Collapse of Real Estate Prices/Sub-Prime Crisis

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Item added by abichara. Added on 01/13/2009

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abichara
02/28/2009

This was a significant contributing factor to the economic collapse. The economic forces that were at play here had been building up for some time, but the sub-prime crisis was the real catalyst for the mess we find ourselves in today. Part of the problem is that the national economy has become far too reliant on finance as our industrial base was broken down and shipped overseas. And now the meltdown of the financial markets and the services sector has left the American economy in tatters. We've come to a point where the US dollar's position as the world's reserve currency is being challenged successfully by other nations, including our trade partners like Saudi Arabia and China.

Those are the broader trends at play. The immediate causes of the breakdown has to do with real estate market. During the first half of the decade, the Federal Reserve lowered interest rates to almost zero percent. That allowed financial firms to aggressively market home loans and other forms of construction financing at very low rates. Some even marketed adjustable rate mortgages whose interest rate goes up or down with the market. Renters and others who could normally not afford a home were falsely induced by the prospect of easy credit and low interest rates. The result of this was one of the biggest real estate bubbles in history.

Mortgages, which were once held only in the portfolio of the issuer, were securitized. In other words, lots of individual mortgage debts were pooled into a security. Each mortgage was assigned a specific "tranch", or tier of risk. Higher risk loans paid out more, but had a higher risk of default. These were the first loans to start going bad when interest rates adjusted upwards around the middle of 2006. After these mortgages were securitized, the interest payments would be stripped out from the mortgages and they would be sold as derivatives, thus creating a third debt instrument based on the original mortgages.

Derivatives are essentially bets placed for or against a certain outcome occurring in the market. Financial institutions were gambling on the success or failure of these debt instruments. Brokers, traders and hedge fund managers bought and sold a type of derivative called collateral debt swaps. A buyer paid a premium to a seller for a swap to guarantee the value of the asset as a hedge to "insure" against failure. If an asset "insured" by a swap falls, the seller is supposed to make the owner of the swap "whole". The problems began arising when the seller could not guarantee the value of the assets. Now we should note here: no one owns the asset in question, these are just bets for or against their success or failure. The amount of people who could place bets on these assets are unlimited. What happened in this situation was that the value of the swaps, or the derivatives themselves, greatly exceeded the actual value of the asset in question.

As you can see, the prospects or ability to game the system here are significant. Some have benefited from the collapse of the economic markets. That's what happens when you turn the banking system into one huge casino. Holders of these swaps would then "sell short" the asset in order to drive down its value and collect on the guarantee. The sellers of the swaps were not required to reserve against them, and since there is no limit to the amount of swaps, many times the value of the derivative itself exceeded the value of the actual asset.

Some believe that the total value of all this derivatives trading is worth over $560 trillion!!! That's more than the value of the whole Earth! Warren Buffet calls these derivatives "weapons of financial mass destruction". And it appears like these weapons exploding in diverse places throughout the world. Iceland, Hungary, Latvia, and Ukraine are all on the brink of bankruptcy because of investments made in the derivatives market. We have been living through the greatest, more widespread asset bubble the world has seen and we still have a lot more to go.

This was the most shameless form of speculation. Gamblers were betting hands that they knew they couldn't cover. The US regulators, specifically the SEC ignored the whole thing. Financial institutions abandoned all integrity for huge profits. As a result of all this, American financial institutions and rating agencies are trusted nowhere in the world now.

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Wiseguy on 2/28/2009
You really need to cut it out, Abich. You constantly make too much sense.
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fitman
01/19/2009

These are symptoms, not causes of the disaster (thanks to the so-called Reagan 'revolution' and its aftermath).

UPDATE:

Those who wish to understand how we got into this mess are likely to find most of the answers in Thomas Frank's, 'The Wrecking Crew'.

UPDATE 2:

I'd like to make it clear that I don't blame Saint Ronnie for the (counter) revolution that bears his name. Anyone who was paying attention knows he was an 'amiable dunce', manipulated by the forces of unbridled greed.

http://tinyurl.com/UNBRIDLEDGREED

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EschewObfuscation on 1/13/2009
Wow, I didn't see that coming. Blame Reagan, liberals on parade.

fitman on 1/15/2009
Why do I suspect that those who've marked 'disagree' have not read and/or understood Thomas Frank's, 'The Wrecking Crew'?

Wiseguy on 1/16/2009
I understand Frank, that's the problem.

Victor83 on 1/16/2009
Wise...exactly...

callitdowntheline75 on 1/17/2009
Yup...dump on Reagan. Surprise there.

Victor83 on 1/19/2009
WTF is "inbridled"??

fitman on 1/19/2009
typo: substitute u for i.

I'd have corrected my own spelling, but the new improved RIA apparently doesn't allow for editing comments.

fitman on 1/19/2009
Spelling corrected and link to conservative media opinion provided.
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James76255
01/19/2009

This was not a symptom, but it wasn't the sole reason either. I don't think there is a sole reason. This was just the straw that broke the camels back.

When Sarah Palin even hinted that part of the problem was individuals with a lack of financial responsibility, some people threw a fit. I wonder what their reaction will be when Obama says essentially the same thing.

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numbah16tdhaha
01/18/2009

I'd hardly call it the cause, but I would call it the trigger. Once this popped the other dominos followed.

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FranksWildYear s
01/16/2009

Good thing we are seriously looking at whether this was Jimmy Carter's or Ronald Reagan's or Franklin Roosevelt's fault. Because the people who bought houses that cost 5 (or more) times their annual income with little or no equity at low introductory interest rates need some one to blame, other than themselves.

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fitman on 1/16/2009
And of course all victims of the flim flam man have only themselves to blame and corporate conmen and their enablers are blameless.


Victor83 on 1/16/2009
Who do I blame for these damn tennis reviews I keep getting in my email?
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Victor83
01/15/2009

Those who wish to understand this mess need look no further than three irrefutable facts: 1) Jimmy Carter and his Democrat Congress passed the Community Reinvestment Act. This unconstitutional socialism was repealed by Reagan, but reinstituted under Clinton. 2) In 1999 Bill Clinton signed the repeal of the Glass-Stegall Act (FDR legislation). 3) Clinton allowed Reno to force lending institutions to make bad loans, under the threat of lawsuit, to people who could not and did not repay the loans.
This was in no way Reagan's fault. Anyone who says differently is either ignoring the truth, lying, or both.

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LabRat on 1/15/2009
Didn’t Bush run on the record number of minority home ownership in 2004 re-election campaign?

Victor83 on 1/15/2009
Lab, I don't recall that specifically but I will take your word for it. Bush has been a horrible Pres and was nothing more than a leftist in republican clothing.

LabRat on 1/15/2009
everything seemed alright until a couple of yrs ago. I think you're right, Bush wasn't very good.
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