It’s a really good explanation of how the current mortgage crisis came into existence, but I’ll just quote the last few bits:
So what happens next? Well, the bonds are worth shit. But they’re insured! The insurance companies will take the hit, and cover the loss, right? Well, that’s where we get to the specific bit of bad math that inspired this here rant. The insurance companies based their calculations on the same ideas of “safety by distribution” that the banks used when they bundled things together! So the people who are guaranteeing the safety of the loans are relying on exactly the same assumption of safety that they’re supposedly insuring. If the insurance is ever needed, it’s because the assumption of safety was wrong. But because the insurance company used that same assumption, they’re not going to be able to pay it back. (This is big bad math point number two.) So that didn’t work out. So the insurance companies are crashing and burning. And when the insurance on your bond that allows you to rate it low-risk disappears, because the insurance company failed, then you’re in deep trouble. Your bond is no longer considered low-risk. And that means that a shitload of investors are going to get out and sell your bonds. But no one wants to buy them – because they know that they’re a pile of shit, and no one is really sure what they’re worth, because no one knows how many mortgages under the umbrella of that piece of shit are going to fail. So the prices of the “safe” bonds totally collapse. And all of the other investments that relied on those bonds – those start to fall apart too.
So – the banks know that they need to stop the insurance companies from collapsing. How can they do that? Here’s a truly brilliant idea, which was floating yesterday by a bunch of big banks like Merrill Lynch and Bear Stearns: loan money to the insurance company.
So – the insurance company is guaranteeing the value of the banks mortgage loans, using money that it borrowed from the bank, which the bank had to borrow because it’s got these bundles of leans insured by the insurance company. In other words, the banks are insuring their loans themselves, using the loans to pay for the losses on the loans. It’s circularity on circularity on circularity – cycles within cycles of stupidity, relying on stupidity to prop it up.
And there are people – lots and lots of them – who are falling for this as a scheme to save the banks from the bad loans.