I’ve had an email and a few message board posts asking me “what the…” is going on with the economy.  I’m not an economist (I was an English major) but I’m incredibly curious, and I read a lot.

Here’s my take:

A big part of this whole Wall Street collapse are something called “adjustable-rate mortgages” (ARMs).  Especially problematic are ARMs that “balloon” in cost two or three years down the line.  These mortgage companies sold this crap using the first few years’ “teaser rates” of 1% or 2% interest to lure in lots of new customers, many of whom didn’t read the fine print and didn’t see the 10% (or higher) price hike coming.  When so many borrowers couldn’t pay the ballooning interest, the house of cards fell down, taking the financial sector (and the world economy) down with it.

Yesterday I saw someone ask, “since interest rates have been low, why would anyone sell ARMs instead of fixed-rate mortgages?”  The answer has to do with projected revenues.  That is, these companies sold lots of “balloon” ARMs (mortgages that increase years later) so that they could bundle them into securities, go to Wall Street and brag about their securities’ “projected revenue,” which is a big part of what determines prices.
“Look!  In ’09, earnings on our securities will TRIPLE!!  BUY BUY BUY!!!”

A Dilbert cartoon from Dilbert.com

Selling “balloon ARMs” was motivated by greed, and the market’s insatiable appetite for these mortgage-backed securities after Greenspan lowered interest during the post-9/11 slump, and thus the return on safe Treasury Bills, to 2%.  An unintended consequence of that was that it drove investors to desperately seek out another safe investment (with better return than 2%).  Pension funds, 401k managers, mutual funds, banking chains, investment banks and even New York City’s MTA, FLOCKED to mortgage-backed securities.  Moody’s rated them AAA!!  STRONG BUY!!  And hey, if something goes wrong, the losses were insured with credit default swaps from AIG!!   Why worry?  BUY BUY BUY!  Sell even more mortgages and create more and more and more securities to sell!  People made a fortune doing this.

Problem is, the “adjusted” rates led to THIS, too many mortgages defaulting.

Around 24% of subprime ARMs were delinquent in 2006… it’s likely much worse now.  The securities held up by these mortgages collapsed, becoming the “toxic assets” that are now all over the news and causing the economy to tank.   EPIC FAIL.

Yes, the Treasury Department is going to help finance the purchase of these worthless assets (congratulations, American taxpayer!)  The plan is to pull them off Corporate America’s balance sheets to try and keep the financial sector afloat.

But I think we’ve let the greedy elite build this particular Tower of Babel so high (a lot like Yertle the Turtle) that it crashing down is completely unavoidable, and we’re essentially screwed, no matter what the government does or doesn’t do.

What goes up, must come down.

Nick

Later this week in the “Nick’s Crusade” blog: federal regulators missed an awful lot of chicanery; what happened?

AP: Economists see financial bailout as necessary

O RLY??

It’s hardly the soup kitchen for people at the very top.

The chairman of Lehman Brothers, Richard Fuld, still has his mansion in Greenwich, CT, his oceanfront estate on Jupiter Island in FL, and his Park Avenue co-op in Manhattan.

Many at Lehman blame Fuld for dallying while his investment bank went bust, taking risks with other people’s money while he cleared over $40 million in salary and stock in the last year alone.

Fuld could not be reached for comment by 20/20, but outside the Lehman offices this week, employees took glee in telling him off in pen on a portrait of Fuld.

“He made a lot of money and he lost a lot of money,” said Fox business news anchor Alexis Glick, “and he made dramatic mistakes, mistakes of the highest magnitude.”

Glick has been highly critical of Fuld, feeling the pain in a direct way. She has many friends at Lehman and her mother worked there for years.

“It’s just unbelievably shocking,” said Glick, speaking about the devastation felt by her family and friends. “So they’re crying, they’re sick, I mean guys have been telling me they’ve been throwing up because they just can’t stomach what has happened.”

Fuld isn’t the only top executive who remains well-off despite his firm’s collapse. Former Bear Stearns CEO Alan Schwartz collected more than $38 million in salary and bonuses in the last three years for which figures are available, though he and Lehman executives also saw their net worths drastically plummet as stock values crashed. Bear Stearns was on the brink of financial ruin when JP Morgan Chase bought it in March.

Full article: The Fall of the Gilded Age

IS BAILING OUT LEHMAN REALLY NECESSARY?

Shouldn’t we wait until their CEO had to sell one of his three luxury homes before bailing out Lehman?

It really seems like we’re rewarding these guys instead of letting them naturally get picked clean and displaced by smarter competitors.

Obviously we do need to do something to restore confidence in our banking system. I recently overheard nurses talking about pulling their money out of banks and hiding it at home (1930s-style) for fear it’d disappear in a bank collapse. That’s how serious the problem is getting. I’m not saying do nothing. I don’t have an issue with helping out banks like IndyMac or Washington Mutual, but bailing out rich Wall Street investment firms seems a whole ‘nother animal.

The $700 Billion financial “bail out” bill seems to be all about providing a soft, pillowy landing for stupid decision-makers at taxpayer expense. They keep their three luxury homes, and we pay the price for their idiocy.

And articles like this only highlight the unfairness:

7. Do the Wall Street executives get to keep their bonuses?
The Bush Administration says it needs to encourage executives to get their cooperation, and that clamping down on their pay would only hurt their willingness to get on board. Critics in both parties say the threat of the executives’ firms going belly-up should ensure their cooperation regardless of what restrictions are placed on their once golden parachutes. Mounting pressure from constituents on Main Street is likely to mean there will be some cap on compensation associated with the bailout. But corporate America usually finds a way around such limitations, and there are even legal questions about what kind of restrictions can be placed on the firms’ compensation structures.

Full article: 7 Questions About the $700 Billion Bailout

If this disaster really requires $700 BILLION worth of government intervention, who is paying for it? My first instinct when corporations harm us, is TRUST-BUSTING! And this meltdown is a screw up of unprecedented magnitude, with harm to the public of historic proportions.

Where are the CONSEQUENCES for bad, stupid leadership?

Can anyone tell me why, as part of this bill, the Treasury Department isn’t seizing CEO yachts and mansions to pay for this debacle? Why is demanding real consequences worse than paying nearly one trillion ourselves? We’d rather foot the bill in their stead? WHY??

If these idiotic decisions by Wall Street have no real consequences, and the dumbasses responsible keep their three estates and golden parachutes, no real lessons have been learned, we’re basically incentivizing even more stupidity down the line.

And now Congress has weighed in. They are saying:

I’m not saying do nothing. But clearly we have to do something different. The original Paulson plan isn’t going to fly. We can’t afford a cushy deal for the uber-rich.

Nick