For those of you whom (like me), haven’t really been paying attention, over the past three or four weeks the U.S. stock market has been taking quite a beating.  Check for yourself on The NYSE; and recently the Fed has asked for a $700,000,000,000.00 bailout for traders.

The bailout will go to prop up corporations like Fannie Mae, Freddie Mac, AIG, and other “supergiants”, businesses that are, according to President Bush, “Too big to fail.” This money will be used to buy securities that will take debt out of these companies and inject liquidity back in, so they can continue providing credit to other corporations as well as American citizens.

The basic steps

This began in the early 1980’s, when the government deregulated markets, rates were low and “greed is good” was sweeping Wall Street. Housing prices began to rise, slowly at first, but in the later parts of the 1990’s and early 2000’s they shot up like a rocket. In 2002 they increased dramatically, and the following year, 2003, the Federal Reserve Interest Rate was a measly 1%, pretty darn close to zero.

Of course, this meant all sorts of people could now afford loans, since the thirty year fixed was at all time lows, and there were suddenly more people wanting houses then houses were available. This lead to a dramatic increase in house prices (see above), hence bankers, brokers, and everyone in between found themselves getting creative in pushing giant mortgages out. Heck, if house prices kept rising at their current rates, within ten years $250,000 wouldn’t even buy a deluxe cardboard box! Or so they (the bankers) screamed.

So Joe McSixPack found himself with a fifty year, five hundred bazillion dollar adjustable rate mortgage, interest only of course, payable with his salary of twelve fifty an hour.

At this point, Joes’ mortgage got repackaged with a bunch of others, and sold to some giant investment firm for a tidy sum. This forms the core of an Asset Backed Security (ABS), typically a safe investment and reliable source of income. These ABS’s were then sold to small Norwegian villages and everyone lives happily ever after. Until Joe defaults.

One default isn’t too bad. After all, you have probably sixty, seventy mortgages in a package. The real problem is when most of your package goes into default, and stops paying. At this point Joe, his neighbor, his neighbor’s neighbor, his neighbor’s neighbor’s pool guy, his dog, parakeet, boat, bank, broker, cell phone salesman, and his beloved partridge in a pear tree are all defaulting, losing their homes, cars, and other assorted goodies.

The bank is out Joe’s loan, minus the actual cost of the home (plus any assets they can seize). The investment firms have all their unsold, smelly mortgages which cost them quite a bit, going under and costing them gobs of money, and the small Norwegian villages are sending their angry moosen to deliver a big angry message to America’s vulnerable shores, with their sharp head thingies, giant legs, and car crushing giant bodies. (If a moose breathed fire, it would become the coolest animal on the face of the planet.)

Anyway, at this point, no-one wants to, or is able to buy any more of these money losing mortgages, and the companies are forced to sell off or shut down in order to stay in the black. After all, you can’t run a family, much less a business (or country) with more money flowing out then flowing in. People get kinda cranky when they don’t get paid.

Two solutions

At this time, there are two solutions. The government wants to buy these smelly mortgages for cash, with the hopes of selling them back later, hopefully at a profit. This puts America even further into debt, keeps the real estate market artificially propped up,sends inflation through the roof, and the execs whom make millions walk away scott free.

Or, we can let the market take care of itself. These “supergiants” go out of business, easy credit dries up, and more conservative and/or successful companies buy the remains for a song. This will put us into a short lived depression, but once the credit market stabilizes, the easy credit will vanish, and good solid credit will remain.

The third option is to let the banks try and work new deals with the home owners, to prevent foreclosure. I think this option is a bit of the “too little too late” variety. After all, you can’t just magic money out of thin air, and if the home owner can’t afford the loan in the first place, a new loan probably won’t do much to help.

Conclusion

This sucks. Either way we are in for a wild ride. If you are going to invest, play conservative; invest in metals, mining, farming, or energy; something that actually produces a tangible material. You could also buy treasury bonds, but I don’t think their interest rate is going to keep up with inflation.