lot of these loans won't be paid back.

    The houses bought with these loans aren't worth as much as was paid for them.

    Banks can't make any good loans because they have used all their "loaning ability" on bad loans, which will lose money one way or another.

    More people took out loans to buy these loans from banks. These investments are bad, and bought with borrowed money.

    When our entire economy is based on credit, this is very bad.

    The current double edged sword is that if the treasury (ie. the taxpayer) buys all these loans, we will have to print more money to do it. More money in the economy leads to inflation.

    If we don't buy these loans, banks won't be able to loan money as usual. This would cause a slow down in the economy.


    I can write out the long answer if you want.
    This is a good, simple explanation.

    But yeah, this is by no means sudden. The economy has been crumbling for a while now. My uncle actually called this about 5 years ago when the housing market was still doing great. It's very interesting how correct he was, cause we dismissed him as alarmist and crazy for a good 3 years.
    Post edited by George Patches on
  • But yeah, this is by no means sudden. The economy has been crumbling for a while now.
    I had a suspicion that all was not well, but I chalked it up to all the alarmist media attention. I just thought it was odd that not one, but two of the mortgage giants fell apart at the same time.
  • But yeah, this is by no means sudden. The economy has been crumbling for a while now.
    I had a suspicion that all was not well, but I chalked it up to all the alarmist media attention. I just thought it was odd that not one, but two of the mortgage giants fell apart at the same time.
    This is not just media hype. I think the media has not been hyping this enough, actually. I am a financial bear though, and pessimistically fear the worst. I'm not the only one though, many economists have said that the current financial crisis is the worst since the great depression.

    I had a nice long chat about this with my dad last weekend, he has been following the markets at least since I was born, one of my earliest memories is my dad watching the market news channel every morning when I woke up. He pointed out that while the current recession is the fifth one that I have lived through ('79, '87, '91, and '01 before this one), this one is potentially the worst.

    Right now this is mainly a crisis in the financial market, meaning it is a problem for banks, investment firms, and other financial companies, but there is the potential that this will spill over and become an economic crisis, which would effect most people on a day to day basis. That would mainly mean less jobs, less raises, less home/auto/college/etc loans, and/or inflation.
  • edited September 2008
    I had a suspicion that all was not well, but I chalked it up to all the alarmist media attention.
    That just goes to show that not every portent of bad news should be dismissed as being "alarmist".
    Post edited by HungryJoe on
  • Something that will help is an understanding of what exactly Fannie Mae and Freddie Mac do, why they do it, and why they were effected to heavily. I have an understanding, but I can't explain it well.
  • Something that will help is an understanding of what exactly Fannie Mae and Freddie Mac do, why they do it, and why they were effected so heavily. I have an understanding, but I can't explain it well.
    Here you go.
  • In summation: the economy is fucked the fuck up.
  • I think NPR's Fresh Air radio show/podcast has been doing a good job explaining the unfolding crisis over the last few weeks.
  • I think what some are failing to realize is the long-term benefit: government is reintroducing risk into the market. This can only be good in the long run as it will encourage better decision making and hopefully prevent this kind of stuff from happening again.

    Also, I believe media hype is a large reason for the "Mach 10" failure, namely in that as people realize that some shit's going down, they get more scared and as such investor confidence decreases, which stalls investment, causing stocks to fall across the board, etc.
  • Here's something I don't understand. WaMu was a regular old bank. Why did it fail? All of the other normal banks are fine.
  • WaMu was a regular old bank. Why did it fail? All of the other normal banks are fine.
    It was a savings and loan: a large one. It was invested heavily in sub-prime mortgages. As its losses increased, investors/depositors began pulling their money out in droves. The resulting bank run destroyed the already weak bank.
  • It was a savings and loan: a large one. It was invested heavily in sub-prime mortgages. As its losses increased, investors/depositors began pulling their money out in droves. The resulting bank run destroyed the already weak bank.
    Was it an FDIC insured savings and loan? My money is in an FDIC insured savings and loan. There's no reason to run on the bank if there's insurance and you have less than $200k in there.
  • here's no reason to run on the bank if there's insurance and you have less than $200k in there.
    It's $100k, not $200k, and many entities had more than this invested/deposited.
  • edited September 2008
    here's no reason to run on the bank if there's insurance and you have less than $200k in there.
    It's $100k, not $200k, and many entities had more than this invested/deposited.
    But it's $100k per bank right? So if I win the $300k lottery, I can spread it between three banks to stay safe, right?

    Also does it apply to checking, savings, CDs? Total per person per bank in any kind of deposit?

    Never mind. Wikipedia says that I'm exactly right. It's per person per bank. However, if you have an IRA you can have $250,000.
    Post edited by Apreche on
  • "The withdrawals were largely concentrated among retail deposits that were over the Federal Deposit Insurance Corp's $100,000 insurance cap, said Tim Ward, the Office of Thrift Supervision's deputy director for examinations, supervisions and consumer protection."
    source
  • If I were an American I'd worry more about my money becoming worthless because of inflation than losing my money.
  • It was a savings and loan: a large one. It was invested heavily in sub-prime mortgages. As its losses increased, investors/depositors began pulling their money out in droves. The resulting bank run destroyed the already weak bank.
    The problem with WaMu was that they are particularly active in the shakiest real estate markets (SoCal, Seattle area, San Fran, etc) and were hit badly by the default rate. It only takes one bad loan to cancel the profits on 50 or so good loans. Lots of 'liar loans', otherwise known as stated income or no documentation loans, interest only loans and other highly risky loans. They got bought today for less than 1% of their value last year... pretty sad to go from $15 a share at the beginning of last year to less than $1 last week.

    FWIW WaMu is my personal bank and I'm not worried about my personal deposits. The FDIC insures $100k per depositor per bank, but if you keep $100k in cash.... not a good idea.
  • edited September 2008
    As I'm watching this whole thing unfold, I can only think about how happy Americans with some form of dual citizenship must be.

    So as not to make this post completely off-topic, perhaps I should ask a question that's been bothering me all day: Why exactly did the bailout get voted down? Don't get me wrong, I'm not unhappy about Congress financially cockblocking men who want to offload almost a trillion dollars of debt onto my generation because of their friends' screw-ups, I'm just wondering what happened, and what the other option is. From what I hear (and correct me if I'm wrong), they want to insure all the loans in the US...but I'm likewise pretty sure that that would entirely destroy all market liquidity. Am I missing something?

    I guess this is what the US gets for deciding that it needs to guide the invisible hand.
    Post edited by WindUpBird on
  • edited September 2008
    I guess this is what the US gets for deciding that it needs to guide the invisible hand.
    Actually, it's what the US gets for slapping it. From my understanding, a lot of this is fallout from key deregulation I briefly touched on in another thread.

    On that note, I'd like to ask if I was moving in the right direction with any of that. This whole business is a lot to wrap one's head around. :x
    Post edited by konistehrad on
  • It's a good thing McCain showed so much leadership and got it passed . . .

    Seriously, what are the dire ramifications, if any, of it not passing? Does anyone seriously believe that the Republicans scuttled it because Nancy Pelosi said mean things?
  • It's a good thing McCain showed so much leadership and got it passed . . .

    Seriously, what are the dire ramifications, if any, of it not passing? Does anyone seriously believe that the Republicans scuttled it because Nancy Pelosi said mean things?
    Well, it means a 700 point Dow drop, for starters (the largest single-day drop in at least 20 years); there will probably be more extreme drops in the stock markets, followed by a "rock-bottom" period when a plan gets passed, then (hopefully) a recovering period.
  • Well, it means a 700 point Dow drop, for starters (the largest single-day drop in at least 20 years); there will probably be more extreme drops in the stock markets,
    I can't comment on stocks or give advice, but that drop was really just the cattle being spooked by lightening.
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