This worldwide "real estate" crisis doesn't make sense to me!

[napi21]

I just read a post that referred to the PANIC in the European financial market. http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=102x3532516

I understand there are approximately 120 million workers in the US. (310 million people) First, not every one of them recently bought a home. Second, of all the people who DID recently buy a home, they weren't ALL sub-prime! I think, somewhere, I heard about 20% of mtgs were sub-prime loans. Lets assume that EVERY sub-prime loan went bad. How much money could that possibly be?

The market is trying to convince me that that relatively small # of loans were BIG ENOUGH to exceed $835 Billion in the US, and now it's BIG ENOUGH to cause a multibillion $ crash in Europe TOO?

What the hell am I missing here?

[nadinbrzezinski]

1. The connections in derivatives

that is what you are missing

And you can thank the Enron clause in the GRAMN bill for this mess

[napi21]

8. What all are they calculating in derivitives? I certainly understand

financed but unsold homes, and inventories at support businesses like lumber, plumbing, heating, etc. But I would think the biggest effect would be on unemployment, not credit.

[nadinbrzezinski]

14. It is not the lumber, it is the financial derivatives

the broke up and securitized home loans... good, bad and ugly

Once they broke down and were securitized, people started betting... and nobody really knows what the REAL versus FICTIONAL value is

I expect a couple trillion to go poof in the next few days... and worst from there

And untangling these and making them into the ORIGINAL loan is next to impossible

And they were never regulated so there is no transparency whatsoever in these financial devices

[anigbrowl]

20. Here's an example

You look like a steady guy and you want to buy a house, yes? OK, I'm Bank of Anig Browl, I'll loan you $250,000. Now, I'm out $250,000 in cash, but I know you're a steady guy - so I go to Nadinbrzezinski and say 'hey, I want to buy a bunch of shares in DU'. Nadin asks if I have the money, and I say no, but I do hold a mortgage from napi21, and napi21 is totally reliable - I gave him $250,000 and he's promised to pay me back $350,000 over 20 years. Plus I sold a bunch of other mortgages to equally reliable people.

Awesome, says Nadin, I'll loan you $1.5 million to buy DU shares and we'll split the profits. As long as you keep paying your mortgage to me, I keep paying off the interest on the loan from Nadin and buying more shares in DU. But if you stop paying me, then suddenly I can't pay the interest on my loan, and Nadin doesn't want to loan out money to anyone else because he's still chasing me for the money I owe him (or her, I never remember).

That's super-simplified, but it sort of explains what's going on. Money isn't supposed to sit still in the financial system, profit is only made by loaning it to other people so financial institutions are generally trying to loan out as much as they can at any given time to maximize profit, while companies are trying to borrow as much as they can to invest in new equipment, hiring etc. etc. Most of the time it works, because the combination of a rising population and improving technology means productivity (and thus wealth) is constantly increasing.

[ContinentalOp]

2. It's not the bad loans that brought the system crashing down.

It was the greedy people speculating on those loans in an elaborate pyramid scheme.

[Hannah Bell]

3. that's because you're smart.

[wtbymark]

4. 1 Quadillion dollars

is what I haerd the global derivitave markets are worth
*heard

[Vincardog]

7. I believe the Ponzi scheme called Derivatives is 500 Trillion dollars. The greedy bastards have

run up a debt equal to several hundred times the gross WORLD product.

I am only in favor of a bailout after they return the money they stole
and begin serving their prison sentences.

[sam sarrha]

21. i heard on AAR the total loans out are 617 Trillion, 10x more than all the money in the world.. F'n

gambling addicts

[onethatcares]

5. what the hell is a derivative?

a fancy name for, give me a commission for doing nothing? I don't understand this stuff.

[nadinbrzezinski]

9. You buy a house, there is a loan

the lender sells it to another company that proceeds to break it into three or six parts and then packages them into mass packets of securities and are sold to yet more parties

That is a derivative in a nutshell

[Vincardog]

10. Nobody knows what a "Derivative" is. That is the problem. The greedy bastards made them up

and they assigned them value. The valued held until the scheme broke down.

[napi21]

12. I'm certainly no expert, but as I understand it, a derivitive is a

business or industry that supports the"main business". ie: The real estate business is supported by the lumber, plumbing, electrical, A/S, heating, etc. That means a booming RE market means the Home Depots and Lowes of the country boom too. There are THOUSANDS of support businesses to the RE market. When the Main One dies, so do the rest of them.

[anigbrowl]

18. It's a form of insurance

There are many kinds of derivatives, and this isn't the place to explain them all. Basically, a derivative is a financial instrument whose value depends on the performance of another financial instrument. http://en.wikipedia.org/wiki/Derivative_(finance)

The simplest one is called an option. Say you think that the stock in company X, which is at $1, is going to rise by 20% this year, but you don't have the cash to buy a million shares. You can, for a much smaller sum, buy an option to purchase those shares a year from now at a fixed price, say $1.05. The option itself costs 5c (times 1 million is $50,000, an affordable sum of money compared to $1,000,000). So if you are correct, and the price goes to $1.20, you exercise your option. Now you've paid $1.05 for the share + 5c for the option = $1.10. Anyone will loan you the money to exercise the option because you can immediately turn around and sell the share at $1.20, meaning you have made 10c profit. For a million shares, that would be $100,000. If the stock didn't do as well as you hoped (ie didn't go past $1.10), then your option is worthless, you lost $50,000 - but at least you didn't tie up a whole million bucks in the process. This known as a 'call' option.

Alternatively, if you think the price is going to go down, you can buy an option at 5c to sell the stock at 95c. If the stock falls to 80c a year from now, you can exercise your option, buy the shares at 80c each + 5c for the option = 85c, and then sell the stock at 95c - again, you made 10c per share, times a million is a cool $100,000 profit on a $50,000 investment. Again, anyone will loan the money to complete the transaction because if you have the option and the company's share price has changed as you predicted, it's obvious that you're going to make a profit. This is a 'put' option. Again, if the stock didn't go down as much as you expected, the option is worthless, you tear it up and bemoan your loss.

It is quite possible to buy both call and put options, and make a profit whichever way the stock moves, as long as it moves by more than the value of your options. In this case, assuming the options cost 5c each, as long as the stock goes up or down by more than 10 cents you've made a profit. In this case you are making a bet that the price of that stock is going to be volatile and change significantly, even though yo are not sure in which direction. An example of when you might want to do that is if you heard the CEO was going to be fired, and you couldn't guess whether the new CEO was going to be competent or not, but you knew the shareholders were demanding major changes.

The key point here is that although you may have only invested $50,000 or $100,000, it is actually like making a deposit on a million dollar investment. A great many derivatives work along similar lines, so when you hear that the derivative market is worth a gazillion dollars, it doesn't mean there's a gazillion actual dollars in play, only that investors have made down payments on a gazillion dollars of POSSIBLE future transactions. A lot of these deals are going actually cancel each other out, since it's not possible for all such transactions to profitably take place.

[EmeraldCityGrl]

6. The more I learn, the angrier I become...n/t

[anigbrowl]

11. ~Well, you know, other countries have real estate markets too

And other countries have house price booms, where people overextend themselves, and then the market peaks, house prices fall, it becomes hard to sell, etc. etc. It so happens that because money has been extremely cheap in recent years (ie, rates of interest have been historically low) that a lot of places set themselves up with quite similar economic timebombs to the US.

Take Ireland - as the country's GDP etc. has improved in recent years, house prices have also gone through the roof because most people want to own a home if they have the chance. Now they're having a housing crash. Same story in Australia, the UK, Germany, and a lot of other places.

Why would you think that what's going on in other countries is entirely driven by the US to begin with?

Also, you wonder how big the mortgage market is and so forth. Let's suppose there are 10 million mortgages in the US (note: I am making this # up! it's just an example) and let's suppose the average home is $100,000 (ditto). Well, multiply those together and you're talking about property worth a trillion dollars - $1,000,000,000,000. This is a lot, but not unimaginable - it's about 1/3 of the annual federal budget.

But due to something called leverage, the holders of such mortgage debt may use it as collateral to borrow more money to invest in the stock market, buy currency and so on. It's a complex subject, but the bottom line is that the absolute number o bad mortgages is not the whole story.

[Rockholm]

13. The number of actual mortgages that were sunprime...

is quite small. I was thinking the same thing today. Not everyone bought a home in the last 3 years. However, many of us have taken equity out to renovate, etc.

[PSPS]

15. A million liar loans with 500K bubble per loan = $500 billion

I'm using rough numbers, but it's as simple as that. Throw in HELOCs where people used their houses as ATM machines, and you get even more.

[napi21]

17. That's true, but not everyone who took out an equity loan is

defaulting either.

I'm well aware the total mtg. mkt. is HUGH! I'm also sure it's been impacted by unemployment. I just don't buy the story being promoted by the financial mkt. It doesn't make sense to me, and I learned a LONG TIME AGO that when something doesn't make sense, it's usually a lie.

[Lex]

16. The inflated prices of housing

had something to do with it all crashing too.

[SoCalDem]

19. a house

1976..sells for $38,000..somebody has a loan for 30K
1986..sells for 60K..new loan for 50K (previous owners pocket $22K)
1996..sells for 120K..new loan for 110K(previous owners pocket 60K)
2000..sells for 250K...new loan for 225K(previous owners pocket 130K)
2006..sells for 400K...new loan for 400K( previous owners pocket 150K)

that ONE house has generated loans of $815K over 30 years, and every time it's been sold, REAL money went to someone, and the "new" person assumed more & more debt every time it sold...But now no one can afford, can get a loan big enough to generate profit for the seller, or the seller cannot find a better one they can move into and AFFORD..or real estate just got too pricey for anyone, so the last person holding the hot potato gets burned..and they bank still paid out $400 K for a property that no one wants/can afford..

Any child who has ever played musical chairs understands.. That's all wall street is, really...just musical chairs/hot potato for MBAs..played with money, instead.