For the normal person, an answer to the questions, in order:
1) Keeping the banks from losing their shirts, and panicking.

2) Mostly overnight loans to allow banks to cover their reserve requirements.

3) Example of a disorderly credit market - the bank has a bunch of customers default on their loans. They need money to prevent their depositors from making a run on the bank. So they call your mortgage, car loans, and student loans. (Look in the fine print, they generally do have the right, in certain circumstances, to demand you pay your loans early. If they didn't have the Fed to rely on, they would write it into the fine print more often and extensively - a lot of people lost their farms in the depression due to such clauses.) If you don't pay, you lose your house, car, and savings. Meanwhile, the bank doesn't get enough cash from you, pays out to the first 100 depositors who show up and demand their money, and then folds. The depositors who didn't get to the teller's window first lose their money. (They are, after all, people who loaned the bank money - that is what your checking account is, a loan you extended to the bank.) 1930s-type banking crisis ensues. (Or 1980's style S&L crash, if Federal Insurance covers the depositors. Either way, fun is had by none.)

4) Well, you, if your are trying to pay a mortgage and your bank/mortgage company needs cash fast. Otherwise, bank owners, which means by proxy bank depositors and/or the FDIC. Yes, Countrywide CEO whats-his-face, and all of his employees. (Visualize being a random Enron employee whose duties include mopping the floors. Enron fails, you too lose your job. It isn't just the fools at the top.)

5) Countrywide CEO, and all of his employees. By extension, everyone all of these people will buy goods from that they wouldn't be able to afford if they lost their jobs. Like your small business.

6) Idiots exist, and may unfortunately be saved. It is the second order affected (the employees, depositors, and good-faith investors they drag down with them as they drown) whom the Fed is also helping that motivate this intervention. Think lifeguard at a busy pool. Some idiot has 10 hotdogs, swims, cramps, panics, and flails, grabbing at anyone nearby to hold him up ultimately dragging three of them down with him. Or the lifeguard grabs him, dragging his sorry ass out of the water, thus saving all four of them.

7) When the Fed doesn't talk in weird, euphamistic terms, the markets tend to react, well, emotionally. (Think the uproar around 'irrational exhuberance' a few years back. Now imagine the result if HRH Greenspan had said what he meant - "The people buying tech stocks right now are bloody morons. This is vaporware, people! When the merry-go-round stops, whoever holds these stocks will lose it all!")

8) Yes. An entire industry is now at the mercy of moral hazard. It used to be: banks loan money, and have to collect the payments. They were, thus, very careful to only loan to people they think will pay them back. Then someone had the bright idea to 'package' some of these carefully-screened loans, and sell them to investors. (More on that later).) This was fine, until the banks realized no one was watching whether the loans they packaged and sold were actually solid. Banks then minted money by loaning it to anyone who wandered in off the streets and stuffing their packages with these less well-thought-out loans. Now everyone who bought these packages, or owns a bit of these packages(like your pension fund), is finding out the banks stopped screening the loans they bought. (Caveat emptor and all that, but there is a good-faith expectation that banks don't loan money to people who won't pay them back.) The banks are home free, but now realize they can't sell more packages, and so are tightening up credit requirements. So are the 'mortgage companies' (businesses set up to explicitly loan money and package, without the other bank functions), but they are dying on the vine because of the inability to make more loans or sell more packages. If this continues, no one will be in business to loan money to new house-buyers. The extra credit will protect the package buyers, making sure all of these fine loaners can keep loaning, hopefully at least slightly chastened about loaning money to the odd unemployed car washer for a mini-mansion, while still loaning the worthy accountant money to buy a three-bedroom before his kid is born. Existing homeowners won't see their values crater as the accountant who they would sell to doesn't materialize.

(Later) Why buy 'debt'? Let's say I owe you $100 in a month, and am good for it. For you, that IOU is an asset - it is a claim you have on money in the future. Unfortunately, you need cash now to pay your book...keeper. So John over there is willing to pay you $90 now, in return for the $100 I'll pay you in a month. You get your $90, and John gets a $10 profit when I pay. We have now made the IOU 'liquid', meaning it can be sold for nearly its face value at any time. That being true, you will be more willing to loan money (knowing you can get cash when you need it), lowering interest rates. Everyone is better off - I get more favorable terms, you get more cash flow security, and the John gets the difference between the face value of the loan and the liquid price, if/when you sell. John is the one 'buying debt'.

Posted by: rvman on August 17, 2007 11:06 AM

Economic turmoil hits home, so to speak, because my grandfather was totally wiped out in the 1929 stock market crash.

A bankrupt investor jumped out a window and landed on his pushcart.

Posted by: Peter on August 17, 2007 11:11 AM

Is it fair to say that what can tick people off about things like this is that the people who created the problem for which so many are paying 1) are making out like bandits, and 2) aren't being punished, even as the problems they created are being cleared up?

Posted by: Michael Blowhard on August 17, 2007 11:51 AM

Is it fair to say that what can tick people off about things like this is that the people who created the problem for which so many are paying 1) are making out like bandits, and 2) aren't being punished, even as the problems they created are being cleared up?

Well yes. I would, however, be somewhat surprised if the mortgage situation doesn't result in a fair number of high profile DOJ and SEC actions against individuals and corporations involved. Retribution, if it comes, is unlikely to be immediate, though.

Posted by: Taeyoung on August 17, 2007 12:03 PM

MB, looks like Johnathan Pearce thinks along same lines.

Posted by: Tatyana on August 17, 2007 2:40 PM

Who are these "people" making out like bandits? Let's take the example of Mozilo, the head of Countrywide. Do you realize how much wealth he has lost due to the home loan crisis? What about all of the employees of those mortgage lenders and brokers who have lost their jobs due to the crisis?

Posted by: jult52 on August 18, 2007 6:11 AM

At the end of the day, the "winners" will be real-estate investors who sold last year, legions of mom&pop mortgage brokers who made very good livings for several years, and hedge-fund investors who owned these bonds and got their money out. Also, local governments who benefited from increased property taxes have to be numbered among the winners.

The losers will be basically the same as the winners, except for the timing.

The "middle guys" will be bigger mortgage originators and resellers like Countrywide, who did very well for a while, but now will take a dive.

Also, one could argue the winners include lower-income or younger people who don't currently own property and will be able to buy something they can afford as RE prices deflate.

I'm hoping that Congress doesn't try to bail anyone out here. The sophisticated losers knew the risks they were taking, and the people losing their houses typically bought them with 0% down anyway, so while they'll have an awful few months of getting back on their feet, they won't take much of a long-term hit.

Posted by: Foobarista on August 18, 2007 4:08 PM

Much as we dislike the idea of money
being spent to rescue those who made
unwise investment choices, there is a
very good reason why we cannot let
banks go under.

Once a bank goes under and people realize that it is foolish to trust
them with your savings, you may see a
return of that old standard method: under the mattress.

Sure, people could become savvy customers and learn how to tell good banks from bad, but saving your money under the mattress is a lot less work than doing your research ("never underestimate the power of laziness in the decission process").

Before you know, all the money which would otherwise be availabel for investment, some of it quite worthwhile and profitable will be lying in thousands of beds, waiting for better times.

Basically, you cannot allow people to doubt that it is wise to put their money in the bank.

Posted by: Adriana on August 18, 2007 7:19 PM

1) Banks extended loans to borrowers for real estate who could not afford the loan or any increase in interest rates on adjustable-rate mortgages--bad loans! Borrowers were thinking that real-estate would go up forever and bail them out of their excesses--wrong!

2) Banks bundle these crap mortgages, buy some investment "insurance"--derivatives--and upgrade the rating of such crap paper to investment quality, and many pension funds, money market funds, hedge funds, etc, buy such bundled loans.

3) Adjustable rate mortgages are re-set with higher interest rates, so bad borrowers are in over their head, fall behind on such mortgages, or fall into foreclosure. All of a sudden, said bundles of supposedly high-grade paper are not performing (able to pay interest), and the bonds are no good. As usual, word gets out, and nobody wants to buy any more of this bad paper, nor take it off the hands of unlucky investors who bought it previously.

4) All of a sudden, these bundles of paper are becoming worthless! Nobody will buy them, so no "liquidity", or the ability to sell an asset in a market, is available. Huge, huge losses are occurring, and people are doing everything they can to get their money out of hedge funds, etc, that holds the paper, but the buyers of said paper have no cash on hand to re-fund their investors. So they either go belly-up, or have to borrow the money from somebody. Also, such derivatives, or investment "insurance" start hitting the crapper. More squeals of pain!

5) Viola, the FED runs to the rescue, creating money out of thin air to make a market for such crap paper and derivatives--either by making it available for people to borrow, or buying the paper indirectly as funds sell every other asset they have, including US Treasuries, which is all the FED is supposed to be able to buy. The buying and selling of such crap paper ensues, even if the crap paper is discounted to pennies on the dollar, "order" is returned to the market, and catastrophe is averted or put off to another day. Some people lose, most get bailed out, and life goes on--the life of the non-productive gamblers and flim-flammers who inhabit the marketplace.

6) Of course, in the end, the bailing out of such reckless financial behavior will simply encourage more stupidity, until the whole thing collapses in a giant crack-up boom. And inflation will roar ahead as the money created out of thin air eventually makes its way into the real economy, where people actually do something productive for a living besides gamble with other people's money. Its just another form of privatizing profits and socializing losses. Once you understand that the role of the FEDERAL RESERVE is to contunually create money out of thin air for pumping up the business cycle, enriching bankers, and averting the financial ruin of gamblers, you've got the picture. Its neither Federal, nor does it have any reserves. It is a private corporation that is in fact a banking cartel--a perpetual monetary inflation machine granted a license to create money by the government in exchange for the promise to always buy government bonds to fund the wars and political vote-buying schemes of politicians, which has been exploited as well by the gamblers on Wall Street.

There, that should be simple enough for you.

Posted by: BIOH on August 18, 2007 10:58 PM

I'll give it a go. Basically, the Fed cut interest rates a lot between 2001 and 2003 to get the economy going after the dot com bubble collapse and 9/11. With the cost of loans so low, demand for buying homes shot up, but supply didn't (it takes a while for builders to, um, build). So prices began to rise.

Things were peachy for some time. Lenders, who make their money from origination commissions on loans, wanted to keep the party going. Since there is only a limited amount of prudent, creditworthy individuals, they offered finance to "subprime" borrowers (those with bad credit) and property flippers (by not asking them to prove income).

Prices kept on rising and builders kept on adding supply. When rates went up and prices became unaffordable even for marginal buyers, demand slowed. Thus, there was massive oversupply. Prices began to fall in late 2006.

People began to realize they couldn't make the payments and couldn't sell to pay back their mortgage. So they defaulted. The investors who bought their morgages, many with borrowed money, were hit by huge losses.

The problem is that no one knows who's holding the hot potato. If a fund blows up, investors lose. But if that fund can't pay back its creditors, and so on, then all hell breaks loose. So far, some funds have had problems, but have been rescued by their parent firms. However, no one knows what's lurking out there, so lenders are cutting exposure (i.e. not lending).

What the Fed is doing is assuring everyone that it's willing to help banks ride out the storm by lending them money and cutting rates. Will it work? I sure hope so, but many surprises await.

Posted by: Andres on August 20, 2007 7:01 PM






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