Where does the money go?

I’ve read lots and lots on the credit crisis, and I think I have a good idea of what’s caused it, and what’s happening… but, there is a major component that I don’t understand, and I was hoping someone here could explain it.

Where did the money come from, and where is it going?

To clarify the question: if money supply is at a set amount, all other factors being equal, prices should never change. But, other factors are not equal, nor is money supply => prices rice.

My economically-uneducated-guess is:

Companies booked profits that were based on assumptions, and were based over a number of years. Those profits were ‘realised’ (realised on the accounts I mean) for example in the year 2004, but were never actually made in 2004, and were basically planned on being made over for example the next decade. Then, when the assumptions that were made on those profits were shown to be false (this year), the ‘profits’ disappeared, and the companies have to make all these writedowns. Is that even close!?

The other guess I have, is that banks can loan out a multiple of the money they have on deposit, so they are ‘creating’ the money. If this is the case, why are the write-downs coming in so hard and fast?

Have a look at this video:

It’s actually quite funny and scarily very close to the truth

Money is simply an efficient form of barter.It can be created
by the state or privately.

The state can cheat its citizens by reducing the amount of
gold or silver in the coins. This is called inflation.

The government can be even more dishonest by printing
paper money with no gold or silver in support.

…A student of the Austrian School .

to make a really simple analogy (and not entirely accurate but something digestible) it would be this:

when a person borrows money the bank can take that debt and then create money out of it, so money is basically ‘born’ into the system (this is keeping things really really basic).

if you borrow 200k for a house and then the house is only valued at 180 then the 20k is sunk into the land which is not worth the loan based on it, and then if that loan goes bad the loan - and the money born of it - unravels as a loss.

in the whole crisis the people who did the best out of it were land owners, everybody after that basically helped to create money that went to them and then they lost out as the market turned. derivatives and putting loans into complex investment structures exacerbated the situation even further.

most of the losses are based on lower valued assets which the money is tied up in, the liquidity issues this raises are a separate issue and that has to do with banks ensuring they have money at hand when they hold an investment, if you are not bored to tears yet then i’ll send you pm about margin calls.

I’ve seen the documentary about where money comes from, and I’ve a weak understanding of geared share purchases, so I know a relatively small amount of change in a geared share can cause large losses. In such a situation, is there no winner? In regular share trading, I buy a share, it goes up in value, and I sell, I have taken my money back, and my profit, from another shareholder, and if it goes down, I have effectively paid some other shareholder’s profit.

BUT, why are all the banks making such huge losses, all at the same time? What’s on the other side of the equals sign?

When the banks leverage the deposits, by e.g. 30-1, do 3.33% of the loans not have to completely default (yes, there are costs too, but let’s keep it simple for now), before all the capital is depleted. Would it not take a much larger percentage for billions in losses to occur?

In a default situation, where the house has decreased in value, the bank gets the house, which is worth less than they paid out, but the person who sold the house has the loan money. (Leaving aside SIV’s, and selling on mortgages)…initially the bank loaned X, that amount X goes the the person selling the house. The bank then reposses the house, which is worth (0.5)X, the bank has lost (0.5)X + future interest, but the money in the system is still (1.5)X? The bank takes a loss, but there is more money in the system than before the whole thing started, does that not keep the system spinning?

If all mortgages LTV also became over 100%, that would also have to be addressed, but since a large proportion of mortgages have been taken out prior to the booms, there should be lots of mortgages that have a very healthy LTV, and only the more recent mortgages will be going LTV over 100%?

The answer to my question may be that there is no balance, there is nothing on the other side of the equals sign, but I don’t know, and I would like to!

p.s. that youtube video is a classic, I love it!

P.P.S. I hope there is something useful in this post, I’m pretty confused thinking about this. Maybe by tomorrow it will have settled in my head!!

Derivatives. An estimated $55 trillion in complex financial instruments - CDO, CMO, CDS, SIV etc etc etc - that all the banks have been buying off one another, slicing and dicing and repackaging and selling on at a profit, for the last 20 years.

It is now gradually emerging that most of these instruments, which at the height of the boom were thought to be “worth” $55 trillion, are now in fact “worth” the square root of f*** all. So the banks have to write them off as worthless, and with many banks it quickly becomes clear that without the “worth” of these “assets” on the balance sheet they are, in fact, insolvent.

And that’s why I’m firmly in the deflation camp. The $2 trillion or so in fresh liquidity that the central banks have pumped in over the last 18 months is trivial compared to the massive destruction of liquidity happening just out of most people’s sight in the derivatives markets. The media have done an abysmal job of trying to explain to ordinary people the scale of the chicanery that has been going on.

Dead on there Sidewinder…

In addition it should be added the transmission vehicles for these derivatives was the shadow banking system of investment banks such as lehmans etc.

They were able to loan out any amount without any deposits in their banks as they were not regulated.The credit default swaps market ( the $55 trillion which I think you refer to) grew out of insuring these loans.

One theory advanced ,particularly by the ratings agencies was that spreading the risk by selling these dodgy loans on through as many different countries ,hedge funds ,investors etc lowered the risk to any one investor.
The same product could have been insured several times over through credit default swaps without each link in the chain knowing .
This has had the counter effect of increasing the scale of losses instead of containing them.

Another way to look at this is if you cut your fiinger you dont bleed to death or if an engine in an aircraft fails the plane does nt crash to the ground.
This is because in natural and man made systems redundancies are factored into the system so that a crisis in one part is contained and doesnt spread.

In the credit crisis sovereign , trade and investment barriers that previously contained risk were systematically obliterated (e.g. the repeal of the Glass/Steagal act by the clinton regime in 1999,NAFTA ,NICE treaty etc).
Instead of spreading the risk around credit derivatives ,CDO’s etc in fact actually transmitted the risk around the world and at each point on the way increased that risk almost in an exponential way.

So ,although no real money was ever created massive investments were made in real estate backed up credit issued by a shadow and parralel system of banking .

That shadow system is gone…now the real economy and taxpayers are being forced to bail out this shadow and parralel system .

Deflation is the way forward for the immediate future.

What people need to know is this has been the greatest scam and organised theft in the history of the world.