MORE FINANCE NERDSMANSHIP WITHOUT SPELL CHECK THANK YOU IPHONE

WTF HAPPENED BRO TO THE WORLD

Okay, in order to understand wtf happened, you need to first take off your pants, and second listen to this:

Now you're ready to understand. 

The huge increase in home prices led to a situation where people were getting into mortgages they could never practically afford because "it doesn't matter broseph, houses always go up, I'll fip that shit naga no worries."

Not only did recent legislation enable banks to increase their leverage ratios (and thus lend out more money relative to the capital they had on hand), but the huge number of players in the mortgage space led to fierce competition between all the banks competing for customers and thus offering increasingly lower mortgage rates to attract customers.

Shockingly, lending money to people who don't seem like they can ever pay it back was a failed strategy and banks started to see ridiculous rates of deliquenicies. (MOTHERFUCKERS NOT PAYING)

These mortgages or "mortgage paper" are restructured because of the idea that through diversification you lower risk. I'll explain with a scenario:

House Speculator (Faggot): So how about that loan? This third house in vegas is going to be $ when I flip it. I'm gonna take that money and buy myself the fattest mexican hooker I can find and shit all over her. FUCK YEAH.

Mortgage Broker: Well, you don't have any $, bro.

Faggot: So?

MB: Fair enough. Not my problem anyways.

Faggot: Gimme a sweet low rate.

MB: Sure. (Cackles because the rate will go up and the dumb fag won't notice)

Faggot: PEANUT BUTTER JELLY TIME PEANUT BUTTER JELLY TIME

Faggot leaves. MB schemes.

MB: All these shitty bastards are never going to pay me. I need to transfer this risk to some retard. (Gets on phone) YO BEAR STEARNS HOLLLLLLAAA.

Bad Stearns: WASSAAA

MB: Dude, that was played out a decade ago.

BS: I fucked your first girlfriend in the ass before you even said "hi."

MB: She was ten.

BS: I know.

MB: Um, do you have any customers who want to buy my mortgages?

BS: Yeah, our customers buy all kinds of shitty shit. But nobody will buy individual bad loans. You gotta group them to aggregate the risk, nub. See, it's like, what are the odds that a bunch of them don't pay?

MB: Um, by "diversifying" you aren't doing shit. You're just clumping lots of shitty baddies who won't pay off their houses.

BS: STFU NERD. THIS IS AAA PAPER NOW.

MB: Whatever, you buy these shits?

BS: Word. (Now Bear Stearns owns a ton of these bad loans, the broker got paid, the BS trader got paid buying them off the broker, the BS salesmen got paid selling them to a customer, everybody won, omgs!!)

But Bear didn't actually sell the mortgages, they sold securities backed by these aggregate mortgages. (CDOs) The money that would come in from the home owners would feed the CDOs which in turn fed the securities (ARS) the banks sold to cusomters. 

This went to shit once people stopped paying their mortgages, the CDOs weren't taking in $, and thus couldn't pay their customers on their "safe, AAA+ collaterized" term securities. 

Customers bitched because they weren't making $ on the stuff the banks sold them, and they couldn't get out of their positions, because people were increasingly hesitant to buy anything backed by mortgages. 

While this was going, the simultaneous and perhaps greater fuckshow started to happen in the CDS marketplace. Credit Default Swaps are contracts that are basically insurance. They are quoted in terms of how much premium you will give up to remove the risk on a cash flow you are due. If you buy a CDS on your 10yr GM bond, if GM explodes before you get paid, you're okay because you're insured, and whoever sold you the CDS has to pay you the difference you are due. They are slightly complicated, but basically they're just insurance on loans. 

Now the whole world was basically a synthetic short of these CDO CDS contracts -- everyone was praying that these CDOs wouldn't fail, and everyone would love to buy protection on their mortgages. And they tried. But the shit was expensive. Too expensive in fact. So expensive that instead of buying that shit, you should just sell the shit out of it. SELL SELL SELL MWAHAHAHAHA OMG IT KEEPS GOING UP OMG IM FUCKED AHHHH IT BURNS.

So lots of retards sold the fuck out of basically mortgage insurance, but since these CDS are not traded on public exchanges, it wasn't exactly obvious who was the most fucked. Since accounting rules are a total fucking joke, you just couldn't tell. 

Now the way the world works in a very simple fashion is that the fed loans money to big banks who lend it out to smaller institutions who in turn lend it out to businesses and home owners and your grandma whatever. But the banks now all suspected that their peers were totally fucked because they had all this garbage mortgage shit on and didn't want to lend each other money... at all.

(THIS IS COMPLICATED AND REQUIRES A WHOLE SEPERATE EXPLANATION ON WHY BUT FUCK YOU MOVING ON)

So banks won't lend each other money, and the US fed, despite slashing rates and doing what it can to provide liquidity and dollar funding for the big players is unable to get that $ out to the smaller institutions. (The ones who really need it)

This is basically the credit crisis. The "credit spread" is the difference between where banks can borrow from the federal reserve and where they are willing to lend it. Typically in finance, we look at the difference between OIS swaps and LIBOR to estimate spread, but you can look at Fed Funds vs Libor or Basis swaps or whatever you like. It's a number. It used to be 8. Always 8. Sweet sweet 8. It's now just under 200. That's bad. And truthfully, that's a severe underreprsentation, it's probably closer to 400.  (This is also kinda complicated...)

How do you fix the problem and get banks to provide liquidity?

There's not a magic fix to this problem. You can slash rates all you want but if I think you are likely to blow up any day now, I'm not lending you money. An extra 1% (100 points) just doesn't matter. (If you're a finance nerd, think about the term structure of credit and what this means for short term lending)

Okay, I can only nerd on for so long on a friday. I'm off to a stupid charity event for breast cancer or something. I don't even have breasts.