Real estate prices soared and then they did what they always do. They collapsed, in this case, with a giant thud. All that "wealth" acquired through the housing bubble vanished. Just as the economy slowed, many of those hard working people who just wanted a home were greeted with the full cost of their mortgage. Loan defaults soared and then it happened.
Those premium stocks collapsed. Record bankruptcy and default rates will do that to real estate stocks. Premium subprime real estate stocks became plain old subprime real estate stocks, which is what they were to begin with. Subprime loans vanished. The housing market stalled, then crashed, and there was no new scheme to feed the greed of the geniuses who thought up this scam.
Home value and retirement funds are taking a massive beating. It's survival of the fittest for the vast majority.
But the planners and perpetrators of the scheme are doing just fine. The current rulers decided it's time to expand socialism for the rich. In full public view, they're bailing out the people who created and pushed this crazy scheme. How many in the management chain are getting fired? Not many, it seems.
Is this just another example, outrageous as it is, of the super wealthy taking care of each other or is there something even worse lurking in the wings?
What are they hiding?
Each financial entity bailed out so far had major holdings in the very risky financial product called derivatives. Merrill Lynch even bragged about getting the "Risk Magazine" award as "Derivatives House of the Year 2007.
Warren Buffet sees derivatives as a major threat: "The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear." He went on to describe derivatives as "weapons of mass financial destruction." These financial products were valued at $516 trillion dollars in 2007. The value of world economy was $65 trillion that same year.
Overly complex and insider oriented, derivatives are designed to "reduce risk." They are, in fact, the looming mega risk that apparently can't be discussed. If the derivatives market collapses, interlinked major financial institutions around the world are finished. The financial system will have failed.
Analyst and author Michael J. Panzer describes derivatives as clearly as possible:
"-- it is not hard to grasp the basic economics of a garden-variety derivative such as a futures contract. If the market price of wheat goes up between the time a deal is struck and the expiration of the agreement, the buyer wins and the seller loses. That is what is known as a zero-sum game. Nonetheless, whatever a farmer, to use the earlier example, might give up as a result of hedging his output is offset by the reduced uncertainty.
"But it is an altogether different story when it comes to analyzing options, or a portfolio of derivatives, especially those with lots of complicated bells and whistles. In most cases, valuation and risk assessment depend on mathematical formulas and computerized models, with many inputs derived from estimates and past data. That is all well and good if the tools are perfect and the history is complete."
Panzer goes on to point out that the history, data, and assumptions used to analyze value and risk are often sorely wanting. Hence, this pervasive financial product is a risk, in and of itself, due to questionable assumptions.
These products are sold by very aggressive financial services groups based on serene assumptions. For example, the products often don't factor in the impact a recession derivatives. Daniel R. Amerman made the point in simple terms. If sellers will target home buyers who can't pay loans, we can count on bigger sellers going full tilt to get major commissions on this widely held financial product.
So the financial geniuses have created a market that has no relationship to reality, other than the reality conferred arbitrarily by banks and brokerage houses. Michael J. Panzer explains how something this detached from oversight takes hold:
"In the modern global financial system, where many participants are either unregulated or are monitored by a patchwork of country or sector-specific regulatory overseers, chances are that a derivatives-related catastrophe will see a similar lack of coordination that will produce a far more devastating outcome than if it was a purely domestic affair."
