Friday, February 27, 2009

How did we get into this mess?

1. Housing price steadily went up since 2001.
2. Buyers of all sorts sensed opportunity and started buying.
3. Lenders loosened lending standard because they saw low risk in the short term, due to rising price of housing; long term they had planed to sell the loan to Wall Street for repackaging and resell
4. Wall Street used financial models to create complex securities based on mortgages and then sold them to investors, especially from China and Oil countries
5. China and Oil countries accumulated savings and need to invest. Treasury was yielding low so they invested in these mortgage backed security thinking they have good collateral behind it.
6. Credit rating agencies didn’t understand the new instruments, such as CDO square, and went to Wall Street for help. They use the same financial models to assess the risk of these new financial instruments, and gave AAA rating to a lot of the product that turned out to be CCC.
7. China and Oil exporting countries see the AAA rating and bought those securities in bulk. This creates a credit boom as liquidity is everywhere.
8. But when housing market reversed its upward trend and started to go down, everything turned.
9. Buyers stop buying, foreclosures are rising, lenders stop lending, Wall Street can’t sell the securities they repackaged, foreigners stop buying those security, and rating agencies quickly down graded previous AAA to CCC, consumers are reeling, corporations cut back and layoff, and quickly we are in a financial crisis plus recession.
10. Deleveraging process needs to run its course. We will see down turn extend beyond 2010. When everything is purged, the economy will grow again.