Charles Ferguson INSIDE JOB
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Flow of capital:
- High risk consumer wants mortgage because the housing prices will forever go up.
- Banks do not have money to lend as due to capital reserve requirement so they sell the loan to an investment banks
- Investment banks package this up as a financial instruments which can be leveraged and measured on it performance
- Investment banks sell these to investors including other banks, consumers, governments, everyone else who wants high return thinking that housing will forever go up.
- Other banks, consumers, investors, and governments want even higher risk to invest to get higher return thinking that housing will never go down.
- Investment banks, due to the demand, creates another product which is a derivative of the original product which has a leverage of 10x or 100x and sell it to the people who demand it.
- Investment banks buy insurance on these investments just in case they fail to protect themselves and their investors.
- Insurance companies (i.e. AIG) sell these contracts to banks but also makes a derivative product with the same contract on how well it will perform.
- Companies like IBM, GE, banks etc sell their bonds and CDO to maintain cash flow and make money which is also leveraged which get sold to consumers, banks and investors.
- Through these profit and credit, they are able to hire people.The economy grind to a halt because all of these things are based on loans, credit and ability to lend money based on trust between institutions. Through out the capital movement and when loans are made, they are obligated to provide a collateral. What everyone provided as their collateral were these derivative products. Everyone had them including government, investors, consumers (form of contracts or mortgage holdings), when these became worthless, they were worthless and could not be used as a collateral.
When you buy a $500,000 house and mortgage $500,000, your financial worth is $-400,000 (based on average 30yr fixed rate mortgage) but everyone thought that they had $500,000 or more. Consumers leverage this to buy more stuff, rack up credit cards etc. Banks sell these debt to investors because they yield high returns.
No bank will make a product that will not sell. They see demand for high yielding investments and they sell it.