# Financial Armageddon for Dummies **URL:** \ **Category:** Great Debates\ **Created:** [October 1, 2008, 1:25am UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953 "2008-10-01T01:25:42Z")\ **Posts on this page:** 20\ **Page:** 3
**Author:** ![Maeglin](https://avatars.discourse-cdn.com/v4/letter/m/8baadc/32.png) [@Maeglin](https://boards.straightdope.com/u/Maeglin)\ **Post date:** [October 1, 2008, 3:31pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/41 "2008-10-01T15:31:42Z")
> [@treis](#): > > No offense, but this is a load of shit. The people that originally bought/made these loans made the same calculations, and they’ve lost their shirts. The bonds, as you call them, are so complex that it’s impossible to accurately gage the risk of default. This is is the root of the problem. It’s very likely that the Fed will be buying securities at a price that gives them a very high risk level, and relatively low potential returns. No private company is going to be happy with that trade off, and that’s why no one is buying these bonds. This is also not true. Bond math is extremely complicated, and mortgages even moreso. There are a lot of inputs to model and a lot of sources of variance. It is not “impossible” to accurately gauge the risk of default. If that were true, than banks would not extend mortgages and credit cards would not exist. This modeling works very well most of the time. The problem is that when it is wrong and everyone uses it, the cost of being wrong is extremely high. ---
**Author:** ![treis](https://avatars.discourse-cdn.com/v4/letter/t/bc79bd/32.png) [@treis](https://boards.straightdope.com/u/treis)\ **Post date:** [October 1, 2008, 3:46pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/42 "2008-10-01T15:46:49Z")
> [@Maeglin](#): > > This is also not true. Bond math is extremely complicated, and mortgages even moreso. There are a lot of inputs to model and a lot of sources of variance. > > It is not “impossible” to accurately gauge the risk of default. If that were true, than banks would not extend mortgages and credit cards would not exist. This modeling works very well most of the time. > > The problem is that when it is wrong and everyone uses it, the cost of being wrong is extremely high. The impossible to gage part comes from the sheer amount of mortgages being packaged together and sliced apart. ---
**Author:** ![Dangerosa](https://avatars.discourse-cdn.com/v4/letter/d/22d042/32.png) [@Dangerosa](https://boards.straightdope.com/u/Dangerosa)\ **Post date:** [October 1, 2008, 3:52pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/43 "2008-10-01T15:52:12Z")
Thank you very much. Very informative. > [@Scylla](#): > > The vast majority of the debt that we are talking about is still paying interest, is not in default, and is not expected to be in default. It is simply illiquid. Correct me if I’m wrong - of course, some of this debt is “bad” in the traditional “house in foreclosure” meaning of bad. One of the issues at play is no one really knows what proportion of the debt that is held will not be made good over the term of the bond. And the more uncertainty there is, the higher the likelihood that risk occurs, and the less attractive those bonds are to buyers - which is the reason for the urgency - prop up the market now (and maybe put in foreclosure protection), money starts moving, jobs are retained, people make house payments. Let the people who made dumb decisions take their knocks, that Delorian looks less and less attractive by the minute a the risk on the “good debt” - in the traditional sense, increases. ---
**Author:** ![Maeglin](https://avatars.discourse-cdn.com/v4/letter/m/8baadc/32.png) [@Maeglin](https://boards.straightdope.com/u/Maeglin)\ **Post date:** [October 1, 2008, 3:52pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/44 "2008-10-01T15:52:32Z")
> [@treis](#): > > The impossible to gage part comes from the sheer amount of mortgages being packaged together and sliced apart. There are highly specialized people whose jobs are to do just that. And now a lot of them are either unemployed or are getting ready to box up their personal effects. At the same time, the government might be purchasing mountains of hybridized CDOs, each with a fat prospectus. Someone with the right skills needs to be able to analyze these instruments. I wonder… ---
**Author:** ![NurseCarmen](https://avatars.discourse-cdn.com/v4/letter/n/5daacb/32.png) [@NurseCarmen](https://boards.straightdope.com/u/NurseCarmen)\ **Post date:** [October 1, 2008, 3:54pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/45 "2008-10-01T15:54:42Z")
> [@Scylla](#): > > Realistically, we are talking about a lot of transactions here. Is the government going to get screwed on some of them? Yeah, it’s pretty likely. Are some of the institutions going to screw each other? Yeah, it’s pretty likely. Will there be abuses? Yeah, it’s pretty likely. > > It has to be done right, and those abuses have to be minimized for this thing to work. > > Again, I’m trying to be mechanistic in my answers rather than trying to sell the plan. It could get screwed up pretty easily. Competance is necessary. Don’t you think Bernanke/Paulsen/Cox (hah! Like Cox has actually ever done _anything!_) pretty much screwed the pooch with the initial “No oversight, what I say is law” 3 page wonder? Don’t you think that is why the bill is facing such difficulty right now is because nobody trusts them? Along the same lines, why the rush? Shouldn’t we prefer this get done the right way, and not shoved down our throats like items in the recent past? I know the mere fact that there is a bailout discussion freezes the market because they are seeking a better offer from the gov’t than they would in a private sale, but isn’t okay to tell the petulant pukes that caused this problem to sit down and shut the hell up? Once the credit crisis is averted, don’t you think Bernanke will then have no reason to keep interest rates artificially low? He has been trying to strike a balance in stagflation, but the bailout will lop off half of that equation, so what’s to prevent him from jacking the rate up to 11 (if he is a fan of Spinal Tap) ---
**Author:** ![gonzomax](https://avatars.discourse-cdn.com/v4/letter/g/e8c25b/32.png) [@gonzomax](https://boards.straightdope.com/u/gonzomax)\ **Post date:** [October 1, 2008, 4:14pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/46 "2008-10-01T16:14:19Z")
The crisis will not be averted. We will have a bad economy for years while this mess gets worked out. The group on Rose agreed that we will be downsizing and have problems with the credit industry for at least 3 or 4 years. They may be optimistic. Bad times are ahead. ---
**Author:** ![treis](https://avatars.discourse-cdn.com/v4/letter/t/bc79bd/32.png) [@treis](https://boards.straightdope.com/u/treis)\ **Post date:** [October 1, 2008, 5:00pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/47 "2008-10-01T17:00:54Z")
> [@Maeglin](#): > > There are highly specialized people whose jobs are to do just that. Yeah, and they did a crappy job of doing it. ---
**Author:** ![Maeglin](https://avatars.discourse-cdn.com/v4/letter/m/8baadc/32.png) [@Maeglin](https://boards.straightdope.com/u/Maeglin)\ **Post date:** [October 1, 2008, 5:12pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/48 "2008-10-01T17:12:53Z")
> [@treis](#): > > Yeah, and they did a crappy job of doing it. No, not really. The business decisions were crappy. The math was fine. ---
**Author:** ![slaphead](https://avatars.discourse-cdn.com/v4/letter/s/e9bcb4/32.png) [@slaphead](https://boards.straightdope.com/u/slaphead)\ **Post date:** [October 1, 2008, 6:50pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/49 "2008-10-01T18:50:01Z")
> [@Dangerosa](#): > > Let the people who made dumb decisions take their knocks Unfortunately, they’ve already taken whatever knocks they’re going to take. The question know is whether ordinary chump taxpayers around the world stump up a trillion or more bucks now in order to try to avoid a risk that the world economy transitions to a model where everything is paid cash in advance and the only people who can borrow money are the ones so rich they don’t need to. ---
**Author:** ![prodicus](https://avatars.discourse-cdn.com/v4/letter/p/d9b06d/32.png) [@prodicus](https://boards.straightdope.com/u/prodicus)\ **Post date:** [October 1, 2008, 8:12pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/50 "2008-10-01T20:12:39Z")
Once again, thanks Scylla for a great thread. And am I the only one who LOL’d at the title? 🙂 ---
**Author:** ![Voyager](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/voyager/32/133_2.png) [@Voyager](https://boards.straightdope.com/u/Voyager)\ **Post date:** [October 1, 2008, 8:31pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/51 "2008-10-01T20:31:55Z")
> [@Maeglin](#): > > No, not really. The business decisions were crappy. The math was fine. I can hear the CEOs shouting “don’t tell me the odds!” I’ve heard of people using models of consumer credit that allow the adjustment of credit lines to just barely safe - in other words, affordable. Clearly there is incentive for credit card companies to adjust this to find the optimal tradeoff between interest payments and the chance of default or even falling behind significantly. I believe some of the inputs to this model involve payment and purchase records. Do you have any insight on this? ---
**Author:** ![foolsguinea](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/foolsguinea/32/14751_2.png) [@foolsguinea](https://boards.straightdope.com/u/foolsguinea)\ **Post date:** [October 1, 2008, 9:08pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/52 "2008-10-01T21:08:39Z")
> [@gonzomax](#): > > On Charley Rose last night the financial experts said that the bottom for housing will be at about 50 percent of the rate 2 years ago. Homes are dropping 20 percent a year. These financial papers include a lot of transitional foreclosures. They had not bottomed . That would have us overpaying for them. The housing cost will eventually stabilize ,some time in the future and at a lower rate. So we would never get it all back and would take a loss. This is my objection to the current bill. Looks like Paulson’s trying to do some favors & arrange some kickbacks before he leaves office, rather than look out for the interests of the government or taxpayers after he leaves. ---
**Author:** ![Sinaijon](https://avatars.discourse-cdn.com/v4/letter/s/dc4da7/32.png) [@Sinaijon](https://boards.straightdope.com/u/Sinaijon)\ **Post date:** [October 1, 2008, 9:25pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/53 "2008-10-01T21:25:16Z")
I think this was aluded to earlier, but can you elaborate the role mark to market played in all this, if any? I’ve seen that some people claim that removing that accounting requirement would make this whole thing go away. My understanding is basic, so I really can’t tell if they are full of it or not. I think this is also in the Senate revision of the bailout. ---
**Author:** ![China\_Guy](https://avatars.discourse-cdn.com/v4/letter/c/779978/32.png) [@China\_Guy](https://boards.straightdope.com/u/China_Guy)\ **Post date:** [October 1, 2008, 11:14pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/54 "2008-10-01T23:14:24Z")
The models behind the theoretical value of the CDO’s are esoteric and maybe accurate. there are plenty of examples where the models fail - most notably AIG Financial Products. AIG FP guaranteed/wrote insurance for a lot of the CDO’s, and they got it so wrong the very conservatively run AIG parent need a $80B bailout. (I used to create and sell esoteric derivatives to institutional investors based on models.) Assume that the models are correct, the problem still resides with the underlying assets, primarily the sub prime loans. Sub prime loans were made under rosy bull market conditions that assumed a ‘manageable’ default rate. Now with housing prices in a freefall, reset rates kicking in to raise the payments, and no way to sell the homes at breakeven prices, the CDO’s underlying ‘assets’ are being devalued every day. Even if one holds the bonds to maturity and assume housing prices will bust and recover before then, the percentage of bonds that will be worth zero is going to be considerably higher than it is now. In other words, CDO prices as an asset class have to fall to reflect the much greater risk. Look, it’s real simple. if a homeowner can’t afford payments on a 30 year mortgage at 5%, then they wiill lose ‘ther’ homes. (these people are renters not homeowners). Until housing prices fall enough to be ‘affordable’ eg when all theses foreclosed and should be foreclosed homes finally all find buyers, then and only then will the recovery begin. Then and only then will one be able to accurately price CDO’s to maturity. ---
**Author:** ![Scylla](https://avatars.discourse-cdn.com/v4/letter/s/a5b964/32.png) [@Scylla](https://boards.straightdope.com/u/Scylla)\ **Post date:** [October 1, 2008, 11:14pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/55 "2008-10-01T23:14:28Z")
> [@Polerius](#): > > So, there was a bubble in the bond market (or CDO market)? > > If there was a bubble, then shouldn’t people \*expect \*to lose money when the bubble bursts? Why weren’t the head honchos and financial gurus running these companies (like Lehman) ready for the bursting of the bubble? Sure. We’re not really talking about a couple of firms losing money, anymore though. It’s cascaded. > [@](#): > > Also, what do you think about what [this article](http://news.goldseek.com/GoldSeek/1221672153.php)says: > > To the untrained eye (i.e. me) the potential collapse of a $62 trillion market seems terrifying. Is it as potentially bad as it sounds, or is the $62 trillion figure an artificial number that doesn’t mean much in practical terms? > > On a side note: how can you have a market that is larger than the entire global economy? Is it because people are just betting with lots of money on events that don’t have as much underlying value? For example, if a couple of kids are playing marbles, with the winning kid getting all the marbles, two adults observing the kids can bet $10,000 on the outcome of the game, which is much higher than the value of all the marbles in the neighborhood. Is this at all close to how we can have a derivatives market that is larger than the entire global economy? You can make 100K and still buy a house for 300k, if you finance it. The size of the market, particularly the credit default swap market isn’t an issue. Credit default swaps are bets. Let’s say you have 10k of bonds from issuer X. You make a bet, or take out insurance with me. For a small fee, I agree to make good on Xs bonds that you hold if X defaults. There are credit default swaps on Treasuries. The treasury market is huge, hence the big numbers for the size of the market. The chance of a default though is perceived to be very small though, so you can insure a lot of treasuries for a small amount of cash. ---
**Author:** ![Scylla](https://avatars.discourse-cdn.com/v4/letter/s/a5b964/32.png) [@Scylla](https://boards.straightdope.com/u/Scylla)\ **Post date:** [October 1, 2008, 11:23pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/56 "2008-10-01T23:23:12Z")
> [@China\_Guy](#): > > Scylla, some good points but you also miss a few key elements. May I share experience from the 97 Asian flu and emerging market crisis? BTW, I used to work for Swiss bank as an analyst and on the equity derivatives desk, then the institutional desk of Lehman’s fixed income in Hong Kong in 1996, and from my convertible bond/warrants desk perch at Nikko watched the unraveling of the Asian equity and debt markets, and then left the biz. Corporate and Governments desk, Lehman Bros, late 80s early 90s. Feel free to join in, I could use the help. > [@](#): > > #4 - You’ve got the right framework with your fire sale (clearing level), market price and hold to maturity price. However, these bonds can not be clearly valued. Just ask AIG, who wrote so much insurance on stuff they thought would never be called. The bonds are made up of variables of essentially individual debt - such that even with a big pool one can’t with a strong degree of confidence in these economic times be able to predict what the maturity price will be. That’s a big reason why the bonds are illiquid. It’s just a degree of complexity problem. All the individual components can be valued, and a value can be determined as Bill Gross suggests. More likely, what one man puts together, another can take apart. > [@](#): > > Three reasons why we are not at clearing price levels: First, no one can value these bonds to maturity value with any kind of confidence. I disagree. Did you read Bill’s article? What exactly is the technical issue that prevents such a valuation. > [@](#): > > Second, assuming these bonds can be valued to maturity, the big holders of these bonds know they are truely (instead of theoretically) bankrupt if they change the mark to market to the clearing levels or real maturity value. That’s been happening for the last several quarters. > [@](#): > > Third, massive systemic risk - if the global economy really “craters” in McCain parlance, then whatever value you have for the bonds now is going to be further haircut. Yup. Liquidity risk becomes systemic and creates credit risk. ---
**Author:** ![Scylla](https://avatars.discourse-cdn.com/v4/letter/s/a5b964/32.png) [@Scylla](https://boards.straightdope.com/u/Scylla)\ **Post date:** [October 1, 2008, 11:24pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/57 "2008-10-01T23:24:39Z")
> [@GSV\_Consolation\_of\_Dreams](#): > > Thanks to **Scylla** for starting this thread. > > My question concerns banking. Like everyone, I have a few accounts here and there. With banks being sold around the world now for seeming fractions of their former worth, or collapsing, I’m worried that my money could be lost. > Not likely, I know. I haven’t heard of anyone actually losing their life savings yet. > I have heard that the “CDS price” of a bank, gives an indication of their exposure to risk of “bad debt”. Is there somewhere I can go and compare the CDS prices of various banks? Just keep below FDIC limits and you should have no worries. ---
**Author:** ![China\_Guy](https://avatars.discourse-cdn.com/v4/letter/c/779978/32.png) [@China\_Guy](https://boards.straightdope.com/u/China_Guy)\ **Post date:** [October 1, 2008, 11:55pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/58 "2008-10-01T23:55:20Z")
Scylla, you’e obviously in the markets. i strongly urge you to find a bear market rabbi. don’t make the mistake of using a bull market glasses to judge a bear. Fact is the underlying can not be accurately priced at this time. eg, any derivative of the underlying can not be acurately priced. One can make estimates and then build in a fat risk premium. ---
**Author:** ![Pleonast](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/pleonast/32/1183_2.png) [@Pleonast](https://boards.straightdope.com/u/Pleonast)\ **Post date:** [October 1, 2008, 11:59pm UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/59 "2008-10-01T23:59:58Z")
Some people I know, complain that the government needs to do more “stimulus” packages–tax rebates, lowered tax rates, lowered interest rates, government-funded infrastructure projects, etc. They think that these things will help us recover from the economic downturn we’re in. I think that’s pointless. We’re not in a typical recession, where production has outstripped demand and industry has to scale back until things have caught up. This is a liquidity crisis where the money and trust that let the economy actually work are not functioning properly. Stimulus is not at all helpful. At least, that’s my opinion. What do you guys think? ---
**Author:** ![Scylla](https://avatars.discourse-cdn.com/v4/letter/s/a5b964/32.png) [@Scylla](https://boards.straightdope.com/u/Scylla)\ **Post date:** [October 2, 2008, 12:12am UTC](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953/60 "2008-10-02T00:12:49Z")
**shibboleth:** Looks like your question’s been answered. **Gary Kumqat:** Nice to see you again. Would you care for a beverage with your cite? > **[Home Owners' Loan Corporation](https://en.wikipedia.org/wiki/HOLC)** > > The Home Owners' Loan Corporation (HOLC) was a government-sponsored corporation created as part of the New Deal. The corporation was established in 1933 by the Home Owners' Loan Corporation Act under the leadership of President Franklin D. Roosevelt. Its purpose was to refinance home mortgages currently in default to prevent foreclosure, as well as to expand home buying opportunities. > The HOLC created a housing appraisal system of color-coded maps that categorized the riskiness of lending to h... (Sorry, I said S&L crisis, I meant depression. The RTC lost money on paper because it paid back with interest the REFCORP bonds that funded it. [Previous page](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953.md?page=2) [Next page](https://boards.straightdope.com/t/financial-armageddon-for-dummies/465953.md?page=4)