[stu]

I noticed this forum was lacking an overall guide to economics for dummies such as myself who have no idea what derivatives or hedge funds are.

I therefore decided to start this thread in the hope that it will be able to be used as reference for people who are trying to get a proper understanding of the current sub-prime crisis or how the mechanics of a dollar collapse would work.

I would really appreciate anyone who wishes to give their time to provide information or links that would help.

It can be really frustrating reading articles on economics and then finding out that the crisis is linked to CDO's etc and not being able to understand it.

With that in mind I thought I would start with the current crisis involving the sub-primes. Here's how I currently understand it.

Following the collapse of the dotcom boom and the events of 9/11 governments round the world slashed interest rates in order to prevent serious damage to the global economy. In Japan rates went to 0% and in America to 50 year lows of 1%.

These interest rate cuts sparked a boom in credit lending throughout the Western world leading to booming housing markets and lots of people being able to get loans and credit cards.

However over the last few years interest rates have been going up again. This is mainly to combat excessive spending and also to control inflation which has been rising due to the high demand for commodities which have pushed up raw material costs.

In the United States, during this housing boom, many unscrupulous lenders gave mortgages to lots of people with questionable credit ratings known as Sub-Prime Mortgages. With each interest rate rise these peoples budgets were stretched further and further to the point that they foreclosed on their mortgage and lost their home.

Now here's the part I don't get.

A lot of these sub-prime mortgages were actually owned by banks and other major companies who were expecting a return on these mortgages at some point. As foreclosures increased banks realised that they would not get the return they hoped for and so tried to bail out. This caused stocks to plummet and central banks to intervene which brings us to where we are now.

I guess that in order to properly understand economics you just have to follow the money. Or then again it may not be as simple as that. This brings me to the first few questions that I have.

1. If central banks are intervening by injecting money where does this money come from? Other banks that are also in trouble? Doesn't make sense.

2. Surely this money has to be paid back sometime?

3. How did these companies come to have these sub-primes as an important part of their long term profits and surely the risks on these "investments" would be extremly high?

Thanks in advance for anyone who answers.

[Farmboy]

What you aren't getting is that a lot of the subprime mortgages have been packaged by investment banks into securities and sold on the bond market. It's the holders of these bonds that are exposed to the risk of mortgage defaults and bankruptcies. I believe that the Bear Sterns hedge funds that imploded had high exposure to this type of paper for example.

[RonMN]

I'm just learning this myself, But i find it fascinating.

The subprime mortgages were not very riskey because house prices kept going up (for the last several years), and access to refinancing your home-loan was so easy & available. And even if there was a foreclosure, the bank/fund could recoup any loss my selling the house.

All of a sudden, house prices started to fall and (starting with the Bear Stearns hedge funds collapse)... TPTB realized that they were not recouping their losses when selling a house after a foreclosure.

Now this set off a panic, & everybody (Hedge fund managers, Big banks, and the little guy as well) are all rushing for the exits on anything to do with mortgages, especially subprime & ALT-A...all of a sudden there's no money to lend for mortgages...everybody is stuffing their money into US Treasury bonds to avoid loosing their money. (Really not much different than a bank run).

So the Fed steps in & says We'll borrow you half a zillion & you borrow us those CDO's...that will put cash back into the system & things will start working again...it will build confidence in the system & people will start putting their money back into CDO's.

My understaning of it, it that the money (liquidity) they pumped into the markets was simply created out of thin air...Sure wish I had that ability

I'm just learing this stuff myself (& I don't claim to be an expert) so anybody feel free to correct me if i've gotten anything wrong).

You also have the CDO thing...now it used to be that a bank would hold your loan...so before giving you that loan they had good reason to check out your credit history & deny you if anything looked bad. But now, The bank/lender gives you the loan, packages it up in bundles of loans (Collateralized Debt Obligations) and sells it to investors on wall street...Who then use that as collateral so they can borrow more money from said bank to buy EVEN MORE CDO's (this is where we start getting into that complicated thingy called derivatives I believe). This removes the responsibilty of checking out the borrower from the original lender (bad idea).

I'll try to write more later, but first I'd like to see if anybody is gonna tell me I got it all wrong

[Pops]

Here is my take:

Real estate markets go up and down in cycles.

Lenders find loopholes in regulations.

Taxi drivers invest in real estate.

Anyone with sense gets out.

Everyone else gets stuck.

Are you out?

EOS.

[IrrationalExuberanceMonky]

$this->bbcode_second_pass_quote('Pops', '
')
Real estate markets go up and down in cycles.

[IrrationalExuberanceMonky]

$this->bbcode_second_pass_quote('stu', '
')
1. If central banks are intervening by injecting money where does this money come from? Other banks that are also in trouble? Doesn't make sense.

2. Surely this money has to be paid back sometime?

3. How did these companies come to have these sub-primes as an important part of their long term profits and surely the risks on these "investments" would be extremly high?

Thanks in advance for anyone who answers.

[CrudeAwakening]

$this->bbcode_second_pass_quote('stu', '1'). If central banks are intervening by injecting money where does this money come from? Other banks that are also in trouble? Doesn't make sense.

[stu]

I'm beginning to get the gist of this.

The central banks intervene by buying the debt and replacing it with fresh money (apologies if that is oversimplifying things). These banks that are getting hit now have to pay back ECB, FRB, BofJ etc.

In order to understand this part of economics more I believe it really helps to understand the process involved in the creation and distribution of money. In a way it's just like trying to dig to the roots in order to understand how the tree came about.

From what I know money was first created as a form of IOU. Essentially people held their assets in the form of gold and because gold was either too heavy to constantly carry round or you could get mugged on the street carrying the stuff the best thing was to leave it in a building in exchange for a piece of paper which told you how much you owned. Apparently that is how the first banks came to be. Please feel free to correct me as I go on.

Nowadays it seems there are two ways of creating money. The first is the stuff that comes out of thin air and the second is the actual paper stuff. I believe the amount of money in circulation is dependant on various things such as inflation, interest rates, currency exchange etc.

This leads to me to my next few questions:

1. What are the main reasons for the creation of a) paper money and b) digital money.

2. What are the main factors that determine the amount of money needed to be in circulation?

3. If central banks are bailing out the investment banks by taking on their debts and injecting fresh money into the system then surely the repayment of this debt back to central banks is dependant on a growing economy? Considering Western economies are 70-80% dependant on the housing market and consumer spending surely there is the possibility that these debts will never be repaid as all central banks are doing is delaying the inevitable?

Thanks again.

[crossthread]

[I have a link too a Pic that may help...
Can I please get help uploading Images?? Or inserting them?
Thanks CT

http://s149.photobucket.com/albums/s75/ ... ic_550.gif

[OilIsMastery]

$this->bbcode_second_pass_quote('stu', '1'). What are the main reasons for the creation of a) paper money and b) digital money.

[IrrationalExuberanceMonky]

$this->bbcode_second_pass_quote('stu', 'I')'m beginning to get the gist of this.

The central banks intervene by buying the debt and replacing it with fresh money (apologies if that is oversimplifying things). These banks that are getting hit now have to pay back ECB, FRB, BofJ etc.

In order to understand this part of economics more I believe it really helps to understand the process involved in the creation and distribution of money. In a way it's just like trying to dig to the roots in order to understand how the tree came about.

From what I know money was first created as a form of IOU. Essentially people held their assets in the form of gold and because gold was either too heavy to constantly carry round or you could get mugged on the street carrying the stuff the best thing was to leave it in a building in exchange for a piece of paper which told you how much you owned. Apparently that is how the first banks came to be. Please feel free to correct me as I go on.

Nowadays it seems there are two ways of creating money. The first is the stuff that comes out of thin air and the second is the actual paper stuff. I believe the amount of money in circulation is dependant on various things such as inflation, interest rates, currency exchange etc.

This leads to me to my next few questions:

1. What are the main reasons for the creation of a) paper money and b) digital money.

2. What are the main factors that determine the amount of money needed to be in circulation?

3. If central banks are bailing out the investment banks by taking on their debts and injecting fresh money into the system then surely the repayment of this debt back to central banks is dependant on a growing economy? Considering Western economies are 70-80% dependant on the housing market and consumer spending surely there is the possibility that these debts will never be repaid as all central banks are doing is delaying the inevitable?

Thanks again.

[IrrationalExuberanceMonky]

So you need to understand one thing and that is that when a repo takes place the "money" or the bid from the Fed comes from nowhere, it doesn't exist but is still credited to the account of the holder of the security. BUT WAIT! This is not all bad, there is a good reason to have a system like this despite what the tin-foil hat wearers claim. But let's be clear this is inflationary, money has been created out of nothing. This is not an criticism of "hard money" nuts, nor an endorsment of fiat money folks, fiat money has a sound "theoretical implementation" but does it work? Do "hard money" systems? This is a rather more complex discussion...

[IrrationalExuberanceMonky]

$this->bbcode_second_pass_quote('CrudeAwakening', '')$this->bbcode_second_pass_quote('stu', '1'). If central banks are intervening by injecting money where does this money come from? Other banks that are also in trouble? Doesn't make sense.

[mmasters]

http://www.peakoil.com/fortopic30856.html

[IrrationalExuberanceMonky]

$this->bbcode_second_pass_quote('mmasters', 'h')ttp://www.peakoil.com/fortopic30856.html

[mmasters]

$this->bbcode_second_pass_quote('IrrationalExuberanceMonky', '')$this->bbcode_second_pass_quote('mmasters', 'h')ttp://www.peakoil.com/fortopic30856.html

[BigTex]

NEW QUESTION:

If money supply is growing at the same rate as GDP, it is not supposed to be inflationary (I think I have that right).

So when the economy slows down, we inject liquidity to soften the slowdown, but now the money supply is growing faster while the rate of GDP is slowing--isn't this inherently inflationary?

When I think of recession, I think of prices being lower to induce spending by frightened consumers. I always think of rising prices in a recession as stagflation, but if my analysis above is correct EVERY recessionary period should involve stagflation if additional liquidity is being injected to stimulate the economy.

OTOH, when the economy is expanding quickly we reign in the money supply, but one of the symptoms of a hot economy is rising wages, which are viewed as inflationary. But how can mere wage growth be inflationary if the money supply is not expanding?

[FreddyH]

$this->bbcode_second_pass_quote('BigTex', 'N')EW QUESTION:

If money supply is growing at the same rate as GDP, it is not supposed to be inflationary (I think I have that right).

So when the economy slows down, we inject liquidity to soften the slowdown, but now the money supply is growing faster while the rate of GDP is slowing--isn't this inherently inflationary?

When I think of recession, I think of prices being lower to induce spending by frightened consumers. I always think of rising prices in a recession as stagflation, but if my analysis above is correct EVERY recessionary period should involve stagflation if additional liquidity is being injected to stimulate the economy.

OTOH, when the economy is expanding quickly we reign in the money supply, but one of the symptoms of a hot economy is rising wages, which are viewed as inflationary. But how can mere wage growth be inflationary if the money supply is not expanding?

[Flowerr]

Life is a monopoly game.

The kid who is the banker is able to hand out money to whom he likes and can even give loans.
The ones he don't like he shortchanges them .

When park place needs money he lends them cash and forgets about it.
When other players see how to do it, they take loans

Banker writes more money on paper napkinseveryone has money but the guys the banker doesnt like.

He writes more money on napkins to give to the poor guys just enough so they can give him his interest.

When the poor kids get broke theyngive him a line of credit because if they were out of business, they would have no excuse handing out money to the favorite players every turn.

They dont like you, they are trying to keep ripping off the bank, that is what it is all about.

and the Fed collects interet from everyone and even from overseas.


The money they are handing out now is written with disappearing ink.

Soon the poor kids will throw the game board against the wall and punch out the banker.
Everyone goes home

[LastViking]

$this->bbcode_second_pass_quote('Flowerr', 'L')ife is a monopoly game.