General Question

nikipedia's avatar

Where does all the money go?

Asked by nikipedia (28071points) March 2nd, 2009

All these banks keep “losing” x billion dollars. I understand that this is not real money that’s lost but projected earnings for this quarter. But where did this projected money go? Who has it now?

Clearly, I know nothing about economics and would appreciate any basic instruction…

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17 Answers

poofandmook's avatar

My first thought was the money they expected to come in from loan premiums, but now the loans have defaulted.

Not sure if that’s accurate, but that’s the first idea that came to mind.

LouisianaGirl's avatar

to people like the octo mom

aprilsimnel's avatar

@LouisianaGirl – If anyone is swiping the money, it’s not octomoms as it is executive bankers who buy $1200 wastepaper baskets.

LouisianaGirl's avatar

@aprilsimnel oh yea who would buy $1200 wastepaper baskets when you can run down to Wal*Mart and get one for like $5? Well other than them that is.

scamp's avatar

@aprilsimnel I read your link. Looks like the same guy got “an $87,000 area rug.” WoW!! I’d like to take my dog to his office and let her shit on it!!

Mamradpivo's avatar

There are several types of losses that we’re looking at. First is what AIG just had: they spent billions and billions of dollars more last quarter than they brought in. They had plenty of cash on hand, and they blew through it. It’s the opposite of a profit.

The other losses are more complicated. They involve writing down future revenues. If someone defaults on their loan, the bank loses all future loan payments and interest.

This is a verysimple explanation, but I hope it helps. It’s not as though this money is necessarily going anywhere, in a lot of cases, the market value of an asset is less now than it was, so the presumed value simply disappears.

aprilsimnel's avatar

@scamp – Bank of America gave dude the heave-f’n-ho. I hope they got the receipts on what he bought!

But, yes, @Mamradpivo‘s answer is the real answer.

poofandmook's avatar

So I was partially right then?

cwilbur's avatar

@nikipedia: This is going to be an oversimplification, but it should hit the main points.

Company A underwrites mortgages. So when interest rates were low, and there was a housing boom, Company A’s executives thought it would never end, and gave its employees large bonuses for getting people mortgages. They also suggested very strongly that they would look the other way and not bother to verify credit ratings and incomes, and that adjustable rate mortgages, which were tied to the prime interest rate, would be more attractive to customers than fixed-rate mortgages. Generally, ARMs have a really low rate for 3 to 5 years, and then the rate goes up with some relationship to the prime rate. Company A’s mortgage salesmen falsified some information on the applications, so that they could close deals, and got many people into adjustable rate mortgages.

So then investment banks got the idea that they could treat mortgages like many other sorts of investment—they can assign a value to it now based on how much income is supposed to come in over the next few years. And some companies, like some people, would rather have cash money now than investment income later.

So Investment Bank B goes to Mortgage Company A, and says, hey, I’ll give you $100K today for that mortgage you have there, which will only net you $120K in the long run. Mortgage Company says hey, liquidity! We can offer more mortgages if we have more cash! and takes the deal. Investment Bank B does this for dozens of mortgages.

Then these mortgage papers are sliced and diced—Investment Bank B aggregates a couple thousand mortgages, and sells Investment Bank C, Commercial Bank D, and Private Investor E partial interest in its mortgage paper.

But this is all too good to last. Three years in, some of the ARMs go up to the higher rate, and people who didn’t realize what they were getting into can’t make payments anymore. Or, with the economy pulling back a little bit, some of the people who got mortgages based on false information can’t afford to make payments anymore. So people started to look at the whole secondary market in mortgages, and they came to a terrible realization.

All of these mortgages have been sliced and diced and reapportioned. But they were valued based on the original assumptions—among them, that the people holding the mortgages would make the payments regularly. This relies on the ability of the person to pay—which, in the case of mortgages where the numbers were fraudulent and in ARMs that have gone up in interest rates, is no longer as certain as it was.

Meanwhile, the foreclosures start, and people are not willing to spend as much on houses anymore in the uncertain economy. So the values of houses drop, and because many of the mortgages required no money down, a lot of people are in situations where they owe more on the house than it is worth. And if they can’t make the payments, they are better off walking away and letting the bank foreclose on the property. This lowers property values further, and keeps the cycle going.

And now, the investment banks and commercial banks are in a terrifying space. They know that all those mortgages they bought are not worth what they thought they were. They paid $100K (for instance) for a mortgage they thought would be worth $120K over its lifetime, and that’s a good deal; but now they suddenly realize that they are going to be lucky to get $50K for some of those mortgages—but they don’t know how many, or which ones. So they know their assets are worth considerably less than they thought they were, but they don’t know if they’re worth 85% of what they thought or 15% of what they thought.

Now, bankers know that some of their loans are not going to work out. But when they’re already sitting on what may be a veritable mountain of bad debt, they only want to give loans to sure things.

So, the answer is, the money was never really there in the first place. It was based on people who had fraudulently acquired mortgages and on people who didn’t understand adjustable rate mortgages overestimating their ability to pay, and the investment banks overestimating the value of mortgages on the secondary market, and the customers of the investment banks not looking too carefully at what they were buying.

And a lot of the money that really was there is now being hoarded by the banks, because they want to have enough cash on hand to cover all the bad debts they have. So they’re not loaning it out, so businesses that rely on debt financed growth are hurting really badly, while businesses that rely on cash-savings financed growth are not doing badly at all.

aprilsimnel's avatar

@cwilbur – Your answer is also available in a handy cartoon stick figure men PowerPoint format!


galileogirl's avatar

The money went the same place peopl’s retirement investments went. My only (thank God) stock investment was purchased on August 25, 2001 for $5000. Six months later it lost 33% (where did it go?)when on April 1, 2002 it was worth $3300. Then almost 6 years later it had grown to $8000(where did that come from)on December 31, 2007. As of one year later it dropped by almost 50% to $4600.

It is an economic truism that anything is worth only what people are willing to pay for it. If your house was worth $300,000 a year ago and worth $150,000, you lost $150,000. But hold on, if you just sit there and pay the mortgage in order to have a place to sleep, over time you will find that money again. (sigh)

SquirrelEStuff's avatar

To undwrstand where the money went, one must undetstand where the money came from. The money never existed to begin with.
Out banking system is called fractional reserve banking. A commercial bank can loan out 9 times the amount of reserves it is holding. A bank creates ” new money” via loans. This is what I mean by new money being created out of thin air. If, or when, the loans are defAulted on, this created money is still debt.

Watch the first 15 minutes of zeitgeist:addendum on google video to get a complete lesson on fractional reserve banking. It will always keep us in debt and basically makes us economic wage slaves.

“Slavery requires your owners to house and feed you, economic slavery requires you to do so yourself.”

Bri_L's avatar

it’s with the missing socks.

wundayatta's avatar

Go to This American Life and listen to this. Then you’ll be an expert. I kid you not. Major bank managers listen to this broadcast (which is aimed at ordinary smart people) to understand it. It’s very accessible; even fun to listen to.

Bri_L's avatar

Here is an interesting article about it as well.

erinstlou's avatar

Well, I find this all very sad. In reading about all the billions the billionaires lost it would be comforting to know that someone now has it… do you think they know it never really existed?

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