March, 2009

The Real Reasons Behind the Financial Crisis

Although the financial problems of the United States started many years ago, many Americans tend to think of the September/October, 2008 period as the start of the financial crisis in our country. After all, this is when global credit markets seized up and well-known financial institutions such as Lehman Brothers, Fannie Mae, Freddie Mac and AIG either went bankrupt (Lehman Brothers) or were taken over by the U.S. Government so that they wouldn't have to file bankruptcy (Fannie, Freddie and AIG). This crisis environment resulted in the passage and signing into law of the ill conceived and poorly thought out $ 700 billion TARP (Troubled Asset Relief Program) by our esteemed Congress and the lame-duck Bush administration in October, 2008.

Since this September/October, 2008 period and the subsequent assumption of office by President Obama in November, 2008, we seem to have lurched from one financial crisis to another with no end in sight. Further, additional costly bailout/stimulus programs have been enacted with, to date, little discernible positive results for we the people.

Like many Americans, I have wondered if anyone from the Bush or Obama administrations, members of Congress and/or members of the media would step up to the plate and tell us the real reason(s) as to why our financial system almost collapsed in September/October, 2008 and remains in jeopardy today. After all, trying to place the blame for this crisis on banks, who made home loans to "poor people" who couldn't afford to make the payments on the loans (so-called sub-prime loan crisis), simply didn't "pass the smell test" as an explanation for a crisis of this magnitude.

President Obama, in a question and answer session at a Town Hall Meeting in Costa Mesa, California on March 18, 2009 finally "let the cat out of the bag" on this issue when he referred to "credit default swaps" and "bets" as major contributing factors to the on-going banking/financial crisis.

In using the term "credit default swaps," President Obama was referring to one specific type of a financial contract or financial instrument known as a derivative. There are various other types of derivatives with the types and complexity limited only by the imaginations of the "financial engineers" working on Wall Street.

In using the term "bets," President Obama was letting us know that many of these derivatives represented nothing more than " gambling " by the companies involved in the development, sale and distribution of derivatives.

Each American should understand the following facts about derivatives:

1. They didn't appear on the world financial scene, in any meaningful way, until about 1990, with the biggest growth starting in approximately 2000.
   
   
2. The size of the global derivatives market, at the end of 2007, was $1.144 quadrillion (a quadrillion is 1 followed by 15 zeroes; it is also the next major number after a trillion) or approximately $190,000 for each of the 6 billion people on planet Earth.
   
   
3. Over 50% of the $1.144 quadrillion in derivatives are not regulated by any government agency (domestic or foreign).
   
   
4. Derivatives have been labeled as "weapons of mass destruction" by billionaire investor Warren Buffet who also said, in his company's 2002 annual report, "we view them as time bombs for the parties that deal in them and the economic system."
   
   
5. Derivatives have been purchased or sold not only by large financial institutions but also by government entities, non-financial corporations, mutual funds, pension funds, hedge funds (private investment funds for wealthy individuals), etc. - i.e. THEY ARE EVERYWHERE!
   
   

What happened, in a nutshell, is as follows:

1. Wall Street, in its never-ending quest for excessive profits, developed, sold and distributed, throughout the world, derivatives of various types and complexity.
   
   
2. At the same time, Wall Street, through a systematic use of campaign contributions, "favors" of various sorts, etc., made sure that strategically placed politicians and administration officials supported their agenda of either no new regulations or lax/non -existent enforcement of existing regulations.
   
   
3. AIG was one of the largest sellers of derivatives, especially credit default swaps (a type of derivative), to financial institutions (foreign and domestic) and other entities throughout the world. In essence, the buyers of these credit default swaps (a type of derivative) thought that they were transferring the risk of loan losses from their balance sheet to AIG's balance sheet (AIG being the insurer).
   
   
4. What actually happened, at a bare minimum, is that AIG never had sufficient reserves set aside to pay the buyers of the credit default swaps (a type of derivative) in the event of default. Why didn't AIG have sufficient reserves set aside? Because credit default swaps (a type of derivative) were not regulated nor were they classified as a traditional insurance product requiring reserves ! So AIG took advantage of the lack of regulation and a loophole in the insurance laws to enrich selected company employees while setting the stage for the on-going destruction of the world financial system.
   
   
5. The U.S. Government owns about 80% of AIG and, to date, has poured approximately $173 billion into the company to keep it alive. Information has now surfaced, in spite of stone-walling by the Federal Reserve, that a good deal of this $173 billion, has been passed on from AIG to selected buyers of AIG's credit default swaps (a type of derivative). The recipients include both domestic (Goldman Sachs, Merrill Lynch/ Bank of America, Morgan Stanley, Wachovia/ Wells Fargo) and foreign (Deutsche Bank, Barclays, HSBC, Lloyds, etc.) financial institutions. In other words, since AIG couldn't pay off on its " bets gone bad, " it is using taxpayer money from the U.S. Government to do so! Can you believe the unmitigated gall of these people?
   
   

What each of us needs to understand, as we move forward in this on-going crisis, is the following:

1. We, the people, are receiving, at best, bits and pieces of the " real story " about what has happened and what is continuing to happen. We are kept in the dark because " we don't have a need to know " and/or " we can't handle the truth."
   
   
2. The on-going financial and economic crisis is going to last much, much longer that we are being led to believe. The recent statement by Ben Bernanke, Chairman of the Federal Reserve, in his March 15, 2009 appearance on the television show "60 Minutes," that the economy would begin recovering next year, is a "pipe-dream."
   
   
3. We all need to find ways to "fend for ourselves" during these difficult times as opposed to sitting around and believing that many of the same people who got us into this mess are going to be smart enough and honest enough to get us out of it.
   
   

Educate yourself!

Take action yourself!

Fend for yourself!