The thing is (1) I am not an accountant or stock broker...but I do like to read up on this stuff and invest the Lord's money as wisely as possible. (2) everyone involved seems to be giving a different story and pointing the finger all around, so some may contradict what I write here...no problem, I'm not claiming to be an insider with vast knowledge on this topic. (3) this situation is occurring in an election year and thus many of the "facts" are tainted with political mud slinging and blame shifting.
I have tried to cite my sources as much as is possible for further reading.
Ultimately though, keep in mind, God is bigger than all of this scary stuff. He is in control. He owns the cattle on the thousand hills (and doesn't need AIG to insure it! LOL). God can take care of us, and meet our needs, and may even use this awful situation to bring some badly needed revival to our lands. Our God is a recession-proof God. God is faithful.
Julie wrote,
THIS MAKES ME FEEL SO DUMB. I SO WANT TO UNDERSTAND WHAT IS REALLY GOING ON IN THIS FINANCIAL CRISIS (AND TEACH IT TO MY KIDS).
Julie, I don't understand all of it to the most minute detail but I have kept up with this and understand most of it. Friends and I had a huge discussion on this just this weekend, and I feel I have a pretty good understanding now...In a very, very basic nutshell here is what happened.
In the 1990s, the government put pressure on Fannie Mae (A government backed mortgage enterprise that makes and guarantees mortgages via our tax dollars--Freddie Mac is the other government enterprise which is similar) to make home ownership for everyone...by lowering the standards and "not discriminating". These loans are "sub prime" because the people who took out the loans (1) didn't have good credit (2) didn't have reliable employment or good income and (3) the home usually was mortgaged to 100% or 120%...on the faulty gamble that home values would always go up (not when you are giving poor people with a track record of poor money management skills mortgages!!!! Now everyone's savings and home values are in the toilet..but more on that later.). There has always been "sub prime" (high risk) loans but this was ramped up to a new level with the influx of new home buyers with bad money management skills.
This created a sort of bubble...an insulated cocoon in which home values have gone up at insane rates because pretty much anyone qualified for a mortgage of some sort (even if it was at 14% ARM--meaning the rate would go up when the fed raised interest rates). More home buyers, meant more competition when buying a home, which meant the prices went up.
In the later Clinton years and in the Bush years, various policies and different circumstances caused the manufacturing sector (people who work in factories) to start to falter...and a few people started to default on their mortgages, and fewer people were buying new cars...causing the factories to lay people off, causing more home mortgage defaults...and this huge cycle was put in motion in which people couldn't pay their bills if they were maxed out, or were paying late, and after a while they couldn't even sell their home to move due to job changes because the value of the home had dropped so dramatically (this happened to us, in fact, in 2005 when my husband was laid off, got a job out of state, but our house wouldn't move, and appraised for quite a bit lower even after we made improvements). Some incomes stagnated and others went down, which meant foreclosures, bad credit, etc.
Sure, they claim more jobs were created, and that the workers just needed new training, but let's face it: a daddy working 50+ hours per week in a skilled trades job trying to support his family with no other job skills is hooped if his job is outsourced, because he can't take time off from working and supporting his family to take some class and learn a new skill, even if that class is "free". Not everyone is flexible in their career choices. Single moms, breadwinners, etc....it's not like you can just stop paying your bills while learning a new skill only to have to start over again at entry level wages.
A house's appraised value (what a mortgage underwriter feels it is worth) is based on a number of things including the value of "comparables" (similar houses that have sold in the area recently). This caused many problems....for example, when my husband lost his job in Michigan and was working in Ohio, we couldn't sell our house because all of our comparables that had sold recently were foreclosures that sold for 1/3rd of what we owed on our mortgage! Nice, huh? So, we couldn't sell our house because (1) no one would pay full price for ours when there was a few foreclosed bargains up the road and (2) the house would not likely appraise high enough for a mortgage even though we had done some improvements to it. So we were stuck, not that I wanted to move to Ohio (I didn't). So, for someone who, say, couldn't get another job in that area, that caused HUGE problems...and more foreclosures. We have foreclosed houses all around us right now. It's bargain shopping time in Michigan...if you can find a job.
Why did banks do it? They could justify higher than normal interest for one, and they could also count on people who get sub prime mortgages not being smart enough to read the fine print, or understand what an Adjustable rate mortgage was, or understand that it is NOT a good thing to have your house mortgaged to 120% it's appraised value (the best is to only mortgage 80%...putting a 20% down payment down). This whole Fannie Mae thing "generously" allowed people to buy houses without downpayments, and sometimes borrowing on equity that they gambled would be in the house in a few years. Ie, say a house is worth $100,000. Because values were climbing at a certain rate, the bank allowed people to borrow $120,000 for a mortgage (keeping the $20,000 for moving costs, home repairs, or whatever), and so now they owed $120K on a $100K house...with the assumption that the house would climb in value, and be worth way more than that in the future. This was true...for awhile...but isn't anymore.
Add to this the fact that even my not-quite-16-year-old daughter gets credit card pre approvals, and most Americans are in debt up to their eyeballs...we have done what the banks did, but on a smaller scale...spread ourselves too thin financially. This also contributed to the present situation.
Through all of this AIG, an insurance company, was insuring these loans for the banks, and making a killing...but they were also creatively balancing their checkbooks, and didn't actually have enough money to make good on the promises they were making in their insurance policies. They were promising bankers that they would pay for a loan where the person defaulted...and 10 years ago that was a safe bet, because few defaulted, home values consistently went up, and they were making lots of money. But, it was a house of cards. AIG didn't have enough money to pay the banks if too many people defaulted....and too many people did default.
Now these banks are crying poverty and those of us who pay our bills on time are getting rewarded by having to pay this bill.
Picture two columns on a spread sheet. One has a plus over it and one has a minus. The minus is money the bank has to pay (to keep the place open, to pay dividends on investments and deposits, etc.), and the plus is money that is coming into a bank (people paying the bank interest for loans it is giving out, for example). The bank is not going to make money by just charitably holding onto other people's money for nothing, and in fact if often owes people who have deposits, due to interest dividends they receive (for example, I have some money in a CD right now that is earning 5.05% interest...that is money that costs the bank something...so it needs to earn money somehow to pay me when it comes time to get my dividend come November). The money has to be put to work for them while they are holding onto it. Loaning it all out to Joe Blow who is already maxed out on his credit cards is RISKY, but the higher the risk, the higher the potential return (profit)...though the higher the potential loss too. Instead it looks for ways to invest that money so that it can make some money for itself while it holds onto it for you. The problem is those risky loans make way more money in interest, because you can charge more interest to someone who is higher risk...though if you do that too much, and too many default...you are in serious trouble. Thankfully those kind folks at AIG insure these risky loans so that the banks don't have to worry .... er, until the day AIG files bankruptcy! Whoops.
Imagine a bank is buying up a bunch of mortgages made to people who shouldn't have been given them in the first place ("subprime"), and earning all of that interest, but just in case, he needs to insure this investment, against people defaulting on them, so he goes to an AIG guy, and buys some insurance for this investment. If all of this sound surreal, it's because it is completely whacked. Without a fancy Ivy League degree in finance, I am pretty sure that normal people like us will never understand why banks thought investing huge percentages of their money into very risky loans was a good thing, or why no one bothered to ask if AIG could really back all of these loans.
On our ficticious 120,000 mortgage, the banker is paying some percentage rate based on the likihood of the mortgage holder defaulting (let's say, 2%) to insure the loan and thus the AIG guy gets $2400 a year with a promise that if the person who was given a loan without being able to manage their money defaults on the loan, then AIG promises to pay the bank whatever this person still owes on the loan. The big problem was that AIG made this promise way more than it could actually BACK the promise. It simply didn't have enough money to back all of these risky loans and no one really noticed (or they noticed, but didn't care).
Here is the problem. In a secured loan, you have to put down collateral. That means, you insure it with something real. you don't just get a $120,000 loan with a handshake and a smile. The problem is that these transactions were "unregulated" and AIG didn't have to prove to anyone that it had enough money to back up these presumptous promises it was making. It was promising to pay these banks all of this money for all of these loans if these people defaulted...counting on them not defaulting, of course...but it was allowed to write up these contracts and make these promises to the banks without proving to anyone that it could back up the promises (with capital...namely what it owned...what it was worth...the money it personally had in the bank)
Now the Fed is reaching into our wallets now to pay for their day to day operations (supposedly...I wouldn't be surprised if someone is also lining their pockets with some of this green too)...because they are having to be far more cautious and conservative with investing money, and so less is coming in...and they have to pay those who have deposited money....like me with my CD that is coming due in November. Essentially, the banks are not earning enough money on a day to day basis anymore (because they can't invest) and so now their cost of operations, in addition to what they owe depositors, is coming out of the pockets of we the people. Don't you love how the CEO of AIG gets a 15 Million Dollar Severance package after running the company into the ground and WE get the bill?.
I'm glad God is in control, and that even in this situation, He can work, frustrating as it is for the rest of us.
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