Crisis (1): What has happened

Article written by Xavier Sala Martí (Columbia University) in La Vanguardia, a Catalan newspaper. Translated from Spanish to English using Babel Fish (sorry for the translation mistakes, if you want to suggest any change leave a comment).

The perfect storm continues its inexorable course and we all wonder what is the solution. Before talking about remedies, it is important to know what has happened because, without a proper diagnosis, there is no sensible solutions.

It all began in 2001 when Alan Greenspan wanted to avoid the collapse of the stock market after the fiasco of the dot-reducing interest rates from 6.5% to 2.5% in less than a year. With these guys so low, banks, who live in lending money in exchange for an interest, sought profitability in families with low incomes and with a high probability of being unable to repay the mortgage, calls families have an increased risk subprime.Al, those families pay a higher interest, although the banks thought the risk was mitigated by the fact that the price of their houses were going up: if one day they have problems, they thought, the families will be able to sell the house at a price higher than the mortgage, enabling them to return the money.

But they could charge the margins were so small that in order to obtain profitability, they had to multiply the volume. The problem is that the number of mortgages they could give was limited by regulation to Basel prevents credits granted by a bank exceed a certain proportion of their capital. Curiously, which does allow such regulation is that banks think about parallel investment funds (called under pressure) who buy their receivables. And so they did: the calling given under pressure, buying mortgages to the banks and those recovering the money. Having disappeared from their credit balances (to allow regulation and the Basel accounting of the bank and the conduit was made separately), banks could return to provide the same money, thus expanding the business.

The under pressure, in turn, the Prime Minister took the mortgages, the repackaging (in sophisticated language, title) in ways so complex that get ratings of AAA, which indicated minimal risk and sold to investment banks. To facilitate the operation, even got names pompous as insurance with credit default swaps.Los investment banks, in turn, used these assets as collateral to borrow additional leverage and more financial operations, thus creating a huge snowball of assets , No matter how sophisticated they were, were guaranteed the last of the families subprime mortgages.

And all this was going very well while the price of housing rose. But came a day left to climb. Families who had borrowed 100,000 U.S. dollars saw that his house was worth only 60,000 and had to make a decision: return home or return of 60,000 a mortgage of 100,000. No one should be very ready to see that if the regulation allows to choose, many will return home and not pay the mortgage. And it turns out that the regulation allowed to pick and, therefore, decided not to pay the late payment was fired and all assets secured by those mortgages began to lose its value and to be cataloged tóxicos.El problem is that they had been so many times that retitularizados nobody knew how many active or toxic or who had had. That created a mistrust between banks that made money no longer lend to each other. Interbank interest rates (such as the Euribor) was fired and, with them, the monthly payments of millions of families who stopped to pay their mortgages. Late payments rose, no longer among subprime families, but among the families in the world. Insurers had to pay it insured ... but did not have enough money, so they were the first to break. Their names: Bear Stearns, Freddie Mac, Fannie Mae and AIG. Does it sound like?

And here again to see the regulation of Basel: the investment banks like Merrill Lynch and Lehman Brothers had used such bonds now that were toxic as financial security and the regulation said that when the value of those securities down, banks were required to dispose of other assets and use the money to replenish the lost security. The problem is that this was happening right in the moment that nobody wanted to buy those assets at reasonable prices. But as they were forced to sell, sell. That ... To balance price! That increased their losses, which reduced the market value of its assets, which forced them to sell more, which increased their losses ... and so on in a negative spiral of losses and decreases in trading that led to bankruptcy. The financial panic was served.

Which brings us to the present time: the mistrust, fear and loss of the banks are doing that not only cease to lend to other banks, but will cease to provide a non-financial companies from around the world. Investment in the hospital sector in Germany or the food in Colombia are not carried out due to lack of funding. Economic activity falls, the jobs disappear and what began as a problem in the U.S. mortgage. UU. is getting to the real economy around the world. The public asked their governments to act. The erratic public policies they propose, however, show that they do not know what to do, which raises more distrust and aggravate the situation. That's what we will talk in a future article. For now, this is what happened.