Yesterday was an absolutely historic day in the stock markets as two financial titans fell; Lehman Brothers went bankrupt, and Merill Lynch was sold to Bank of America. Panic ensued, and the Dow dropped 500 points. As a recap, this chain of events started with the subprime mortgage meltdown. Greedy banks were basically giving home loans to a lot of people who simply couldn't afford them. Interest rates moved up, and people couldn't keep up with their mortgage payments anymore, so people defaulted on their loans. You multiple this situation a couple million times, and you have this blackhole in the financial markets where a ton of money has disappeared. Now the government is trying to step in and bail out these banks which are failing, which ultimately means the taxpayers are picking up the tab. It's quite a dire situation since America's debt is already huge, and it's only going to get bigger.
There are two main things that really tick me off about this situation.
- It's insanity to give mortgages to people who can't even afford down payments on houses. The outcome is not unpredictable at all, and there were warning signs as early as last year that the financial markets would be in trouble. A lot of this was avoidable.
- People who are financially prudent are being punished for the mistakes of greedy banks, and people who were financially reckless.
This morning I just discovered that one of my stocks in the solar business dropped about 50% in value because they had a business connection to Lehman Brothers, and because Lehman is going bankrupt, the company is going to be losing money. This was quite an unfortunate revelation, and it shows how there's going to be a lot of indirect ways for people to get financially hurt because the large banks are failing.
This morning, Cramer had some dire warnings of other financial organizations that are on the brink of failing as well, such as AIG and Citigroup.
This evening, it looks like the
government is bailing out AIG by giving it an $85 billion loan.
You may be asking, why do banks fail? Well, generally this is how it works. You and I deposit our money into the bank, and we assume that money is going to be safe. The bank makes money by loaning that money out to people. Typically a bank might take all of their money, and loan out somewhere between 80-90% of the money it has. They try to loan out as much money as they can because money sitting in their vaults isn't going to generate as much money. This works well in theory, as long as the people you're careful in who you loan money to. There will always be the possibility of bad loans, where someone can't pay back, but you weigh your risks. The problem arises when you have way too many bad loans, and you've basically lost your money. Now when you and I go to the bank to withdraw cash, the bank says, uhhh..... we don't have your money, we lost it. Epic fail for the bank.
There's an excellent 45 frame comic called "
The Subprime Primer," that explains exactly how subprime mortgages got us into the mess. Very entertaining to read, and very informative. (Caution: some foul language).
