How It Happened
By Miryam Ehrlich Williamson
When I’m not writing blog essays like this one, or magazine articles, or books, I write short stories (which is what I’d do all the time if I didn’t mind being hungry and living on the street and so forth.) I have a pretty active imagination, so when I see something that I can’t find the answer to, I make up a story about it that satisfies me until I can get a believable explanation, which is practically never.
When the whole financial services/banking crisis hit the fan, I had more questions than a barn cat has fleas. For once both my looking-things-up skills and my imagining-things skills failed me. Then I found in Newsweek reference to two programs on the NPR Radio show This American Life that the magazine said made everything clear to people who don’t do finance.
Here I’m reporting on the first of the two, a program called “Giant Pool of Money.” I’ll tell you about the second program next week.
If you can listen to the radio on your computer, you’ll find “Giant Pool of Money” here. You can also download it from the same link for 95 cents. If you want to read the transcript, as I did, get it here, or from the audio link just before this one. I’m going to give you the CliffsNotes version, in case you lack the time to do either of the above.
But first I want to credit Alex Blumberg, a producer for This American Life (producer is to radio as reporter is to newspaper. Both gather the information; both may or may not write the program or article.) and Adam Davidson, NPR’s International Business and Economics correspondent. For the most part I’m working from their material, not my own research.
The story begins with a giant pool of money, estimated at 70 trillion dollars. If you remember my essay How Many Zeroes in a Gazillion? you know that a trillion is a million million, written as a 1 with 12 zeroes. Davidson says that pool is
basically all the money the world is saving now. Insurance companies saving for a catastrophe, pension funds saving money for retirement, the central bank of England saving for whatever central banks save for. All the world’s savings.
It took the world several centuries to accumulate $36 trillion, and then that amount doubled in just six very recent years.
[Note from Miryam: When I was a child paper money like you have in your pocket represented actual metal money that lived in bank vaults and a place called Fort Knox, which held all the gold the U.S. Government owned. That gold backed up the paper money in circulation in hte U.S. For each dollar of paper money there was a dollar's worth of gold in the U.S. treasury. My grandfather once took me to a bank – a huge marble edifice – and turned a $10 bill into a $10 gold piece, just to show me it could be done. I don't think that's possible anymore. Today, most money is backed up by entries in a database. The only reason a $10 bill is worth $10 is that we agree it is. If we stop agreeing, our economy is in deep trouble.]
A host of investment managers, normally very cautious people, took care of those trillions. Their jobs were first, not to lose any of it and, second, to make it grow. To do that, they had to invest it in something that would pay back more than they invested. While the managers were looking for safe but profitable places to invest the trillions, the U.S. Federal Reserve Bank was lowering interest rates, so the old standby, Treasury bonds, wasn’t yielding enough profit. With all that extra money suddenly appearing, there weren’t enough profitable things to invest in. [My inner child was jumping up and down and shouting, “Me! Me!” but the money managers weren't paying attention to her.]
But wait! Maybe they were. That’s how we got into this mess, actually. I’m remembering the dozens of flyers and letters I got a few years ago urging me to refinance my home mortgage. I laughed; they were all offering me terms far less favorable (higher interest rates) and more risky (an adjustable, rather than fixed, rate) than I already had. But they couldn’t have known that.
Those offers were inspired by investment managers with more money than they could reasonably invest, so they had to develop new forms of investment. After they used up all the people who wanted buy a house, and all those who wanted to refinance their homes so they could take some (or all) of the equity they had built up and buy a new SUV or take a dream vacation or whatever, the investment managers had to find more people to lend money to.
One way they did this was to create new homeowners by letting people borrow to buy homes they couldn’t afford – and, as everyone involved should have known, couldn’t possibly pay for. They started lending to people who said they had enough income, without doing the customary credit check. Some started filling out mortgage applications for people with no income at all. Some even made up income information that looked good, really good, without telling the hapless home buyer what they were doing.
Why would the investment people do that? Whenever money is changing hands, there are always people along the way with their hands out. A commission here, another one there – it all adds up. And it didn’t matter how bad the loans were, the commissions were always there. The temptation proved impossible to resist.
There’s more: banks didn’t want to hold onto individual mortgages, especially chancy ones. About the last thing a bank wants is to be in the real estate business. So the people who were selling funny mortgage loans wrapped them into bundles and sold them as a group, callled Mortgage Backed Securities. Then they went a step farther and sliced up the bundles (that’s exactly what they said they were doing – they called the slices “tranches.” “Tranche” is French for “slice.” )
There were highly rated slices. (The companies that assign credit ratings – Moody’s, Standard and Poor, etc. – give AAA ratings to the least risky loans) and loans with ratings of junk grade. The investment managers bundled slices with different ratings to make them easier to sell. Picture it: pieces of good and bad mortgages – like fresh and rotten sausage meat – in layers wrapped in a casing. If only the bad mortgages had smelled like rotten sausage, we wouldn’t be in this mess.
These bundles of slices were called Collateralized Debt Obligations or CDOs. By this time, if I had refinanced, my mortgage would be cut into so many pieces that I wouldn’t know whom to call if I had trouble meeting a payment. Nobody knew – nobody knows, still – exactly who is losing how much money on which bad, “toxic” mortgages.
I’ve stopped working from the This American Life transcript now. TAL gave me the stuff I couldn’t make up. The rest is what I know.
With mortgages so easy to get, houses were much in demand and in our good old capitalist economy prices go up as demand rises. Enter the housing bubble: in most places in the country, some more than others, the value of houses rose 10%, 20%, and more. I started getting postcards from real estate brokers: the time had never been better to sell my house. I’d get top dollar. Forget that I’d have to buy another house, whose price was also ridiculously elevated. When money changes hands, everyone who can find a way to get between buyer and seller gets a taste. So you had people selling mortgages, people selling tranches, people selling CDOs, people selling houses for the owners, everyone making money except, I bet, you and me.
Well, you know what happened. People started defaulting on their mortgages big time and the air came out of the balloon. When the hissing began, lenders started freaking out. That’s when we learned that, to a surprising extent, our whole global economic system is based on trust. You lend me money trusting I’ll pay it back. If you don’t, I’ll be less likely to lend money to anyone else.
That’s where we stand now. There’s little lending going on, so consumers (that’s you and me) are freaked. Stores can’t get credit to buy merchandise to sell, so they lay people off. Manufacturers don’t get the orders they need to keep going, so they lay people off. Stores close. Factories close. More people lose jobs. And on it goes until the people who have any money left start easing up.
That will happen as people with money they can lend start regaining their confidence that they’ll be paid back. I’m guessing — and hoping — that we won’t see such fiscal wildness for many years to come. Times are tough now for many people, I know, but the outcome may be a more livable world for all of us. A lot of people are learning that money isn’t the goal of life, and that’s a very good thing.