They have rocket scientists working on Wall Street slicing and dicing derivatives. I am not a rocket scientist. I have words, not numbers at my beck and call. I have metaphors and imperfect understanding. But I'm going to try to help you understand What Bankers Think(tm). Some bankers. Bankers who work in Operations and Treasury. Community Bankers. Bankers who deal with Payments and File Transfers and who don't want to cannibalize their Wire Transfer business with their ACH business. Bankers who probably knew that regardless of what Congress did today the Fed was going to pull the big lever on the presses and print a passel more money to sluice into the system.
Some of the Bankers, the ones with gray hair who are over 60 and haven't quite managed to retire yet pulled all their investments out of the market on Tuesday last week and put it into Treasury bonds. They won't even talk money market because some of those "broke the buck."
Others, at fifty, sighed heavily and suggested that the best way to handle the mess is to not open their 401k envelopes. After all, the worst risk now is not the downside, that's going to happen, it's missing the upside when it happens, because historically the market moves up in short sharp bursts. And if it doesn't happen, well that's not any worse than not being in the market.
The community bankers are all telling each other how conservative their management is, how behind the times. They say this will a little pride, because these guys didn't invest in stuff they didn't understand and it really is kind of like that savings and loan where George Bailey worked. But it isn't really that way any more. These same banks make a decision about 2 p.m. every day how much money they can sweep into what investments overnight.
Money skitters everywhere in the banking system. It's like all the bankers stand in a circle wearing cargo pants, everyone has lots of pockets and just some money. They put the money in the right pocket just in time for the banker next to them to reach into it and take it. You don't have to have money in all the pockets. Just in the pocket at the time your neighbor's hand is reaching into it.
That's where the liquidity comes in. If the Fed tosses everyone a few extra bucks, it doesn't matter that housing prices are falling, that people are mailing in their keys, and that a single illness can land a family in their car rather than under a roof. All that money sloshing around just lets the worlds biggest game of three card monte keep a goin'.
Because the Bankers, all those risk adverse, suit wearing paper pushers can't turn on a dime. It takes them 18 months to decide if everyone wants to put a phone number on your statement for an electronic funds transfer. They are still sore at regulations written in the 90's with which they live today. They can do what they've been doing. Or they can stop doing anything at all.
So, Bankers are all asking each other what this bill means, and what it's meant to fix. They want to know, because they know that the Fed has two weapons in their arsenal: 1) They can print money & 2) They can tinker with short term interest rates.
What's happened is also two things: 1) Some banks have borrowed money to invest (leverage) & 2) Some banks have kept the highest risk (and highest interest rate) slices of the mortgages they have sold off for themselves.
About the slicing and dicing... When you slice and dice, you pick from the portfolio of all the mortgages you have to arrive at some piece of that portfolio that you can provide at a certain rate of return for a certain period of time...Low risk for two days, medium risk for three months, high risk for a year. You get the picture.
Here's the problem. The banks, for whatever reason, have kept the high risk stuff. These are the worst performing mortgages. And the other Bankers don't know why. They don't know if they picked these because they're greedy, or because they couldn't sell them.
If they couldn't sell these extra risky slices. Well, that's bad. Because what you can't sell, no one wants. Further, if you go shopping this shit, people who make offers are going to low ball it.
So, say I have a thousand mortgages for a thousand dollars in my cargo pants. I'll give another thousand to you. We'll both have a million dollars worth of loans. We both priced these things assuming that we'd have a default rate of 1%, and that at that price, we'd make money.
Now the default rate goes up to 2, maybe 3%. Is it over? Has the bottom dropped out? I don't know. Atrios says no, so I'm a bit scared. I've gotten to where I can't sleep at night. I start asking around, "how much will you give me." Joe, seems a bit interested. He offers me $800,000 for my loan portfolio. He's assuming a certain number of defaults and a nice little profit left over.
You hear about Joe's offer, and maybe let on that you'd accept $750,000. Then both of us have a cocktail and think, well, maybe we'll just wait this stuff out.
Oops. Joe just set the market price. We didn't sell, but my million dollar portfolio and yours are now worth $750K. And if I borrowed the money to buy my portfolio (leverage, remember), then when the guy who loaned me the money finds out 25% of the investment is gone, well, Jim just asks me to pony up the difference. That's the margin call. The reason he knows? It's called Mark to Market. I have to put my loan portfolio on the books at its current value or wear a little orange jumpsuit.
That's how huge banks go down the crapper so fast. People stop buying stuff. The few offers are low balls. The ink doesn't dry on your books before you have to pay Jim back because he has mortgages of his own and someone else is asking him for money.
More money sloshing around makes it easy to borrow some to pay Jim back. What it doesn't do is fix the problem of not really knowing where the bottom on the housing market is -- or the race to zero. Cause you and me, one day we're going to get scared enough, or in hock enough to either sell out or collapse.
So, the negotiations on the bailout collapses and the Fed waves one of its two sledge hammers. Hello inflation. Bernake and Paulson had two choices. Hold us hostage by allowing credit to a dry up, or hold us hostage with the specter of Jimmy Carter in a sweater.
And those bankers -- they hate sweaters. They're all thinking about retiring to Arizona and driving around in golf carts all day as we speak. If they have the nerve to look at their 401k. I know I don't.