I've been mentally working on a post with a title like "What's Going On In The World: A Summary" lately, but I haven't made time to write it all down. One thing it'll touch on is the "Global Credit Crunch," which grew out of the "U.S. Housing Crisis" stemming from the "Subprime Mortgage Collapse." I don't have any formal education in economics, but I often find that I can construct a decent sense of the key issues by listening to the language of people who do know what they're talking about. But despite all the news references to this major financial current event, I could tell I was missing key pieces of the puzzle.
Fortunately, This American Life
is really good at sharing a full story in a way that's easy to understand in human ways. Episode #355: The Giant Pool of Money
looks at people involved at each level of the house of cards which has now foreclosed. They define key terms, explain why otherwise sensible people made bad decisions, and what factors came into place for everything to fall apart. The whole episode will be available as a free download on their podcast for the next week; even if you don't want to listen to everyday people's stories about weird stuff every week, be sure to listen to episode 355.
One thing they didn't really touch on is the question "Where did all the money go?" They said "It's just gone," but money doesn't just disappear; it goes somewhere. Somebody class of people came out on the winning side. I think the answer goes something like this:
Global investors (the giant pool of money) bought shares in mortgage-backed securities offered by investment banks on the assumption that payments would be regular, producing dividends.
Investment banks bought loans from mortgage brokers and commercial banks on the assumption that they could sell shares to big investors.
Mortgage lenders gave money to people (many of whom shouldn't have gotten a loan in the first place) on the assumption they'd make regular payments (or on the assumption that someone would buy the loan before it would matter).
Some people took out mortgages to pay other debts on the assumption that the going interest rate was better than their other interest rate. So creditors are one set of winners. And not entirely coincidentally, creditors like the financial megalith JP Morgan Chase Manhattan were major players in the shenanigans we're now seeing fallout from. So they may not have lost as bad as their current numbers look.
Some people took out mortgages to pay for big expenses like college for their kids or trips to Mexico on the assumption that American housing prices would keep going up and they could use the equity in their home as an ATM. So smart spenders are one set of winners. If someone took out a mortgage, paid for college, then lost the house in foreclosure, they at least funded a good education for their kid who can find a good job (even in the current economy, they hope) and get a house with some extra room for their parents. Of course, dumb spenders are one set of losers. If they bought a big screen TV and took a trip to party on Mexican beaches and then lost their house in foreclosure, the best they can say is "The real titties looked better than the high def ones did."
And, of course, some people took out mortgages to buy houses. For several years, American home construction was a booming industry. So one set of winners is home builders. But then they became losers as they discovered they had vast tracts of cookie-cutter subdivisions ready to sell just as everyone started losing the houses they shouldn't have purchased three years before. But before the home builders moved to the loser category, they paid a lot of money in wages to construction crews. American construction work these days is largely done by Hispanics. A lot of Hispanics send a significant portion of their income to family members in Latin America.
So the flow goes something like this:
American consumers buy cheap goods at discount retail stores -> discount retail stores buy cheap goods from China -> China invests dollars in U.S. mortgage bonds -> mortgage bonds create a demand for unsound loans -> unsound loans promise American consumers the dream of home ownership -> dream sellers build ostentatious subdivisions -> frugal carpenters send their share of American consumer money to poor Mexican families.
It's not so much trickle-down economics as it is Gordian-hose economics. The flow doesn't start or stop where I've outlined, but it's interesting to see how two groups (Chinese factory workers and Mexican subsistence farmers) who at first seem to have nothing to do with $500,000 houses on Shady Hills Lane are beneficiaries of the complex transactions of the American housing market. Of course, with major increases in the prices of food and oil, those benefits may rapidly dissipate. I wonder how much of that increase has come from investors fleeing poor assumptions about the U.S. housing market in favor of assumptions about commodities markets...
Remember kids, when investing or making other important decisions: The past is not necessarily a good predictor of the future. Life is one big Hume problem.