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Thread: What caused the financial crisis?
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[quote=GEARBOX,355745]Now here is the not so quick explaination of the crisis. Fannie and Freddie basically bought loans from banks at a discount. So for example, if the bank makes a total of $100 million in loans at let's say 10%, Fannie and Freddie would buy them for a 9% return letting the banks keep 1% for making and managing the mortgage, and giving them back $100 million to make more loans. Well after a while Fannie and Freddie would have billions and billions of dollars in mortgages, so what they did was to "Securitize" large buckets of loans and issue something called an "Asset Backed Security" which paid an interest rate that was much higher than the US Treasury Bill. Since these asset backed securities represented huge volumes of loans, the percentage of normal failure rates (non paying morgages) would not effect the interest pay out. Plus with the "Preception" of US backing, it made these securities highly liquid and considered to be as good as a US T note, but with a much higher rate of return. As a result, every bank, brokerage house, pension fund, and even private companies would use these instruments to "park" its cash since it had a higher return and could be liquidated overnight. But over the past 5 - 8 or so years Fannie and Freddie started to incurr higher losses due to the aggressive buying of higher risk mortgages instructed by Clinton. But because the CEO's bonuses where tied to profitability and thanks to Clinton's de-regulations of reporting requirements for both, they all hid the losses so they could collect their $90 million dollar bonuses each year. So when the news was revealed, no one knew the extent of the losses and everyone dumped these securities at once just to find out no one wanted them. So this highly liquid security became un-sellable. Needless to say, every domestic and foriegn entity who held these securities became highly illiquid overnight. Banks liquidity ratios went upside down preventing them to make anymore loans, business' could not make current liabilities to pay employees and vendors, and the economy stopped dead in it's tracks. [/quote]
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