US: Subprime. The giant pool of money

Apologies if this has been posted before, but if it has I can’t find it…

This is quite long but well worth a listen, from America’s National Public Radio, on the sub-prime crisis (May 2008). The individuals involved are almost painfully honest about their roles. … pisode=355

This American Life producer Alex Blumberg teams up with NPR’s Adam Davidson for the entire hour to tell the story—the surprisingly entertaining story—of how the U.S. got itself into a housing crisis. They talk to people who were actually working in the housing, banking, finance and mortgage industries, about what they thought during the boom times, and why the bust happened. And they explain that a lot of it has to do with the giant global pool of money. (31 minutes)

This is a great show, they cover all sorts of interesting topics.

as a non financial head i really got a lot from it. hearing it directly from the players involved made it easy to imagine the insanity of it, all that cash for signatures. my only question was where did this giant pool of money that they talked about at the beginning originate? didn’t they say it doubled in something like four years, correct me if i am wrong.

In short the Americans run a trade and budget deficit and have done so for many years, to make up the difference they go to the American treasury and borrow the money, this debt will normally earn interest and foreign countries can recycle their dollars through this and earn interest.

The problem is Alan Greenspan dropped interest rates to 1% in 2001 and held them on the ground for a long time, at the same time you also have the Japanese who keep interest rates at almost 0%.

What hedge funds discovered was you could borrow Japanese Yen for very low rates, buy dollars and lend to American banks for a higher interest rate (the Japanese carry trade), this worked well as long as a:) Japanese interest rates remained low and b:) the value of the Yen kept falling against the dollar. They would borrow the money from the Japanese for say 3 month terms and roll it over at the end of the term, the problem was this money was being lent out for twenty year+ terms in the sub-prime sector, so they were borrowing for a short period and lending over a longer period.

Since Greenspan held American interest rates to the floor the only sector to earn a decent interest rate return was in subprime mortgages, and because it was so easy to borrow from the Yen and America’s deficit was so large, the dollars saturated the subprime sector.

In 2007 the Japanese Yen started to rise against the dollar, forcing the hedge funds to unwind their leveraged positions, this led to a domino effect leading to the credit crunch.