Stupid Evil People

by digby

For anyone who’s looking for a nice, easy to read primer on the basics of the financial meltdown, I would recommend this post called Economic Disaster and Stupid Evil People. It is pretty long, but this is the nut:

1. People like buying safe investments.

2. Historically, mortgages are very safe investments: people will go to incredible lengths not to lose their homes.

3. Banks realized that they could make lots of money by taking groups of mortgages, and turning them into bonds that they could sell, earning a commission, and passing the risk to whoever bought the bonds.

4. These bonds became incredibly popular. Lots and lots of people and organizations wanted to buy them.

5. There aren’t enough good mortgages to put together the number of bonds that people wanted to buy.

6. So banks started giving out mortgages to people who couldn’t repay them, using elaborate and dishonest schemes to pretend that they were actually not bad mortgages.

7. The people who got mortgages that they couldn’t repay didn’t repay them.

8. The banks act surprised: “My god, no one could have predicted that so many loans would default! Whine, whinge, moan, someone come help us!

What’s going on now is directly related to that mortgage mess. A good metaphor for it is that the current situation is like a huge city of skyscrapers built on a foundation of sand; the mortgages are the sand.

What we’ve been seeing over the last couple of weeks is the same basic scam as the mortgage mess, but on an even larger scale. Lending money is a profitable business. Bundling loans into investment vehicles is an incredibly profitable business for producing what appear to be high-yield, low-risk investments.

Naturally, when there’s a big opportunity to make lots of money, there’s a ton of people looking to get in on it. Of course, just like with the mortgages, there’s a limit. Realistically, there’s only a certain amount of money that can be loaned at any time to people who can pay it back. But there was so much money to be made that as the high-quality loans ran out, they started looking for other things that they could wrap up as investments. Of course, since people who buy these kinds of investments are typically looking for something really safe, that means that they can’t just give money out any-which-way; they need to have some plausible way of saying “This is really safe”.

And here’s where the stupidity really started kicking in.

How do you take a bunch of loans that might not be repaid, and turn them into something that’s safe? Well, what do you do if you had a lot of money tied up in a piece of property that you could lose in an accident? Like, say, a car or a house? You’d buy insurance!

Read on for the amazing next steps…

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