Safe as houses by André Evju
Starting by quoting Warren Buffet: “Derivatives are the financial answer to weapons of mass destruction”. So how exactly was this fragile system build up? Since the beginning of the 1980s, the US experienced a continuously deregulation of it’s financial markets, allowing financial institutions develop complex financial instruments to gain enormous profits. In the late 1990s, there was a consolidation of financial institutions in the US, contrary to previous legislation, building up dangerous structures with powerful players. As a result, this embedded the idea of being too important that in case of a crash, the government could not afford to allow their collapse and where required to bail them out. In 2000, the Bush administration banned the regulation of derivatives, and this was the beginning of an era of “financial innovation”. Traditionally, when bankers lend money to house buyers they will be expecting them to pay back the mortgages and consequently they would be careful to give out loans. Financial engineers then came up with the idea of putting together complex derivatives - called collateralized debt obligations (CDO), partially based on mortgages, but also other various loans - this logic drastically changed. In this new system, lenders sold their mortgages to investments banks and did not care to whom they gave the loan, because they sold them immediately after signing the contract. The investment banks combined thousands of these mortgages and put together CDO’s tagged with triple A ratings, which they paid rating agencies such as Moody’s or Fitch to provide, and sold them to investors. This practice resulted in doubling in house prices from 1996 to 2006. The money the banks earned were not real money but were made in a system rooted on gambling and greed. The money profits were usually booked 2-3 years in the future to smooth their books. The most risky loans – subprime loans – where house buyers were almost 100% financed...
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