Explorations

You know, I’ve spent pretty much every waking minute for the last week trying to figure out what happened, why it happened, why is was a major crisis, and what the Bernanke/Paulson plan does.

I’m busily shopping an article on it, but in the mean time, the big thing I’d warn everyone is that hardly anything that has been published in the media or on blogs has any relation to reality.

Here’s some bullet points:

• this is a real crisis. If something isn’t done soon, we’re talking about something like what happened in Argentina in 2000. Which is to say, 25 percent unemployment and middle class people needing to scrounge and recycle cardboard to get enough money to eat.
• the problem is not not not because most of these loans are in default, nor is it because the banks and financials are insolvent. The default rate of subprime mortgages is less than 20 percent. The value of the mortgage backed securities is therefore at least 80+ percent of the face value, and that doesn’t take into account the real estate owned through the mortgages.
• the problen is a liquidity crisis, like a run on the bank. This liquidity problem comes about through an unexpected interaction between Sarbanes-Oxley’s imposition of a very rigorous mark-to-market rule, and the structure of the credit default swaps used to spread the risk of the mortgage backed securities; those securities were inherently more risky because Fannie and Freddie were required by law, for entirely noble reasons, to make riskier home loans.
• The bad interaction is that mark-to-market artificially caused some securities to be marked down when the market got to be illiquid. Very quickly afterwards, companies like AIG that held lots of CDSes were needing lots of cash, and couldn’t get it.
• this led to a “freeze up” of credit among banks, which was the proximate issue; lots of businesses, including especially small businesses, depend on commercial credit.
• the easy way to fix it is for someone with lots of money to buy the securities (not the underlying mortgages), but no one except the US Government has that kind of money
• buying up the securities would undo the CDS problem, resolving the cash problem, letting the credit markets defrost
• the way the deal is structured is set up to let Treasury buy up the underlying securities for about 50 cents on the dollar; they’re worth at least 80 cents on the dollar in an orderly market. This means that the Treasury should make some big money on the deal.

Outis has a lovely paragraph about it at his blog:

And so, what we have is a blockage (liquidity crisis) that needs a high colonic (some form of bailout). We’ll flush water (money) up the wrong end (that is, via the government, which is the body’s asshole) to shake “things” (home loans) loose, letting the system regain its equilibrium.