Thursday, March 5, 2009

The Housing Crisis in a Nutshell

The Housing Crisis, in a nutshell
02/24/09 - Angry-Economist by Russ Nelson

[edited] Pretend that you are a bank.
  • You make a loan to somebody, say with no down payment at all.
  • Because you're loaning money to everyone that doesn't run away fast enough, everyone thinks they can own a house.
  • The price of houses rises 20%. The loan you originated is now only a loan for 80% of the value of the house, so your risk has gone down.
  • In fact, your risk has gone up; way up.
  • But because there's a school of thought that says that your risk has gone down, people are willing to buy your risk and turn it into a stock.
  • All sorts of people bought "80%" risk mortgage stocks that were really 100% risk mortgage stocks; people who shouldn't have been investing in anything that risky.
  • And because these mortgages were intermingled with real 80% risk mortgages, nobody knows which of these stocks is worthless, so nobody realy knows how much money they have.
  • Time is the only cure for this, but during that time nobody really knows how much money they have, so nobody will want to spend anything.
  • What will the stimulus do to change this? Nothing. In fact, it will make the problem worse because if the feds are borrowing that much money, nobody has any incentive to loan to more risky folks (which is everyone).

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