Apollo11
Posts: 24082
Joined: 6/7/2001
From: Zagreb, Croatia
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Hi all,
quote:
ORIGINAL: USS America
quote:
ORIGINAL: Apollo11
Mike, can you please tell us what is happening with US banks (in layman terms)?
Wow, that's a tough one, Leo. I try to pay attention, but I'm surely not an expert. While trying not to interject political ideas of my own, here's the summary as I understand it.
House prices in many parts of the country have been skyrocketing for several years. Many, many, many "creative" loans were made for mortgages to people who really couldn't afford those expensive houses. A lot of those mortgages were "variable rate", "interest only", or other types which become much more expensive after the first few years. As long as house prices continued to increase, everything was fine, because a homeowner would sell his house for a profit before the terms of the loan became too expensive.
Then house prices started to drop in many parts of the country.
Now, people who in my opinion used very poor judgment by agreeing to take on these creative loans started to not be able to sell their houses for a profit. They had a choice of selling the house for a loss, or starting to make much higher monthly payments on the loans. A lot of these homeowners have fallen behind on their payments, or defaulted completely, and the banks are forced to foreclose on the homes, which means the banks take possession of the house and try to sell it. Of course, the banks can't sell the houses for a profit, either.
That is what led up to the current situation. What has happened now, mainly because of the large default rates on mortgage loans, is that the banks are seeing their assets lose value, or become completely worthless. As these loans, which the banks show as assets since they are usually a source of income for the banks, started losing value, the overall asset value of the banks has dropped. They are forced to write off these bad loans and remove them from their official asset list. This has happened to almost all of the banks, since all of them enjoyed many years of income from these loans.
Banks are required to maintain a certain ratio of assets to the amount of money they lend out. I do not know the specific regulations in this area, but I know that as the assets of the banks has dropped recently, they have been forced to come up with more cash to keep within the legal ratio limits. If they do not, they are not able to loan more money to individuals, companies, government agencies to build roads, etc, or to other banks. The current "crisis" is that system wide, the banks have run out of money that they can lend, because their assets have dropped quickly. The massive federal government "bail out" package that they are currently working on is designed to provide a boost to the assets of banks and others, which will allow them to start lending money again.
Anyone with more insight, please feel free to contribute or correct my attempt at an explanation.
Thanks a lot Mike - much appreciated (I knew bits and pieces but your explanation sorted almost all my questions)!
BTW, I understand that the first crysis was primarily with banks that provided such loans for homes (and in UK similar situation happened) - but how did the big Wall Streen investment banks come into play (and trouble)?
This is what is so worrisome... 
Leo "Apollo11"
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