Snipped carefully from today's headlines, John's World continues its widely unnoticed tradition of unsensational exposés and rumor-laden investigative reporting. And, of course, you can't swing a financial cat these days without crunching credit.
What exactly does a "credit crisis” mean to Joe the Farmer? I talked to Joe, and he hadn't really thought much about it since his banker already calls him at night sobbing and pleading.
To understand the current panic, we need to track how we got here. In 2006 the housing industry was a happy bunch of people. But they could see a problem on the horizon—everybody who could buy a house already had.
Sometimes four, in fact. After pondering the dilemma, they fixed on the notion that we needed to make it easier for folks who didn't have any money to buy houses.
False terms. They devised an ingenious scheme whereby they would sell realistic-looking investment securities with the help of wealthy-sounding firms like Goldman Sacks (of moolah) and loan them to income-challenged folks to buy houses. This also solved the problem of whom middle-income homeowners could sell their house to in order to buy a home they couldn't afford either.
The problem was nobody in their right state of mind would loan money to someone who had zilch-point-nada chance of making the payments. So the housing industry remodeled the basic mortgage. With the expert assistance of Wall Street smart alecks, they developed bookkeeping camouflage for dubious mortgages by piling them together and slicing them into "tranches,” presumably with the scary paper cutter you were never allowed to use in second grade. (You may be asking, "What's a tranche?” The answer is, we thought we knew, but now we know we don't.) They also came up with things like credit default swaps that even experts have never claimed to understand, similar to the ACRE program.
Then, the tranches were shuffled and re-dealt to the buyers several times for hefty commissions, much like blending moldy corn into good corn (not that it is a common practice, of course). Meanwhile, other farmers (lenders) were doing likewise. Then we found more rotten corn (loans), which prompted more shuffling, until the elevator (mortgage) guy had a trainload of corn rejected by chickens (investors) who wouldn't eat the stuff.
The elevator/mortgage dude suddenly realized he didn't know what's in the bin, and, worse still, his buddies in neighboring elevators were calling to see if he would like some bargain corn (tranches). Then, his bank called and asked what his assets were worth on his balance sheet. The sheet then hit the fan, so to speak.
Imagine if farmers decided to swap some grain around to even out the chances of being caught with bad kernels. Each assumes the grain he gets is better than the grain he gives until the first load is sampled at the scales. Now it gets interesting.
During your annual prayer meeting with your lender, she glances at your inventory figures and says, "Ya know, your neighbor Phil just had some corn docked 80% because of mold. Just to be safe, we're going to value your corn at, umm, 83¢ per bushel. Consequently, you seem to be a teensy bit in the hole. By the way, your dog stays here when you leave.”
This is called "mark-to-market,” and it's not half as much fun as it sounds. For the last few weeks, banks of all kinds have been erasing and rewriting the price tag on stuff they think they own—like a Christmas tree retailer on Dec. 23. In the process, they too are in danger of losing their puppies. Meanwhile, they get paranoid about any business deal, figuring the guy is only trying to slip some tranches past them.
Ta-daaa! You now understand the credit crisis. Nobody trusts you, and you certainly trust nobody. Bankers have no idea what is in their bins, unless they are among the few who only invested in government bonds, which yield a whopping 0.4%—slightly lower than your mattress.
- Mid-November 2008