
The answer is supposed to be easy because it should always be about basic economics but, not this time, because this time all the banks, all the bankers, all the Wall Street wise-guys, all the mortgage brokers, all the economists and all the “experts” were greedy. How else can you explain it to a child; I like everything simplified and so, here it is: The housing crisis began when it was revealed that the majority of the banks and lenders had invested in housing, holding tons of mortgage-backed securities and when the prices on the homes securing those MBS’s dropped by 20% the banks found themselves nearly broke. The next logical question is why? if the housing prices dropped by only 20% were the majority of the banks 100% insolvent? And, the answer is: because they were so greedy that they thought they were bullet-proof and were making so much money they didn’t care, or stop to think and so they invested in derivatives.
Derivatives are complex instruments devised as a form of insurance to transfer risk among parties based on their willingness to assume additional risk, or hedge against it. In other words, it’s a financial investment whose prices derive from an underlying asset and the trouble now, in the world economy is that huge numbers of these derivatives have absolutely NO underlying asset! These banks had a gamblers mentality; the old saying that nobody ever bet enough on a winning horse was what they lived by and took “our money” the depositers, money and gambled it on EVERYTHING and I mean that, literally: Hedge funds, credit default swaps and swaps of every conceivable nature, forwards, futures, options, over the counter derivatives, Equity indexes, money markets, stocks & bonds, MBS, economic derivatives, commodities, freight derivatives, inflation derivatives, credit derivatives, weather derivatives (yes, they gambled on the weather). And, now, many banks, like Goldman Sachs, are starting over and doing it all over again; and with our money again, the bailout money has made them huge profits when they gambled it on selling their usual “junk’ to their usual cast of greedy investors.
Goldman Sachs just raised the S&P target for 2009 to 1,060. Why? It's not because things are "really" getting better. And it's not because they would be buyers in this market. No, it's because they need to pump this market, so they can dump their shares to you . . . at inflated prices that will be big losers for you.
Derivatives massively leverage the debt in an economy, making it ever more difficult for the underlying real economy to service its debt obligations, thereby curtailing real economic activity, which can cause a recession or even depression. In the view of Marriner S. Eccles U.S. Federal Reserve Chairman from November, 1934 to February, 1948, too high a level of debt was one of the primary causes of the 1920s-30s Great Depression.
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