A friend gave me this link (same friend with the Ubuntu problem, actually… as he gave me the link he was cursing a problem with his browser not automatically opening when he clicked the link, etc), and after listening to the podcast contained therein I decided to link it here as well.
It’s an hour long podcast about how, exactly, the credit crisis went down, but in layman’s terms. It’s actually rather interesting, sort of like an episode of Connections but about the economy and without James Burke narrating it. It’s also 59 minutes long, just FYI. But here’s a quick rundown.
China and India and other developing nations, in the late 90s and early 2000s, suddenly start bringing in a lot of money. And because of their sudden incredible wealth growth, the worldwide pool of investment money finds itself doubling in just a few years. Whereas these investors normally liked safe stuff like government bonds, Alan Greenspan at the time kept the interest rates down to like 1%. So these investors started going for mortgages.
The system shook out into a long supply chain. Small mortgage firms would set up mortgages, then sell the mortgages up to an intermediate bank, then up to a large bank. The buying at the top end got so fast and furious that the middle and small banks just started making up crazy loan styles to get anyone and everyone into a house. The big banks would usually balk at the terms, but sooner or later one would buy it, and then the others would, too, so they wouldn’t get left behind. And they thought it was all ok because their modeling software said there was, on average, only like 3.5% chance of a default.
But that was based on historical data, which didn’t represent the new crazy loan schemes. One day someone starts noticing that they’re not making the projected returns, and runs the data again… the chance of default, in some cases, are as high as 50%. They start noticing people defaulting on their loan in the first month. So the big banks freak out and stop buying them, the middle and small banks are stuck holding the bag. The small banks go under in droves. The big banks won’t loan anyone anything anymore. Hence the credit crunch.
Anyway. That’s something of an oversimplification of course, but by and large the podcast itself sticks to easily understood concepts, so it’s worth a listen if you can spare the time.