Basic Tips to Understand Economic Crisis

According to Leopoldo Abadía (The NINJA crisis and other misteries, Espasa Calpe, 2009), what basically happened was:
1. 2001.Internet bubble explosion.
2. US Federal Reserve reduces the price of money from 6,5% to 1% in only two years
3. These measures boost a real estate market that was just beginning to take off.
5. For a number of years, interest rates in international financial markets have been exceptionally low
6. So, Banks noticed their business was becoming smaller:They where lending Johnny at a low interest rate, but although they were not paying him nearly nothing for the little money he had in the bank, margins were still decreasing.
7. So, someone in the bank industry in America, thought banks had to skip such situation by doing two things: Give away loans at a higher risk, compensating that with a higher interest rate, and balance the low margins by achieving volume.
They where eager to lend money nearly to everyone, if the interest rate was higher to allow them make money on repayments, and needed hundreds of thousands of people to give away high risk-low interest rate loans.
Understood? Fine.We have almost covered half of the issue.
8. So, they gave away mortgages to NINJAS (No Income, No Job, no Assets), at a higher interest (the risk was also higher), take advantage of the real estate boom , and in a glorious decision, grant the NINJA an amount of money that clearly surpassed the value of the house, because - you know - Johnnies house is going to be valued much higher just in a couple of years, so what is the risk?
9. These mortgages where called subprime (a prime one would be that with no risk of repayment). On top of that, it was almost sure that if Jonny, our NINJA, would eventually loose his job, will find another one no problem.The American economy was going really well. And Johnny was quite happy.He had a loan that paid a brand new house in excess, so he also changed his car and go holidaying with the family.
10. Banks were so happily granting loans, that soon became short of money, so they went out to their foreign colleages to lend some money from them.
So, the money that Jonny got from the bank, might well come from Francois, in the south of France.What Francois still does not understand is that his whole life savings might be at risk. Besides, there is something called the Basilea Rules that basically establish that banks cannot lend money to a total amount below their assets.
11. And they also invented something new: They would get all of their mortgages and loans - the primes, the subprimes and others - and wrap them up in a nice package called MBS (Mortgage backed securities).So, where yesterday the bank had one thousand loose mortgages and loans, today everything was nicely organized in ten boxes with one hundred mortgages and loans each, where you can find the good and the bad, all together.
12. And Johnny´s bank manages to sell those packages at a nice price, so that gets money in and re-balance its accounts.
But the question is...And who bought that? Well, the bank created sister companies called conduits that where basically trusts, thus not having the obligation of consolidating accounts with the mother society. As a result, Johnny,s bank with a brand new shiny face and the trust corporation beginning to have a problem, but...who cares?
13. By the way, conduitsalso get the money to buy those nice packages via loans with other banks.The snow ball effect is beginning to roll.
14. Up to now, and hoping you did not get lost in the article, there is something really important to remember: This edgy situation is only sustainable if NINJAS keep repaying their mortgages, and that the real estate market in the US stills keeping a growing pace...
15. BUT: In the beginning of 2007 prices of north America houses dropped dramatically.Most of the NINJAS realized they where paying for their houses over the real value,and automatically no financial institution wanted to buy more "mortgage packages", and those banks that were ready to sell more, could not find a buyer.
So, Banks have no money now, we have gone into a terrific credit crunch , the real estate industry is in its deepest downturn, and hopefully, three years after that, the sun is again showing behind the mountains.
All the best,
Gabriel Fernandez-Alava.
Besides, there are this Basilea Rules that basically establish that a bank cannot lend money below the value of its assets.