FAQs About the Financial Crisis

8/14/2019 FAQs About the Financial Crisis

1/15

Financial Crisis FAQs:

How the hell did we get here?Step 1 Hot housing market: Since 1998, the hottest assets around were high-yielding sub-prime mortgages

because of the hot housing market. Every financial institution bought them up because if they didnt their

competitors would and make a killing and leave them behind. It was the smart thing to do.

Step 2 Slick packaging fooled everyone: Investment banks started to bundle multiple risky mortgages together

and sell them as a single security this was done to make the risk murky and hard to quantify, thus making them

easier to sell. So not only were the financial institutions buying too many risky mortgage assets, now they werent

able to quantify the risks. But the assets were still hot so they bought them anyway.

Step 3 The unregulated bond insurance casino and the birth of credit default swaps (CDS): Because it was hard

to quantify the risk in these bundled packages, an unregulated form of bond insurance was invented in case the

mortgages defaulted, called credit default swaps. CDS was completely unregulated and almost anyone could

write a swap contract and sell it for cash but had to promise to pay up big if the underlying mortgage asset went

sour. Since the housing market kept rising, the likelihood of that happening seemed slim at the time. This is a

form of leverage and in essence they were borrowing money they hoped they would never have to pay back.

Soon everyone started to write and trade CDS it was free money just as long as the housing market was strong

and it was totally unregulated so anyone could hold thousands of contracts with very little capacity to pay theclaims in case of disaster. There were leverage limits but those numbers were easy to fudge.

Step 4 Everyone needs cash bad but nobody will lend any: Ultimately if you write insurance policies, you have

to be able to pay claims when they come in. The real insurance industry is highly regulated so that claims can be

paid. The CDS market is not regulated so everyone ended up writing too many CDS policies. When the housing

market turned, the claims started to pour in. A stampede ensued to get as much cash as possible to pay all the

claims this was fine just as long as someone else would lend the CDS players more cash but since EVERYONE

was writing CDS, nobody would lend anyone else any money because they needed to cover their own CDS losses.

Credit markets began to freeze and for the past two weeks, they have been completely stalled. Turns out almost

every financial institution owes about 5X-50X more in CDS claims than the entire value of their company.

I heard trading Credit Default Swaps (CDS) is essentially like gambling; is that true?Unfortunately yes. I used to think CDS was so slick, but it was a bad idea to block the proposed regulation and it was

even a worse idea to let firms like Fannie/Freddie, AIG and commercial banks gamble with CDS. It shouldve been kept

in the realm of Investment bank trading departments and hedge funds. CDS is still a great idea and should continue to

exist but the gabling aspect should be eliminated CDS is a hedging instrument and should be used as such.

What can happen as a result of this crisis?Almost every major financial institution in the US (except about ten of them) is about to fail. They all need to raise tons

of cash fast to pay the CDS claims and to reduce their own debts they but only have portfolios full of mortgage assets

that nobody wants to buy. If they fail, businesses, cities and people wont be able to borrow any money to live and do

business. Every business borrows short term money to buy inventory, pay bills and to fund payrolls. If a businessman

only spent money when he had it in cash, he would be considered a horrible businessman, so its not just the

irresponsible businesses at risk.

If the credit markets totally freeze for a year, theoretically 90-99% of all businesses in the US could go into default within

that year. Majority of them will start firing people within three months. For regular people, they will lose their homes

and will stop buying durable goods like cars, appliances and homes. Consumer credit will also freeze and credit card

limits will be reduced. Unemployment skyrockets and we essentially have another depression.


2/15

Whats the probability of a depression if we do nothing?Based on all my research, without intervention of some kind I would rate the chances of a depression at about 70%

and the chances of a deep recession at 90%. However, if China and the Saudis were to divest their dollar denominated

assets in a panic, the chances of a catastrophic disaster would be 100% (but thats not likely). Im not trying to scare

everyone here if 90% of all your banks were to go bankrupt at the same time, its going to cause a depressionplain

and simple and the banks that are left will no longer behave like banks anymore they wont lend money to business

anymore.

Isnt the bailout plan simply saving the asses of greedy bankers so we can save our own?Essentially yes, but you shouldnt hate them. The saying, dont hate the player, hate the game applies here. These

banks were certainly greedy but they werent stupid. You need to understand that banking is essentially a commodity

service with zero switching costs there isnt much difference between one bank over the other and therefore if one of

them finds a loophole and profits from it, the other banks need to quickly follow otherwise they can lose their

competitiveness very quickly. This is why commodity industries everywhere are heavily regulated (including banking)

and most of them form cartels (e.g. OPEC). An unregulated commodity industry with zero product differentiation will

eventually squeeze the honest and reward the cheaters.

Ironically most of the banks that are now in the most trouble are the ones that were the best at the CDS and mortgage

trading business (Bear, Lehman). The banks with the least talented CDS traders are the ones that will now survive

because they couldnt cheat as effectively as the smart guys. Bottom line, all of them believed they HAD to takeadvantage of the CDS/Mortgage business or they wouldve eventually lost to the ones that did.

What does the current bailout plan do?The basic plan is to initially issue new dollars to buy up about $250 billion in sub-prime mortgage assets for about $0.45-

$0.85 on the dollar the other $450 billion will be used later to buy more. In a few months, another bailout fund of $700

billion will probably be authorized by congress. In total, theres about $7-$9 trillion in mortgage backed securities out

there but not all of it is distressed and with a $2.5 trillion dollar capital infusion much of that $7-$9 trillion will become

trade-able again. (With the Feds help, we will most likely be infusing about $2.5 trillion into the markets this year).

A special Gov fund will be created and professional managers will be hired to manage and eventually sell the assets it

looks like right now Bill Gross at PIMCO and Black Rock will be the head managers. Bill Gross is the best fix income

manager in the world and Black Rock has some of the best fix-income traders in the world. I personally think Gross is a

god walking among monkeys and was thrilled to hear that he will most likely be getting control of this fund.

The managers will try to first re-sell off as much of the non-complex assets as possible at cost ($0.45-$0.85 on the dollar)

or higher. What will be left is a fund of extremely complex mortgage bundles that cannot be easily valued. Over the

next five years, the fund managers will begin to break up the bundles and then re-package them into more simple assets

and begin to sell them off at a profit.

Is it true that we can make a profit from this bailout?The governments track record of buying distressed assets and turning a profit is basically perfect but thats not saying

much because even an idiot can turn a profit when youre buying assets at fire-sale prices, have unlimited time and your

cost of capital is the lowest in the business. Really give me unlimited funds, unlimited time, the lowest cost of capitaland political connections with other governments and even I can turn profit easily. In addition, with Bill Gross at the

helm, Id say that there is almost a 95% probability that well profit from this bailout just as long as our currency doesnt

collapse and we avoid another world war.

I heard were not really spending the $700 billion, is that true?From an accounting perspective, the taxpayers will only be hit with the losses on these investments, if any. If Bill Gross

can just break even, then the bailout would technically cost us nothing, minus interest and opportunity costs. From a

use-of-cash perspective, yes we will be using $700 billion in new cash to buy assets.


3/15

How is the bailout plan supposed to work actually?In general, this is an indirect, trickle-down plan. Were setting the spark then asking the market to correct itself.

Step 1: First, the goal is to get the banks to sell their toxic assets at a loss to the government. Participation is the

key because many of them will want to sit on the toxic assets and ride out the storm on their own so they wont

have to absorb the losses and admit defeat.

Step 2: Then we launch the Bill Gross Restoration Shop essentially having him play the role of the classic car

restorer. Once these assets are consumed by the government fund the less complex assets will be unwound,reconstituted then re-marketed immediately. With Bill Gross at the helm of the fund, its pretty certain these

assets will be correctly stripped of the toxic elements, re-capitalized and then priced to move. The icing on the

cake is that these securities will now be federally insured. When the traders, hedge funds and private equity

players see this they will want to get in on the action again (greed and trust in Bill Gross judgment would compel

them to act) thats when the fixed income markets will begin trade again. Bill Gross will also have the ability to

buy more discounted toxic assets from these traders and do the same thing over and over again buy, strip,

recapitalize, insure and price to move. rinse and repeat.

Step 3: Once the markets start to price these assets correctly again (rather than at illogical fire-sale prices), the

higher quality pools of mortgage assets will begin to emerge and will be sold by the banks that need to raise

capital and be purchased by investors that have capital. Once that happens, the banks will be unshackled and they

will be able to do business again, a.k.a, lend money and charge interest.

Step 4: Once that happens, businesses and corporations everywhere will have access to short term funding again

and be able to buy inventory, pay their workers and so on.

Step 5: Many years down the line, Bill Gross would have sold all these assets and report to congress on his results.

He would have written down the totally toxic parts but would have made money on the parts that were

salvageable. If theres a profit, then it will then be used in future government programs or to reduce the national

debt.

Why is everyone saying the bailout plan is flawed?

In general, the plan is flawed because its a conundrum. The plan doesnt actually force any of the banks to dospecifically what we want them to do (start lending money) we set the machine in motion and then sit back and hope

they do what we want. However, if we put in too many provisions and force them to do X, Y and Z, they might not

participate and try to ride out the storm on their own thereby making the bailout plan moot. Then again, do we want to

write a blank check to the idiots that got us into this mess with no guarantees that it would work in the first place? I can

see the merits of both arguments.

Why do the Republicans and Paulson want to get rid of the oversight, golden parachute and equity upside

provisions?I know it seems like theyre corrupt and want to save their Wall St. buddies. Thats not true. The key to the bailout plan

working is PARTICIPATION. We need as many institutions as possible to participate in the sale and prevent them from

just sitting on the toxic assets to try to ride out the storm. Dont get me wrong, oversight, compensation and equityprovisions are good things but if these provisions dis-incentivize the banks from participating, then the whole purpose

of the bailout would be moot.

The Democrats are arguing that these banks will participate even with these provisions because theyre desperate.

Frankly I can empathize with both positions and I dont know which one is right. However, if all you want to do is

increase the likelihood of the bailout working with full participation then fewer provisions is better than more. But I

can understand how distasteful it seems to write blank checks to the culprits of this mess.


4/15

What about those Democrats suggesting using direct capital infusions into the regional banks and the other

direct investment plans versus the current trickle down bailout plan?The various direct infusion plans have the greatest likelihood of working immediately NOBODY will deny this. But it

would mean directly recapitalizing thousands of regional and commercial banks and taking minority stakes in them and

providing tax breaks to directly incentivize lending. The great part of these plans is that they would virtually guarantee

full participation, which is what we need for any bailout to work.

Despite its logic, it would NEVER pass in congress because it means the growth of government and the government

taking partial minority ownership in large parts of the banking system. Although there are provisions so that thesebanks would be privatized again over time (like Fannie and Freddie) this is the type of thing conservatives would rather

die than pass. In addition, were not certain what this would do to the competitiveness of the credit markets 10 years

and it would certainly mean many badly managed banks would survive this crisis instead of just letting the strong ones

survive. Foreign banks will also be made less competitive and would close shop and go home. However, there is no

doubt the direct plans benefit the general population the most and would work the quickest.

Even the conservatives would agree the direct plans would actually create the effect were looking for to save the

markets in the short term but theyll also tell you this is ideologically pseudo-socialism. Personally, I view it like

declaring martial law. The president can suspend our constitution temporarily in emergency situations in that same

way we could suspend private ownership in certain pockets of the system until the crisis passes. Bottom line, the

projected success rates for the direct plans far exceed those of the indirect plans but I do admit it opens up variousmoral hazards.

If the Republicans could make an ideal bailout plan, what would it look like?First off, they wouldnt want any kind of bailout. If they really had their way they would just let it play out and fix itself

regardless of how long it takes. This isnt necessarily evil or irresponsible in fact is probably the fairest of the actions

and the most responsible but the question is who would suffer the most should we let the common citizen who

didnt have anything to do with this suffer for the mistakes of the free market? Some Republicans, including the SEC

chairman, Treasury secretary and the President think something should be done.

The sticking point for the Republicans is full participation. If we put in too many provisions, banks will hold onto these

toxic assets and just hunker down and try to ride out the storm. thus keeping the credit markets frozen. The initial

three page Paulson plan is exactly what the Republicans really want. As far as promoting full participation, I have to

admit that they do have a good point here. Plus Paulson will have to make some moves that seem illogical at first in

order to fix this thing thats why he had a no-oversight provision he wasnt just trying to cover his ass. He needed

the flexibility to make some hard decisions without being bogged down by congressional oversight.

The secondary plan floated by House Republicans would allow $700 billion of these toxic assets to become federally

insurable (rather than purchasing them), thus making them safer and more easily tradable. Almost all of these toxic

assets were already insured but some of the counterparties couldnt pay the claims therefore this program would

provide, government guaranteed insurance. Thats it they would then sit back and hope that these assets would

begin to trade again.

Who is to blame for all this, the SEC, Greenspan, Democrats or the Republicans?If this is all youre concerned about youre destined to remain uneducated about this issue. The real question is what

were specific causes of the problem and how did we get here? Leave the blame game to the FBI who has been given

authority under the senate bill to go after the worst of the offenders.


5/15

What are the primary factors that caused the financial crisis?Imagine dominos toppling if one of the dominos in the line were absent, the toppling would stop. The financial crisis is

quite similar. The strange part about this crisis is that it wouldve never happened unless all or most of the contributing

factors did their part to cause it. Individually none of these factors would have done the trick. Below I will try to assign

weightings based on each factors contribution to the crisis, but like I said, individually none of these factors are

necessarily bad. (Below: Duplicate factors have weightings split between categories)

(40%) OVER-LEVERAGE: The great depressions of 28, the crash of 1987, the Asian financial crisis, LTCMjust to

name a few were specifically caused by financial institutions exploiting exotic instruments to use more leverage.Thats exactly what happened to us yet again. Leverage in moderation is great; it allows you to trade $10 worth of

securities with only $5 in your bank account and maximize your returns. However, over-leverage can be deadly

when markets go sour. Without leverage, when you lose your $10, you lose $10. With leverage, you can not only

lose your original $10 but could end up owing $500 on top.

(+15%) Credit Default Swaps CDS is a derivative asset that is essentially tradable bond insurance.However, it is completely unregulated and very few rules exist that cannot be bent or avoided. When you

write a CDS contract you are promising to pay cash claims if the underlying bond product defaults. If the

bond doesnt default, its basically free money. For excessive CDS writers it can also be a form of leverage

because theyre taking on huge potential liabilities against small cash reserves and theyre just praying the

bonds dont default. Some firms would write hundreds of CDS contracts to raise cash to pay employees or

to use the cash as collateral for additional debt. Writing CDS is a drug and almost all the banks got addicted

to because in a hot real estate market it appeared to be free money.

(+15%) In 2004 the SEC waived its leverage rules for the top US Investment Banks The SEC has capitalrules that limit banks to a debt/capital ratio of 12 to 1. After Bushs re-election, five firms -- Goldman Sachs,

Merrill Lynch, Lehman Brothers, Bear Stearns and Morgan Stanley were granted an exemption; they

promptly levered up 20, 30 and even 40 to 1and a semi-bull run ensued. Four years later, 3 of these

original 5 have gone bust. Why were they granted this exemption? We dont know really most of us on

Wall St. assumed it was done at the request of the just re-elected president to keep the economy strong

during his second term but none of us really knew. Personally, I can tell you that we all didnt really mind

at the time and praised him for it I did too.

(+10%) Wealth effect from home ownership When the value of everyones homes keep going up, theybuilt up a lot of equity. Even though this value is only on paper, the wealth effect is real and people realize

they can max out their credit cards and take out more home-equity loans against the collateral of that

building equity. It now appears the US consumer was just as over-levered as the banking system.

(30%) EXCESSIVE DEREGULATION: When you de-regulate any kind of market, it attracts investment, improves price

discovery, increases efficiency, increases liquidity and promotes growth; its a great thing. Unfortunately abuse of

the system almost always follows. Striking a good balance is the key but no balance at all is disastrous.

(+15%) The 2000 Commodities Futures Modernization Act This act was passed by a Republican congresswith the help of the Democrats and a Democratic president. It made commodities such as "interest rates,

currency, and stock indexes" as "excluded commodities." They could trade off the futures exchanges, with

minimal oversight by the CFTC. Neither the SEC, nor the Fed, nor any state insurance regulators had the

ability to supervise or regulate the writing of credit-default swaps (CDS) by hedge funds, investment banks

or insurance companies. At first it was great because it made markets liquid and very efficient the

intentions were good but abuse quickly followed and even our most prudent institutions got caught up in

its excesses.

(+10%) Financial Services Modernization Act of 1999 This act was passed by a Republican congress, wasspear-headed by Phil Graham and was resisted vigorously by the Democrats and Clinton. It repealed the

Glass-Steagall regulation law that separated the financial institutions that the public needed to function

(commercial banks and insurance) with the more risky world of Wall Street. With its passage anyones

small-town corner bank or insurance company could now dabble in the risky securities and derivatives that


6/15

normally would be exclusive to the realm of hedge funds, investment banking traders and private equity

firms. This single law brought down AIG, our countrys strongest most solvent insurance underwriter. This

law helped to bring down WAMU, Wachovia and IndyMac.

(+5%) 2004 SEC waiver of leverage rulesfor 5 investment banks there were many good reasons why the12/1 leverage ratio rule was in place but mostly because going beyond this ratio almost always lead to a

bubble that would eventually burst. Nobody knows why the SEC decided to waive this rule for the five

largest US investment banks but we all know the result 3 of these 5 have gone bankrupt and the

remaining 2 had to be rescued. Thats a 100% failure rate. The market run between 2004 and 2007 was

great but the cost we had to pay was too great.

(25%) REAL ESTATE MARKET FRENZY AND SUBSEQENT FALL: A strong real estate market is ALWAYS a good thing.

However, like any asset class it should go through periods of ups and downs its healthy. Between 1998 and 2006

it was going at warp speed with no letup everyone was also making money in the stock market, rates and inflation

were kept low and two wars made everyone uneasy about stopping the fun.

Everyone including the least worthy were getting bad loans and buying homes that were extremely over-appraised.

These junky loans were then being repackaged as securities and sold to the markets. Because the real estate market

was still hot, these junk securities appeared to be high-yielding, yet safe bets. These junky bond bundles soon

became the hottest investments around and everyone was getting in.

Ancillary products such as unregulated Credit Default Swaps (CDS) were created to insure these junky bonds but

were greatly abused as cash raising tools rather than insurance. Then the real estate market finally turned. The

junky bonds started to behave like junk and the holders were all rushing for the exits at the same time. The CDS

writers were stuck paying out their entire asset bases as claims and were going bankrupt. Since everyone was

already over-extended they stop lending to each other and the credit markets frozeand now here we are.

* Was the hot real estate market the cause of this crisis? Of course not but it provided the backdrop for all the

over-extension, abuse and hubris.*

(+10%) Alan Greenspan, Bernanke and the Fed In 1997 Greenspan and the Fed missed the opportunity tochange margin requirements. Had the Fed acted, the tech bubble would not have inflated as much, and the

subsequent crash would not have been as severe. Between 2001 and 2003 Greenspan dropped the federal-

fund rates to 1% to prevent the terrorists from crashing our economy. Lulled into a false belief that inflation

was not a problem, the Fed then kept rates at 1% for more than a year. This set off an inflationary spiral in

housing, and a desperate hunt for yield by fixed-income managers. Between 2003 and 2007 interest rates

were still historically low even despite massive deficit spending on a war, a sky rocketing money supply and

an obvious housing bubble.

(+10%) Fannie and Freddie Mac (underwriting) and complexity How were these small mortgage brokersand thrifts able to offer such low interest rates and good terms? Because Fannie and Freddie (F/F) would

keep taking the loans off their hands in the secondary market (50% of all of them to be exact). Even though

F/F were not big loan originators (dealing with customers) they enabled the smaller brokers to do business

by underwriting their loans. How was F/F able to afford dealing with so many middle-men? Because as long

as they kept buying up the all the subprime they didnt have to pay state taxes and because of their size they

had the economics to repackage loans and make them profitable. F/F certainly didnt invent the re-

packaging of loans (which hid risk and increased complexity) the investment banks did, but because of

F/Fs size they made the problem of complexity more wide spread.

(+5%) Awful lending practices (originations) Of the subprime or near-subprime mortgages currentlyoutstanding, 50% of all them were originated by mortgage service companies not subject comprehensive

federal supervision; another 30% were made by banks or thrifts which are not subject to routine supervision

or examinations and the remaining 10%-20% were originated by Freddie/Freddie and others. With interest

rates so low, these institutions were desperately trying to get people to buy homes in any way they could.

They could borrow from the Fed at 3%-5% and lend at 5%-10%... so trying to push through as much volume


7/15

as possible as quickly as possible was the goal. What followed were no money down mortgages,

predatory ARMs and a shift in loan to value from 80% to 120%. Banks began to develop automated

underwriting (AU) systems that emphasized speed rather than accuracy in order to process the greatest

number of mortgage apps as quickly as possible. How many commercials have you seen asking you to take

out loans against your home equity? Then came the real crazy stuff like piggy back, interest only,

negative amort, loans and reverse mortgages. I literally can go on and on but we all know what happened

here: interest rates were unnaturally low and every mortgage broker or bank in the country was desperate

to recruit anyone off the street to lock them into a 5%-10% loan when they themselves were borrowing at

3%-5%.

(5%) REGULATION AND RULES THAT DIDNT WORK:

(+3%) Mark to market rules Enron has taught us that we cannot let financial institutions make their ownassumptions about the value of extremely complex assets because they will most certainly lie about the

value of those assets. Thus mark-to-market were created so that the market will determine the price of

those assets. However, what happens when the market is behaving in a panic, wont those assets then be

grossly UNDER-valued? Because many of these banks are forced to book some of these mortgage assets at

irrationally low values, their balance sheets look terrible and it wont allow them to borrow money and do

business. In the future, the non-governmental FASB must find a middle ground between mark-to-market

and mark-to-model.

(+1%) Credit Ratings Agencies Moody's, S&Ps and Fitch tried their best to rate complex bundles ofthousands of mortgages with mix credit ratings. But in the end there was no way a few ratings analysts

could take the workload of evaluating each and every loan in a loan bundle. Sometimes the SEC needs to

step in and categorize certain extremely complex assets as un-ratable.

(+0.5%) Federal Reserves regulatory authority failed 2003-'07: The Federal Reserve failed to use itssupervisory and regulatory authority over banks, mortgage underwriters and other lenders, who abandoned

such standards as employment history, income, down payments, credit rating, assets, property loan-to-

value ratio and debt-servicing ability. The borrower's ability to repay these mortgages was replaced with the

lender's ability to securitize and repackage them.

(+0.5%) Appraiser / lender collusion Any homeowner can tell buyers that their home is worth much morethan it really is so its the Appraisers job to be the reality check and tell the bank and the buyer what the

home is really worth. However numerous cases of Appraiser/lender collusion have been uncovered by theFBI and will be prosecuted.


8/15

Are Fannie and Freddie the cause of all this? Should we get rid of these horrible government institutions?This was one of my first conclusions until I actually did my research. Now Id have to say Fannie and Freddie were two

of the three primary enablers for onlythe first stage of this crisis: the overheated housing market.

First off, Fannie and Freddie (F/F) are regular corporations. They are only called government sponsored entities (GSEs)

because they get state tax exemptions for buying mortgages held by lower income families in the secondary market;

theyre underwriters for the brokers that serve the poor. But this state tax exemption is no different than the billions in

royalty exceptions and tax subsidies given to US oil companies for drilling in low-yield oil fields (both of which are far

bigger tax breaks than anything F/F get). Technically speaking, all US weapons manufacturers, most farmers, all carcompanies and all US oil companies are also GSEs, its just that we dont think of them that way.

The fact is F/F both do not get any federal aid, nor can the government realistically dictate to F/F its lending standards or

practices. The government has no federal powers over F/F whatsoever. F/F are incentivized by state governments to

underwrite low quality mortgages but its completely optional just like optional tax incentives that are given to

corporations to not pollute, to farmers to continue to farm and to car companies to not ship jobs overseas.

So if Fannie and Freddie are regular greedy corporations, so what are they really guilty of? They are guilty of keeping the

real estate market unnaturally hot for too long, or what we call price distortion. They allowed mortgage brokers, big

and small, to keep writing low quality mortgages because F/F kept buying them up in the secondary market. This also

kept real interest rates unnaturally low. F/F kept buying up these bad mortgages because they knew their size and

economies of scale would allow them to still make a profit by bundling them as high yield income streams. F/F are

essentially gigantic junk bond investment bankers. Were they guilty of the current crisis? No, but they helped create

the environment where Wall St. cheaters could later make a profit from cheating. They were the stage setters but they

didnt force anyone to abuse the system with the CDS craze or to over-lever their balance sheets F/F were just trying to

make a profit like everyone else. Frankly, I hate F/F with a passion because they put smaller and smarter lenders like my

cousin out of business and keep the bad ones in business but I cant get myself to blame them for the current crisis.

Did the government somehow compel or force F/F to sacrifice prudence for the sake of the poor? No unfortunately

our government had no say in how F/F conducted its business. In fact, we should be angry that our government didnt

have any influence over how F/F conducted their business because their business practices and market distorting

policies should have been more tightly regulated and monitored.

Should we kill Fannie and Freddie now that theyre nationalized? Realistically yes, they basically started price wars with

a lot of smart lenders in the market and created too much price distortion. Putting poor families into homes to build

retirement security was a great PR tool they used, but in practice F/F were too powerful and did it in a way to undercut

the competition. In the end, they were profit hungry corporations and behaved that way. Now that theyre nationalized

again, we should be very selective when promoting lending to the poor and prevent price distortion in ultra-hot

markets. And most of all we should make these programs live up to their altruistic mottos.

The new government managed Fannie and Freddie should try and achieve its utopian goals but should do so only in

small segments of the market where theyre most needed and they should remain as government programs or not at all.

The FHA needs to be reigned in too, or change its focus to promoting home ownership OR cheap rental housing -

whatever the market naturally favors at the time. In addition, stopping price distortion should be written into theseprograms charters they should help the poor, but not artificially bolster a market that needs some healthy correction

from time to time.

Why dont some of these banks just hunker down and ride out the storm?Thats exactly what we dont want. Individual banks might start to think theyre unique and can ride out the storm but

if enough of them do this the markets will freeze and theyll all go down at the same time. I can use game theory math

to explain this, but its pretty simple if a few big banks start thinking theyre special and not like the others, those few

start a chain reaction that brings down the whole group including themselves.

Can we trust the FDIC? How long does it take to file a claim for my deposits.


9/15

Withdrawing your deposits in a scare is not necessary. The process is seamless and the applications for the claims are

made by the banks, not by the depositor so the common citizen will not lose access to their money even if their banks

CEO is fired and the bank is defunct. The FDIC takes over the deposits and runs the operations. The websites wont go

down nor will the ATMs be closed before you can find a new bank.

Is there an example in history where there was a financial crisis and it corrected itself?Yes, Japan they were in a recession for 10 years and it destroyed the currency. The recession was so bad their Fed

lowered their interest rates to zero for a long time and still nobody wanted to invest in anything Japan. The government

nationalized some of the banks eventually anyway. But their country didnt implode so theres the example.

Xxx xxx xxxxxx xxxxxxxx xxxx xx xxxxxx xxxxxxxx xxxx xx xxxxxx xxxxxxxx xxxx xx xxxxxx xxxxxxxx xxxx xx xxxxxx xxxxxxxx

xxxx xx xxxxxx xxxxxxxx xxxx xx xxxxxx xxxxxxxx xxxx xx xxxxxx xxxxxxxx xxxx xx xxxxxx xxxxxxxx xxxx xx xxxxxx xxxxxxxx


xxxx xx xxxxxx xxxxxxxx xxxx xx xxxxxx xxxxxxxx xxxx xx

What did the Japanese do wrong in the 90s?In short: They wanted to maintain the sanctity of their free markets and existing contracts and at first left everything

alone. When it got so bad, they then started to intervene but it was too late and their massive liquidity infusions and 0%

interest rates were, by then, ineffective they had already crossed the point of no return. They wanted the free

markets to correct themselves and indeed the markets did but it took 10 years and destroyed the Yen. What we learnedfrom Japan in the late 90s is that decisive and overwhelming force is the right way to stop the flood gates from

opening the piece-meal approach is what killed the Japanese financial system. Lastly we learned that ideological purity

make a few people at the top feel better about themselves, but the rest of the country suffers and dont really give a

damn about ideology. xxxxxx xxxxxxxx xxxx xx xxxxxx xxxxxxxx xxxx xx xxxxxx xxxxxxxx xxxx xx

What did secretary Paulson tell the congress that scared them so much?He told them almost every bank in the US currently holds tons of toxic mortgage assets that when valued at market

rates creates negative equity for almost every single bank in the country. This sets off a chain reaction that is obvious.

What kind of regulation is the best?Lets face it, anything involved in leverage and derivatives MUST be regulated. xxxxxx xxxxxxxx xxxx xx xxxxxx xxxxxxxx


xxxx xx xxxxxx xxxxxxxx xxxx xx xxxxxx xxxxxxxx xxxx xx

Doesnt the government suck at managing assets?Yes, but the government wont be managing this bailout or the fund they can hire anyone to manage this fund. It

appears that Bill Gross and Black Rock will be tapped for the job. Bill Gross and Black Rock is about as good as it gets

when it comes to fixed income management and trading. Spot onBravo.

Shouldnt we prevent the complexity of these securities? Should we outlaw complex instruments all

together?No, but we should put in valuation rules that lie somewhere in between marking-to-market and marking-to-model

and let the private governing board, FASB, determine what those rules should be. However, there are instrumentswhere the complexitys intended purpose is to deceive the buyer into taking on risk that cannot be easily quantified,

such as collateralized mortgage assets that are securitized and then re-packaged more than two times. These should be

outlawed and the SEC should set these rules.

What about getting rid of Mark to Market rules?Something in between mark-to-market and mark-to-model might be best. Temporary suspension for 12 months of

these rules makes sense too but getting rid of them altogether is crazy. It would be condoning widespread cooking of

the books.


10/15

For complex structured assets, valuation is not straightforward just ask Enron. Before the mark-to-market rules,

Enron traded energy transmission contracts far into the future where certain assumptions needed to be made in order

to price the contracts for the present. It was Enrons responsibility to model these assumptions and the tax auditors

responsibility to make sure these model assumptions werent crazy. Having done this type of valuation work myself, I

can tell you that I can make the model say whatever my boss wants it to say really, I can. And thats exactly what

Enron did they lied about the value of their contracts and their greed eventually brought down the energy markets and

almost all the accounting firms.

Fast forward to 2008, these mortgage bundles also rely on many future assumptions for valuation, but because of theEnron debacle, its mostly illegal to keep an asset on your books at mark-to-model numbers, but rather you have to

book it at its current market value, or mark-to-market. But what if we were in a horrible market where everything was

grossly UNDER-priced? You would have to book your assets at levels that didnt make any sense and since your creditors

will only let you do business if your books are healthy theyd start calling in their debts because your books look awful

when you mark these assets to the horrible market.

Mark-to-model valuation certainly leads to abuse but in horrible, crisis-like markets, mark-to-market rules dont

make sense either. If we survive this crisis, we need to find a happy medium. I would let the FASB set and continually

update certain global variables such as GDP growth, inflation and future LIBOR for certain mark-to-model assets and

would set limits for what percent of your assets can be categorized at level-3 (a.k.a. dark assets, or assets that are so

complex you cannot value them). Finally, I would require yearly re-valuation periods where you would re-mark your

assets to the market and reset the value of your books according to FASB rules.

Whos to blame for AIG?I hate to say this because I love the guy and for people that work on Wall St., hes our hero but Id peg Phil Graham for

AIG. Letting insurance companies trade high risk assets like hedge funds was a bad idea and blocking any and all

regulation for leveraged products was also a bad idea. There were many good reasons why this was illegal before Phil

helped unregulated it. Thus, if one thing or person could be blamed for AIG, it has to be Phil. However, you cant really

hate the guy because its pretty clear who he is and hes never hid who he has been fighting for. He and his wife are

partially responsible for stupid things like AIG and Enron, but hes also done some great things to unregulated Wall

Street and keep the markets working efficiently. The reason I dont blame AIGs trading desk for taking so many risks is

that they were just doing what their investment banking trader counterparts were doing there was money to be made

and it was their job to try and chase it. They would have continued to chase it until someone told them that insurancecompanies shouldnt behave like hedge funds.

In the end we learned that any derivative products or instruments that allow you to lever up your book must be

monitored in some way.

Is this a bailout or a rescue package?Its a bailout, but without it were going to crash so badly that a follow-up rescue wouldnt work. The best way to

describe it is, a distasteful yet necessary bailout.

Is the bailout too big or too small?

The answer lies in the psychological state of bank CFOs. What number would compel them to sell their toxic assets at ahuge loss, then to recapitalize and then free up lending? My sense is $700 billion is enough for now but a follow up

$700 billion will be needed in a few months.

Are the bond rating agencies to blame for this?Partially yes, but rating bonds is an art, not a science and its done by a small number of people. The assumptions you

must make to determine the future cash-flow productivity relative to capitalization are just that, assumptions. For these

complex mortgage packages its just too much work to individually evaluate every mortgage in a bundle of 10,000

mortgages. Trusting these fly-by-ratings is dangerous because the ratings agencies are claiming that something is safe

when they know they didnt do enough research to really determine that.


11/15

The question is do we want to be told lies so we can do more business or told the truth and not have any business

transacted at all? How about a compromise?:

What we learned from the current crisis is that if something is so complex that you cant do a good job evaluating it

then you shouldnt put out a rating at all. It should be pegged with a rating of, NA. However, since theres more than

one ratings agency in the game, if one doesnt rate something, then the others can gain an advantage by rating it

thereby forcing all of them to put out a rating, no matter how flimsy.

Thus we should have the SEC deem certain products to be too complex to be given a publically published rating. Thesecomplex products can still be rated privately for investors that need an evaluation before purchasing it, but no public

ratings should be given thereby limiting bad information from spreading or being trusted by everyone. The bond

ratings agencies can still charge a tiny fee for an ad-hoc, private rating this would still allow these complex assets to be

bought and sold.

Do we really have free markets?No the phrase, we must preserve our free markets is a joke to those working on Wall St. That phrase is designed for

public consumption.

Was it the foreign capital inflows over the past 6-8 years that overheated and over levered our economy?

xxxxxxxxxxIt makes it sound like its the foreigners fault. It was the inflows that helped prevent this crisis for this long.

Why did the Euro drop so much relative to the dollar and why is LIBOR rising?Over the past ten years, many economists have theorized that the economies of Europe and Asia have become so strong

and flexible that they are now de-coupled from the US economy making them resilient to our ups and downs.

However, in times of crisis it seems the rest of the world has not de-coupled because many of the markets in Europe and

Asia are now also experiencing credit squeezes specifically in EU inter-bank borrowing rates (LIBOR) are starting to rise

in a panic. So what do these foreign economies and investors do now? Buy more dollars.

First off, the worldwide rush for dollars is a flight-to-flexibility. Since the world conducts trade and buys oil primarily in

dollars and they dont know if their domestic credit markets will soon be frozen too, they want to load up on dollars so

they can at least buy oil and still conduct trade into the near future. If the US wasnt a global reserve currency this

demand would not be as sharp.

Specifically for the EU, this is a flight-to-bailout. Meaning the likelihood of a credit freeze in Europe is now rising but

the likelihood of a bailout is slim. New efforts for a 300bn pan-European bailout are in the works but how quickly can it

be implemented? Even though they share the same currency and central banking system, this consortium of countries

each have their independent governments and leaders and getting all of them to agree to fund a bailout would be hard

to achieve. At the very least its much easier to pass a bailout package in the US than it is in the EU. This is why the

world has not yet switched to the Euro as the global reserve currency despite the EU being much more stable over the

past 20 years.

How will this affect the world?

xxxxxxxxxxxxxxxxxxxxx

What do I do to protect my family?xxxxxxxxxxxxxxxxxxxxx

xxxxxxxxxxxxxxxxx?xxxxxxxxxxxxxxxxxxxxx



12/15



13/15


14/15


15/15

Documents

FAQs About the Financial Crisis