What has happened, as a phenomena, provoking the crisis??…
Let’ s try to describe the first part of it, following the excellent summary of the Spanish Professor of Madrid IESE, Mr. Leopoldo Abadia (http://www.leopoldoabadia.com). The title would be something like:
THE INTERESTING STORY OF THE MORTGAGE BUSINESS AND ITS UNEXPECTED CONSEQUENCES!!! THE «NINJA» CRISIS!!!
- All started in a scenario in which the interest rates were going down in the western world, specially in U.S.A.
- In this scenario, is better to take credit than to invest money, because the interest paid for a deposit is so low that is probable even smaller than the inflation rate. In these conditions, a investor in losing money (for instance, if your deposit pay 2% and the inflation is 2.5%, you are losing 0.5% every year if you have your money invested in the deposit)
- Thereby, the banks start to promote credit, specially mortages, to make business
- All of us start to buy new houses.
- The houses prices rise up.
- The banks forecast that the business is so good that they have to look for more of this business.
- They identify a new kind of client that following Mr. Abadia, we can call NINJA (No Income, No job, No Asset). This is the kind of person that you will never lend even 5 Euros, because they can not pay them back!!!..But, suddenly, this kind of client has become interesting because the banks can lend them money and, in the worst of the cases, recover it selling the house some years later, in case of unpayment, because they believe that the real estate market will continue rising up. So, as you can now understand, the risk of the operation is quite high…what if the market stops growing???…
- The banks give mortgages to the «ninjas», so the mortgage bussines grow.
- The banks begin to lack money, (the business os going so well that they need more money to lend it!!!) so they look for it. where?..All around the world!! This is a global economy!!
- The banks that have given mortgages to the ninjas, and that want to continue doing it, divide the mortgages in «little financial packages». This financial packages are composed of three types of mortgages: good ones, normal ones, and «awfully bad ones». This last type, we can call it kindly «garbage» mortgages, because they are the mortgages of the ninjas.
- Of course they don’t sell «garbage» to other banks, but «Mortgage Backed Securities» or MBS’s, that is a name that sounds much more better, to say it plainly. In a later post I’ll explain other financial instrument that they invented later: the «Structured Investment Vehicle» or SIV, that makes possible to transform garbage mortgages in an attractive investment!!..incredible, isn’t it??…
- Investors and Banks around the world (In England, in Spain, in France, in Iceland, perhaps even in Finland….)invest in «Hedge Funds», that are composed of MBS’s and SIV’s. That is, they invest on garbage, but they don’t know how much garbage is there. They think that have invested in a very profitable international funds. So, in this stage all the banks in the world are full of garbage, but they don’t know.
- Now, the first unpayments by the ninjas start to happen. The illusion starts to crumble down.
- The banks that start to understand that they have garbage in their balance sheets, understand too that the other banks are in the same situation, or even worse. So they start untrust each other.
- What does it mean that they untrust?…it means that in the interbanks market, where they lend money to each other, they ask for an extra interest rate because of this untrust. In europe, this determines directly the Euribor Rate.
- So, as a consequence of teh untrust created by the garbage that the banks had bought, the Euribor rate is rising up.
- And finally, as a consequence of the rise up of the Euribor interest rate, you and me pay more money every month in our mortgage payments.
So, summarizing: some guys in U.S.A. sell garbage around the world, and finally, because of the globalizations, and because of our global lack of consciousness, we pay more every month. Funny, isn’t it?..
Take a look at this video, that explains it really well in an humoristic way:
To be continued….