Math and the financial mess

There was a analysis sent to me for the crisis by one of my friends.

For those who have found it hard to understand the current financial crisis ... the logic simplified ... i guess more clearer once you have a drink and read this !

Linda is the proprietor of a bar in Cork . In order to increase sales, she decides to allow her loyal customers - most of whom are unemployed alcoholics - to drink now but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans). Word gets around and as a result increasing numbers of customers flood into Linda's bar. Taking advantage of her customers' freedom from immediate payment constraints, Linda increases her prices for wine and beer, the most-consumed beverages. Her sales volume increases massively. A young and dynamic customer service consultant at the local bank recognizes these customer debts as valuable future assets and increases Linda's borrowing limit. He sees no reason for undue concern since he has the debts of the alcoholics as collateral.

At the bank's corporate headquarters, expert bankers transform these customer assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These securities are then traded on markets worldwide. No one really understands what these abbreviations mean and how the securities are guaranteed. Nevertheless, as their prices continuously climb, the securities become top-selling items. One day, although the prices are still climbing, a risk manager (subsequently of course fired due to his negativity) of the bank decides that slowly the time has come to demand payment of the debts incurred by the drinkers at Linda's bar. However they cannot pay back the debts. Linda cannot fulfil her loan obligations and claims bankruptcy. DRINKBOND and ALKBOND drop in price by 95 %. PUKEBOND performs better, stabilizing in price after dropping by 80 %. The suppliers of Linda's bar, having granted her generous payment due dates and having invested in the securities are faced with a new situation. Her wine supplier claims bankruptcy, her beer supplier is taken over by a competitor.

The bank is saved by the Government following dramatic round-the-clock consultations by leaders from the governing political parties (and vested interests). The funds required for this purpose are obtained by a tax levied on the non-drinkers

That is a GA, but it left out the most important point.

Linda didn't initially extend credit to the deadbeats that populated the neighborhood. They had to beg for money and hang out on street corners drinking Ripple out of bottles.

Then it was decided by the most virtuous among us that it wasn't fair that some should be able to drink in a warm, friendly bar while others were out on the street, and Linda was "encouraged", via threats to cancel her liquor license, to extend credit to those whom she had previously deemed to be non-creditworthy.

Now you have the beginning of the story...

I'm afraid I have to disagree with your characterization of Linda's patrons as "deadbeats".

Many of her customers had the means to pay off their bar tab over time, and planned accordingly for doing so. However some lost their income because the mill down the street closed unexpectedly. Others supporting the mill lost their jobs or had their hours cut back. Still others were hurt in an accident down at the shipyard and because their medical coverage had been reduced,their savings were drained away.

I know some of Linda's patrons pretty well. They're good folks, caught up in bad circumstances. They by no means went on a free drinking spree.

I dare say that most of us wouldn't be able to pay Linda either in the same circumstances.

You're pushing the analogy too hard.

Certainly some of the cases are just as you say. But if that's all it was, there would be no crisis - that's just life.

But the reality is that the Community Reinvestment Act encouraged - in perfect analogy with my last post - banks to lend to those who would not qualify under traditional circumstances: 20% down payment, the mortgage payment less than 25% of take-home pay. (I may not have those numbers quite right - the point is that they were numbers that worked to ensure safe loans).

Our most virtuous president ever, Mr. James Earl Carter, decided that wasn't fair and the CRA pushed banks to make loans to riskier borrowers. You could get a loan with 10% down, and pay private mortgage insurance (PMI) until you had paid off enough, or the house had appreciated enough to where you had a 20% equity in your home, and then the PMI came off.

Okay, but after they exhausted all of those incrementally riskier loans, they were still under the gun to reach out still further. So you started to see even lower down payments, or no money down loans, but you still had to be able to make the payments.

When that sector was exhausted, they were still under the gun, because there were still unfortunates who didn't own their own homes. But these people couldn't make the payments. So the next thing was interest-only loans, with balloons at some point off in the future, by which the time the house was supposed to have appreciated enough that they could refinance. Or ARMS, adjustable rate mortgages, with artificially low teaser rates for awhile, before reality set in. And hope for the future that your income would rise, or the home value would rise and allow you to refinance on better terms.

By the end, you had loans based on "stated income" - the loan applier would simply state his income (on advice of the financial person who knew what the income minimum had to be in order to get the loan). No cross check.

And all of this financial chicanery was triggered by that paragon of virtue, James Earl Carter, and his successor in virtue, William Jefferson Clinton, who jump-started the CRA in 1995. Not to pick on particular administrations, but the point is this wasn't started by corrupt or greedy bankers. It was a top-down affair - starting from the very top. Once you had that initial push, then of course the old-fashioned type of staid respectable bankers were pushed aside by the used car salesman types, and the rest is history.

Never underestimate the power of greed. Some of the patrons of the Linda's bar took their drinks down the street & sold them for 2x what they paid (?). Took the money paid for the 1st drink & ordered several more, drank one, sold the rest [repeat, repeat]..... Linda even raised their credit limits, after being paid for the 1st drinks, knowing exactly what the patrons were doing. Linda became more & more comfortable as the drinks flowed, [sold a few to some underage kids too], hey there was some money coming in, what could go wrong? Everyone from the top to the bottom should have realized the basic flaw in what was { & still is } a huge ponzi scheme....

Now there's going to be the insult added to the injury as all the big boys [Linda's bankers] get paid back [+ performance bonus] & the children of the patrons down the street being pursued by Linda's bankers for past due! even people who weren't drinking, or like Steve who had his drink paid his money & went home, are going to pay.

As usual emc c is busy pointing out the democrat's flaws conveniently forgetting the republican propensity for deregulation.... all politicans of both parties were there to feast on the largess. While the agenda's of the parties may be different, the results are the same, the good ole boys get paid & the rest of us foot the bill...