There is blame for one and all. When the government forced banks to lend to people who couldn't pay it back (via the community reinvestment act), they did the only thing they could--package them up and sell them to other more stupid investors. This went on for several years and the increase in demand for housing caused real estate prices to rise. That brought in the house-flippers who took advantage of the new 100% loans. They could buy a house, hold it for a few months, and sell it at a nice and tidy profit and they didn't have to invest a dime in the house. It depended upon house prices continuing to rise.

Then came the rise in the price of oil which made it hard for people who were put in houses they couldn't afford, to pay their mortgage. A few of them started failing to meet payments. Housing prices, which by this time had become ridiculously expensive, suddenly were out of reach of the next round of home buyers. Houses sat on the market for a wee bit longer and longer as time went on. Some started lowering prices to sell the house.

I would note, for those who doubt that oil played a role, that restaurants were emptier and emptier as the price of oil climbed. This was true even in Houston where the economy is ok. I think it was because those with lower discretionary cash flows were less and less able to eat out. Indeed, if you look at restaurant companies, they have been going bankrupt and loosing millions over the last 2-3 years. When people don't have discretionary money, they don't eat out.


That brought then a problem for the house-flippers, who may have owned several houses in this kind of deal. They had no money in the house so, if the loss was going to be too big, they could walk from the mortgage with no problem. Sure, they might not be able to buy a house for a long time, but their goal was not to take a financial bath. The banks started getting houses back.

Banks, with houses on their hands, dump them. That meant that more bank-flippers got hurt and more houses came into the banks. Prices fell. Then came the Sarbanes-Oxley 'mark to market' rule. After Enron, it became illegal to estimate what you thought you would get out of an investment if you planned on keeping it for 20 years. You had to value it like we do a barrel of oil in the oil business. We have to do our reserve audit based upon the current price of oil, not what it will be when we actually pump the oil out of the ground and sell it. For the oil industry that is probably ok. But for real estate, it is a bad idea. As the prices for real estate fell, the banks had to write off the values of their mortgages. That brought on a whole nuther (an Oklahoma word), set of problems.

When banks write off assets, they have less money to lend. And that makes it harder to get a mortgage, buy a car etc. But lets focus on the mortgage issue. If it is harder to get a mortgage when the real estate prices are going down, it creates a spiral. Prices drop to attract buyers, but banks have to write off assets because of the 'mark to market' rule and thus have less money to loan. That in turn means fewer buyers and the prices drop further, creating even more write downs on the parts of banks and less money to loan. That is where we are today.

Now, let's go back and look at what happened to those subprime mortgages. They were sold all over the world to investors who thought they were getting a safe investment--because they were mortgages for pete's sake. But as the value of these debt obligations sank, the banks asked themselves, who sold me these things? The answer: another bank. So, banks quit trusting one another. They also knew that if they loaned money to a bank who was writing down these assets, they might not get their money back. So, the perceived risk to loaning money to a fellow bank became greater. That is where an obscure index called LIBOR comes in. It is, London InterBank Origination Rate. Basically it is the interest rate one bank charges another. That interest rate has soared over the past couple of weeks once hitting 6%. That basically means no bank trusts another bank.

Since banks can't get loans, neither can you. Banks have to keep certain quantities of money to cover the deposits. As they write down assets, that number goes up. This means you can't get a loan for college or a car or a home unless you don't need one. That means cars, appliances, houses will not be built and that in turn means that many people will lose their jobs. Many companies will go broke because they can't get a loan to cover temporary cash flow needs (like to pay your salary).

The bail out was an attempt to take these bad notes off the banks so that they could stop the spiral. With the failure (and there is enough blame for stupidity in both parties) the near term economic future looks bad. Reality though is that even if that bill had passed it might not have solved the problem. That only solves the problem domestically when the problem is now a global problem that can't be solved by the US alone. Evidence for this can be found in the failure of Bradford and Bingley in the UK and Fortis in Belgium. Europe, who has been enjoying much Shadenfreud at the US's expence, is just now starting to experience the effect from their own participation in the subprime mess.

Investors knowing that companies won't make lots of money over the next couple of years, sold off in huge numbers today causing most world indices to drop by 5-10% Trillions were lost today, all because we tried to be nice to the poor and help them own houses they couldn't afford.

The danger now becomes greater. At the start of the year the Fed started with about 800 billion dollars on its balance sheet. After AIG, it has about 200 billion left. The FDIC has already used billions to bail out banks and have used up about half of their money, if memory serves me right. There really are only two ways out of this, that I can see. Do the bail out (which we didn't) or inflate our way out of it. Print money like crazy, pay off the debt with inflated dollars. Neither solution is a tasty or palatable one.

While I am right now being killed in oil, I am sticking with it. Israel might attack Iran--oil prices rise. If the price falls low enough to shut in production, the downturn will last only a short time.  We lose 5.67% of oil production each year due to natural decline.  Add to that  the fact that OPEC, whose countries require higher prices for their economy's to work, and oil price will soon begin to rise---assuming one thing.

That one thing is that the Gross Domestic Products (GDP's, the total of all goods and services of a country), of the world don't continue to collapse.  For every 10% drop in gasoline price, the consumption rises 0.5%. For every 10% drop in GDP consumption of oil drops 5%. So, should we have a 20% drop in GDP the downtime for the price of oil might last as long as 2 years.

The present downturn in energy prices is enough to ensure that alternative energy sources are killed for now. They are too expensive and oil is too cheap. That means, that there will not be competition from those alternative sources. (this isn't an editorial comment upon the need for them but upon reality--no one is going to pay the equivalent of $16,000 per kilojoule if one can get oil for $6000/kilojoule. Alternative energy is dead for now. The Nov 20, 2008 Nature Magazine has an article on p. 286 talking about how the global downturn will stop nuclear plant construction dead in its track--at least in the western world. In order to meet CO2 targets,we must bring online 25 new nuclear plants per year--five times more than are being built right now.  There is no capital for these projects in the current downturn.  Oil will get no competition from nuclear energy. Nor will it have any from wind or solar at these prices.  Many alternative energy companies are in dire straits right now. Their product is far too costly and the price of energy too low.  Watch for an energy price spike over the next year.

At least that is my take on the problem. I have no doubt others will have different views on the causes of the problems.  Oil caused the first domino to fall.