Money Meltdown

I came across this site by chance through one of the tweets that I received on twitter.

Site: The site basically talks about the US Economy that is in soup right now.

I hope you must be aware of some crisis in US economy by now. Major Financial Institutions are in real difficult situation. They have either been bought out by FED or they have filed for bankruptcy. I really did not know what was happening and I was eager to know the situation. I was looking out for some descent material and above site really fits the bill.

Let me put things as simple as possible. As you all know that to lend money one should have money or he should borrow money from someone else and give it to others just like private banks which borrow money from RBI. Now if the banks have huge amounts of deposits and it is not borrowing from the RBI and it has to provide a high interest rate for the deposits then banks has to do something about it. The easiest way is to lend the huge sum of money to others and expect them to pay higher interest rates for the loan amount for 20 – 30 years. The situation now is that the depositors don’t need money and the guys who need money do not have either assets or proper steady income. The bank trusts these kind of people and provide them the loan and the guys who wanted money did not have means to pay them back and everything crashed.

The global pool of money got bigger year by year and this is mainly due to the following countries such as China, India, Saudi Arabia and Abu Dhabi. China added to pool of money by manufacturing goods, India by providing services and Saudi and Abu Dhabi by selling oil to other nations. These countries had so much money and they all added to the global pool of money. The money that was collected had to be put in a good high yielding return on investments portfolio. The money was managed by the Investing firms or money managers. These guys had huge loads of money and they did not know where to keep it so that it grows. The main intension of these managers is to keep the money safe and grow the money to considerable levels. Since most of you know that it is good to keep the money with US as they are one of the stronger economies in the world, the money managers preferred that. The US government provided just 1% interest for their treasury bonds. It tells every investor in the world: you are not going to make any money at all on US treasury bonds for a very long time. Go somewhere else. We can’t help you. This was not lucrative for the money managers; they wanted some other means to make huge money and safe guard the money that they had i.e. low risk, high return investment.

These guys were wondering what has to be done; thankfully the Wall Street guys helped them to achieve their dreams. During 2000, there was a residential housing boom. Everyone wanted to own a home and the global pool of money helped them achieve the dreams. The money managers did not want to get into the trouble of providing the mortgage to every customer and all that. They wanted less hassle. The guys in Wall Street had to do something about this and they did this to ensure that the global money managers are happy with higher yield without the hassle or the risk.

The chain is formed like this: A person who is not having proper credit history nor has a proper steady job gets the mortgage from a broker. The broker sells the mortgage to a small bank, the small bank sells the mortgage to a big investment firm in the Wall Street. The investment firm starts buying thousands of mortgages and puts it in one big pile. Now the big investment firm gets monthly thousands of mortgage checks coming to them every month. It is a really huge sum of money if you can imagine. Now the big investment firm sells the shares of that monthly income to the investors. Those shares are called “Mortgage Backed Securities”.

The global money managers loved such low risk high yield concept called “Mortgage Backed Securities” and poured in their money. Since there was a very huge demand for such securities, the money that was flowing around was also huge. The money managers started pumping in loads and loads of money and the small banks and brokers started providing mortgage to every other person without proper background checks. They did not bother about whether the borrower could pay back or not. All that they bothered about was that the money that is in surplus should be lent and they did not care about the return. Everything was going fine till people started defaulting. The expected monthly checks did not show up. That is when things went really bad for everyone and the hell broke loose.

In simple terms, the people who were given loans did not pay back and their assets did not match up to the amount they had borrowed and the banks that provided the mortgage did not know how to recover them and they are in loss.

Now you can understand what role did Lehman brothers and Meryl Lynch would have played to this whole meltdown.


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