May 27, 2011

It's hard to resist when you can make something, out of nothing.


Since Study Leaks Amsterdam is related to the International Business School HVA, I believe a piece regarding the economy is in order. So I’d like to tell something about a recent event which we’re all too damn familiar with: the ‘Financial Crisis’.

2008 to 2010 were dark times for many financial institutions and governments. Banks, insurance companies, government’s agencies and homeowners lost trillions of dollars, and to what?! …Personal gains...

How? And perhaps more importantly, why? -We’ll have to start at the beginning.

Everyone is familiar with our universal lending system; you borrow money from a bank, Credit Card Company or any other cash/credit provider and you pay ‘m back with interest within a certain period, easy…a fool’s game.

With mortgages it takes years and years and years (sometimes the borrowers life-span) to pay back the money, so obviously banks were careful.

In order to lower their risk, the banks cameup with a rather genius idea (which was indirectly made possible by the former Bush administration back in 2001).

The lender (mostly banks) sold the house mortgages from homeowners to investment banks (Goldman Sachs, Morgan Stanley, Lehman Brothers, Merrill Lynch and Bear Stearns) for a fixed price, meaning; the monthly payment for the house now goes to the investment bank since the lender sold it for a few hundred thousand dollars (eliminating their risk of not getting paid by the customer). Note: These mortgages were sold by the dozens so these were million- or even billion-dollar loan sales.

The investment banks then combined the home mortgages, car loans, student loans, commercial mortgages, corporate buy-out debts and credit card debts they bought to a Collateralized Debt Obligation (CDO) and sold these to investors all over the world.

The chain did not end here but what happened from thereon is irrelevant for now.

So, lenders found a way to sell loans to investment banks, investment banks combined these loans into CDOs and sold these to investors worldwide. Kinda looks like this:


Now the real problems began when lenders realized that they could give away endless loans because they would sell these to investment banks anyway! So the bubble started when people received loans for homes, cars or college fee’s while they weren’t able to pay them back, ever!! And this happened on a massive scale.

These loans were called ‘subprime loans’ and were literally farmed by lending institutes, which made them billions in profit of which the CEOs received millions in bonuses.

Now imagine; thousands and thousands of subprime ‘bad’ loans, formed into CDOs, which appear to be worth billions of dollars but will become worthless in time because the homeowners weren’t able to pay their debt in the first place.

You realise that this bubble was a ticking time bomb

So far, the winners in this story (multi-billion profiteers) are of course the lenders and the investment banks. But the story does not end here…Oh hell no it doesn’t, shit has yet to hit the fan.

To make matters worse, investment banks bribed major rating agencies (Moody’s, Standard & Poor’s and Fitch) to rate their CDOs with a AAA rating, the highest possible rating a; stock, option, obligation or any other stock item can receive. Even CDOs that were made out of bad loans were sometimes rated as AAA.

Note: Ratings are ranked as followed: AAA, AA or A, BBB, BB or B, CCC, CC or C and so on. BB is considered junk. (Dutch government: AAA, Greek government: BBB/BB)

Because of the AAA rating, retirement funds (even the smallest ones in The Netherlands) and investment groups (e.g. Robeco) worldwide were now allowed to invest money in these so-called CDOs, even the fake AAA rated ones.

Now of course investors wanted to secure their CDOs and insured their CDOs with so-called Credit Default Swaps (CDS), meaning; Investors paid security and insurance company AIG a quarterly payment and in return, AIG pays back the value of the insured CDOs once they go bad. And again, these Credit Default Swaps were made by the dozens.

On top of that, speculators (people like you and me) were able to ‘insure’ these CDOsas well, allowing us to literally bet on CDOs. AIG now swims in millions and millions and BILLIONS of dollars at this point, which are obviously temporarily. Having made billions of dollars in profit, AIG immediately paid their employers 3.5 billion dollars in bonuses…

You don’t have to be an economist to understand that AIG now has thousands and thousands of subprime loans insured and as soon as this bubble explodes and people aren’t able to pay their debt, the true loser in this picture would of course be AIG…

The money flow I described above is called “The Securitization Food Chain”, a simple loan selling system that was blown out of proportion because of the multi-billion dollar mortgages abuse.

Understanding this system will make you realise what happens when (until now) 10 million American households can’t afford their (lets say average) $150.000.00,- home mortgage. CDOs made out of mortgages instantly lost 1.5 trillion ($1.500.000.000.000,-) dollar in value. Some analysts say that the mortgage-market alone lost 2 trillion dollar to these Securitization Food Chains.

During this period, CEOs from major financial companies like the [Investment Banks: Goldman Sachs, Morgan Stanley, Lehman Brothers, Merrill Lynch, Bear Stearns] [Financial conglomerates: Citigroup, JP Morgan] [Security and Insurance: AIG, MBIA, AMBAC] and [Rating agencies: Moody’s, Standard & Poor’s, Fitch] earned more than 2 billion dollars in bonuses.

Of course this was just the tip of the iceberg, perhaps I’ll follow-up on this with a detailed post on how we saw trillions of dollar disappear, vanish and vaporize from the face of the earth… It might be fun to know what we could’ve had and how our economy could’ve looked like!

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