Wow!
I have loved the explanations given on the "This American Life" radio show, but this graphic explanation is better for a quick take on it. I wish I had it with me last Thursday when I was trying to explain it to an 86 year-old lady I know. My pad and pen were only a tenth as effective.

Over simplified to a huge degree. It does not even reference the fact that once the lenders ran out of borrowers, the Wall St crowd sliced the risky portion of the box into 3 sections, and labled the top one Triple A....and then sold it as if it was worth the same as the original true triple A.

It also makes it seem that everyone walked away from their homes simply because the value plummeted. It does not address the millions who lost their jobs and subesequently their homes because they could not longer afford the mortgage....or those who were duped into predatory mortgages who could not afford the payments once they tripled.

It also does not reference the fact that the Credit Default Swaps were sold more often than not without any money held in reserve to pay out in the event that pay out was required. They (CDS's) are simply unregulated insurance and should never have been allowed to begin with absent regulation...and when the pay outs were required, the money was not there to pay out. This is akin to expecting to collect on life/homeowners/car insurance when neccessary, only to be told by your insurer that they have no money to with which to make the payment.

This is the problem with AIG...and the reason why they keep getting bailouts...to pay back the investors who bought the CDS as "insurance" against loss. And, there are so many players involved, the gov't is being held hostage to make these bailouts..as they have no way of knowing how many other banks and/or investment companies will be brought down by AIG's inability to pay.

There are many more issues that contributed to this crisis than this video addresses...some of which we probably still have not been told...and probably never will....such as how does any company sell "insurance" against a loss, on an investment that they KNOW is high risk, do so without keeping any money in reserve in order that they be able to make payouts if and when required...and...drum roll please...not be charged with fraud?

How does any company sell "insurance" against a loss, on an investment that they know is high risk, do so without keeping any money in reserve in order that they be able to make payouts if and when required...

Problem #1 - during the period when most of this "insurance" was written, home prices were rising, the economy was strong. The odds of the investment being high risk were very much lower than they turned out to be. So, bottom line is that they made some very bad and legal business decisions.
Problem #2 - No reserves - that's simple - there was nothing in place either legally/regulation - wise to require reserves.

You can't be charged with fraud if the activity you are performing is legal. Plain and simple.

Here is why AIG keeps getting bailouts...

Here is a link that might be useful: AIG and bailouts

Logic, you are right, but try explaining all that to an 86 year-old lady who lived in the same house all her life! The little video is a good starting point.

Patser, I remember reading that AIG's worst-case scenario is whole-life policy holders demanding a payout. If I knew it, then anyone can know it. When will we quit being brave and start trying to get our money out of the market and the insurance policies? Once the run starts, I can't imagine it stopping.

It is all a house of cards, and if those of us who know it start taking our money out, the whole economic system will fail. I keep telling my unemployed DH, "we are still okay, we can eat and we still have our house." (Funny thing is, he thinks I am kidding!) I fear that will not always be true. Exactly what happens when an economy collapses? You hold what you have and fend for yourself against the other people who want it? Sudden fear-inspired cooperation breaks out among all and a new system peacefully evolves? I grew up reading end-of-the-world novels in which we meet our end by nuclear war or poisoning the earth or by plague. Nobody ever covered "economic meltdown" in the post-apocalyptic fiction I read. I keep trying to imagine it...

patser: "You can't be charged with fraud if the activity you are performing is legal. Plain and simple."

True. However, just because CDS's are de-regulated (thanks to Commodity Futures Modernization Act of 2000), and, just because by nature they are a risk instrument, that still does not negate the fact that AIG sold them but did not maintain reserves for pay out...especially considering that
they had to know that the underlying investment (sub primes) were virtually worthless...

After all, insurance companies BREATH risk analysis morning, noon and night.

All investments are a risk, however, some much more so than others, as is the case with CDS. But, there is risk, and fraud..and AIG surely crossed that line...

Do you think that if you or I did the same, we would not be arrested?

"Fed's Kohn Concedes Risk in AIG Rescue Article

By SUDEEP REDDY and MICHAEL R. CRITTENDEN

A top Federal Reserve official, under fire for the government's rescue of American International Group Inc., acknowledged Thursday that the aid contributed to "moral hazard" risks by allowing some of the big insurer's trading partners to fully recoup billions of dollars tied to the firm.

At a Senate Banking Committee hearing Thursday, Fed Vice Chairman Donald Kohn conceded that the government's action helped the firms avoid losses and as a result "will reduce their incentive to be careful in the future."

Fed Vice Chairman Donald Kohn at a Senate hearing Thursday on AIG.
The government's help for AIG's trading partners illustrated the politically volatile decisions officials have made in the name of financial stability, pouring tens of billions of dollars into troubled firms to prevent a broader financial meltdown. Late last year, the central bank unwound some AIG contracts that were weighing down the insurance giant by paying off the trading partners at the full value they expected to realize in the long term, even though short-term values had tumbled.

Facing lawmaker objections, Mr. Kohn defended the Fed's action as necessary to avoid broader threats to confidence. "We're not so much worried about those particular counterparties," he said. "I'm worried about the knock-on effects in the financial markets. Would other people be willing to do business with other U.S. financial institutions...if they thought, in a crisis like this, they might have to take some losses?"

Mr. Kohn acknowledged "there is a huge moral hazard," referring to the possibility of encouraging risky behavior by bailing out companies and individuals.

In response to lawmakers' pressure on the Fed to release names of the financial institutions benefiting from the AIG rescue, Mr. Kohn said, "My judgment would be that giving the names would undermine the stability of the company" and risk hurting other firms.

AIG Faces $10 Billion in Losses on Bad BetsNew AIG Rescue Is Bank BlessingThe Wall Street Journal in December, citing a confidential document and people familiar with the matter, revealed that about $19 billion of the payouts went to two dozen counterparties between the government bailout in mid-September and early November. As previously reported, nearly three-quarters went to a group of banks, including Socié Générale SA ($4.8 billion), Goldman Sachs Group ($2.9 billion), Deutsche Bank AG ($2.9 billion), Credit Agricole SA's Calyon investment-banking unit ($1.8 billion), and Merrill Lynch & Co. ($1.3 billion), the Journal reported at the time.

Democrats and Republicans, expressing rising frustration with the AIG rescue, blasted the central bank for some of its decisions related to the loans.

"It's not clear who we're rescuing -- whether it is whatever remains of AIG or its trading partners," said Senate Banking Chairman Christopher Dodd, a Connecticut Democrat. "It's reasonable to ask why holders who would have received only pennies on the dollar for their credit-default swaps absent any government intervention would expect or deserve payments for what essentially is a bankrupt company."

With its latest rescue this week, the government has committed more than $170 billion to prevent AIG's collapse.

Much of the hearing on the AIG rescue focused on the firm's risky financial-products unit and the bets on debt securities that helped hobble the company, along with a securities-lending operation that contributed to its liquidity problems.

The acting director of the Treasury Department's Office of Thrift Supervision, Scott Polakoff, accepted some of the blame by saying his agency failed to catch problems at AIG. "No one predicted, including OTS, the amount of funds that would be required to meet collateral calls and cash demands on the credit default-swap transactions," he said at the hearing.

Mr. Kohn's hesitancy to disclose trading partners' names didn't sit well with lawmakers, who are pressing for more transparency in federal rescue efforts.

"Public confidence in what we're doing is at stake; it's their money that is being poured into these institutions," Mr. Dodd said. Speaking after the hearing, he said he or some other lawmaker would likely seek to compel the Fed to disclose the information.

Here is a link that might be useful: Fed's Kohn Concedes Risk in AIG Rescue

Logic, I hear what you are saying...but were the subprimes worthless when home values were still rising and interest rates stayed relatively low? I don't know the answer.

Re that article - I can't find where I read it, but I did read in the last few months that AIG had over 3000 counterparties. If that number is even close to accurate, I would think the situation spreads alot farther than just helping US firms. Having worked in an offshoot of that business, I would also venture to guess that foreign relations/policy was heavily involved behind the scenes - I cannot imagine that some of the counterparites weren't significant foreign institutions.

I think it's going to be hard to prove fraud...it would be very easy, however, to prove ignorance.

"I think it's going to be hard to prove fraud...it would be very easy, however, to prove ignorance."

Never attribute to malice what can adequately be explained by stupidity.

brickeyee:"Never attribute to malice what can adequately be explained by stupidity.

patser: "it would be very easy, however, to prove ignorance.."

Ah, yes. The "ignorance" and "stupidity" of countless multi million dollar earning Harvard/Priceton,/Yale suma/magna grads...WITH MBA's from the best business schools here and abroad.

Please.

If the above was/is indeed the case, (and, notice I said "if", because I don't buy it for one second) with almost if not all of the entire upper ecehlon of the finance community being THAT ignorant and THAT stupid, anyone or any entity who would trust the stupid and the ignorant with their money is even more so.

No wonder the market continues to tank, as apparently the "investors" are smarter than the supposed finance "geniuses".....or, more like they are no loger willing to be fleeced by their greed.

Martin Weiss has been writing about the coming credit crisis for years. He pretty much nailed it last April when he warned readers about what has turned out to be one of the largest ponzi schemes in the world. Its a shame that no one else was willing to say 'the emperor isn't wearing any clothes'.

Distortions, Deceptions and Outright Lies
by Martin D. Weiss, Ph.D.
April 7, 2008

Beware.

The greatest threat to your financial future is not the danger you see or the beast you know. It stems from all those realities that you don't see or don't know.

This great uncertainty is not your fault. Quite the contrary, I lay the blame squarely on ...

1. Washington's distortions of its most vital economic data ...

2. Wall Street's deceptive evaluations of most of your investments, and ...

3. The outright lies that officials of both Washington and Wall Street tell you on a daily basis to cover their tracks or protect their turf.

Take Friday's news, for example.

If you thought that the surge in the U.S. unemployment rate to 5.1% was a shock, consider John Williams' Shadow Government Statistics.

First, Williams points out that the total job loss the government reported on Friday wasn't just 80,000. It was 147,000. Reason: The previous two months of job losses had been greatly understated, forcing the government to revise them by a combined 67,000.

Second, he argues that these huge revisions are no accident. They are the consequence of the government's continuing misuse of seasonal adjustments.

"If the process were honest," he writes in his Flash Update issued to paid subscribers on Friday, "the differences would go in both directions. Instead, the differences almost always suggest that the seasonal factors are being used to overstate the current month's relative payroll level, as seen last month and the month before."

Third, his analysis shows that the job numbers have a built-in bias based on a model that makes assumptions about birth and death rates. Without those distortions, he calculates there would have been additional job losses of 135,000 in February and 142,000 in March.

Fourth and most important, as you probably know, the government excludes "discouraged workers" from its count of the unemployed; and the definition of "discouraged" is highly questionable" anyone who has not looked for a job in just the past four weeks!

His conclusion: The true unemployment rate in America is not 5.1%. It's 13%, or over two and a half times worse than officially reported.

The government's distortions of other critical data are no less egregious, says Williams.

Annual Consumer Inflation

Inflation: The government reports that the Consumer Price Index (CPI) is essentially the same as it was two decades ago: It was approximately 4% in 1987, and it's near 4% right now.

But without the cumulative affect of a series of questionable adjustments made in recent decades, Williams calculates that the CPI has actually risen to almost 12%, or about three times higher than the official figures.

Economic growth: The government reports that, except for a brief interlude in the early 2000s, the U.S. economy has escaped recession throughout this decade, growing by 2% to 4% each year.

But Williams shows how, without the government's distortions of the GDP data, the opposite would be true: Except for brief interludes of mediocre growth in 2000 and 2004, the economy has been stuck in a recession throughout the entire decade.

These are vital stats that could make or break your financial future. To the degree that the shadow government stats are closer to the truth than the official versions, it means that ...

* The value of your bonds is overstated because of a national complacency regarding consumer price inflation ...

* The value of your stocks is overstated because of false optimism regarding the nation's employment and economic growth. And perhaps most dangerous of all ...

* Trillions of dollars in derivatives �" predicated on the true value of assets like stocks and bonds �" could be even shakier than often feared.

This alone should be more than enough to send thousands of officials into the confessional and give millions of investors sleepless nights. But the unfortunate reality is that ...

On Top of Washington's Data Distortions,
Wall Street Adds an Equally Dangerous
Layer of Investor Deceptions

First, most of the derivatives owned by commercial banks, investment banks and so-called "non-bank banks" are kept off their balance sheets. This means that ...

The actual value and stability of the nation's largest and most important institutions are largely unknown" and probably greatly overstated.

Second, with only the rarest of exceptions, the hundreds of thousands of bond ratings issued by Fitch, Moody's, and Standard and Poor's are uniformly bought and paid for by the very same companies that are being rated. As I've written here many times, the result is that ...

There is a built-in bias in the entire system, causing inflated ratings, delayed downgrades and the continuing deception of millions of investors.

Third, brokers and brokerage firms, despite a clear self-interest to keep their clients in the stock market, are routinely allowed to play the role of "objective" advisers and managers. The result is that ...

Investors are almost universally encouraged to buy when they should be holding and to hold when they should be selling. Despite a plethora of guidelines, rules and laws created to encourage fairness, the very structure of the system continually promotes unfairness.

Lies, Lies, Lies

In this environment, the unrelenting pressure even the mandate to transform well-meaning public officials into chronic liars is undeniable, and the examples are many:

* High-ranking government officials in the 1970s who swore the S&Ls were safe, even as thousands of thrifts were failing all around them.

* FDIC and Federal Reserve officials in the 1980s who vehemently denied the threat to commercial banks, even as the bank failure rate surged to the highest since the Great Depression.

* State insurance regulators in the 1990s who swore to the safety of annuities and life insurance policies, even as six million policyholders were being trapped in failed companies.

* Major Wall Street firms of the early 2000s that consistently affirmed "hold" and "buy" ratings for the shares of hundreds of companies that were going bankrupt. (For our detailed study documenting these extreme deceptions, see our white paper, Crisis of Confidence on Wall Street.)

* Auditing firms like Arthur Andersen, KPMG, and Deloitte and Touche that facilitated or even encouraged accounting distortions and cover-ups. (For the details, see our white paper submitted to the U.S. Senate.)

Today, the names and places may have changed. But the systemic deceptions have not.

This leaves you just two choices: Believe them and risk almost everything. Or strike out on an independent path to safety, protection and the potential for very substantial profits.

Good luck and God bless!

Martin

A link that might be useful:

www.moneyandmarkets.com/issues.aspx?
Distortions-Deceptions-and-Outright-Lies-1640

The SEC instiuted a cease and desist order against this guy in 2006 (see below),yet they could not figure out what Madoff was doing despite Markopolos drawing them a road map????
After reading the above, it is easy to see why they tried to discredit him, but looked the other way with Madoff as he was a major player in the game.

Excerpt: "....Weiss Research, in promotional materials prepared by Martin Weiss, Edelson, and others, sometimes used selective, outdated, and/or hypothetical examples of specific returns that subscribers might have realized on individual trades had they followed Weiss Research's recommendations, without advising that the overall return was or might not be profitable" and that "14. The overall performance of Weiss Research's premium services did not support these profit claims...."

logic-"The SEC instiuted a cease and desist order against this guy in 2006 (see below)"

Logic, could you post a link?

Figures the SEC overlooked Madoff yet tried to shut M.Weiss up.

http://en.wikipedia.org/wiki/Martin_D._Weiss

dreamgarden: "Figures the SEC overlooked Madoff yet tried to shut M.Weiss up."

As the expression goes, the fish stinks from the head down....

The link is below. Scroll down to "2006 SEC Action and Settlement"

Also, this is a link to the record of the proceedings:

http://www.sec.gov/litigation/admin/2006/ia-2525.pdf

Here is a link that might be useful: Martin D.Weiss

"Ah, yes. The "ignorance" and "stupidity" of countless multi million dollar earning Harvard/Priceton,/Yale suma/magna grads...WITH MBA's from the best business schools here and abroad."

Once the underwriting rules are fraudulent the results become a crap shoot.

Issue mortgages to unqualified borrowers, then package them into bonds.
The bonds become worthless if the underlying mortgages have a higher than anticipated default rate.

Now we get to play musical chairs and see who is left holding the bonds.

brickeyee: "Issue mortgages to unqualified borrowers, then package them into bonds.
The bonds become worthless if the underlying mortgages have a higher than anticipated default rate."

And...fraudulent when each one is packaged and re-packaged 30 times over....and unregulated CDS are bought and sold based simply upon bets ...which means that there was no asset at all..pretend or otherwise...backing them.

8% of all mortgages defaulted could not equate to trillions upon trillions of toxic assets otherwise.

"8% of all mortgages defaulted could not equate to trillions upon trillions of toxic assets otherwise."

When you cannot determine what mortgage instruments are bad under a bond or other instrument, the entire 'package' becomes "toxic."

No one wants to delve into the mortgage paperwork and perform the due diligence to determine exactly what mortgages are bad.
It would require actual eyeballs, appraisals, etc. and likely find a lot of outright fraud at the originators.

Fannie survived very well from its creation until forced to help the 'under served markets.'

Those are borrowers with little credit & bad credit.

brickeyee, you oversimplify to a huge degree...read on at the link below.

To thicken the plot (if it could be made any thicker) ex-Treasury Secy and ex-Goldman CEO Paulson was the key figure in lobbying to allow the leverage ratio to be raised from 12 to 1 to 40 to 1...

Yes..the very same Paulson who convinced George W to allow him total control over where, how, when and why the TARP money went...and enriched his cronies with no strings attached...

Here is a link that might be useful: Sold Out: How Wall Street and Washington Betrayed America

Excerpt from "Sold Out":

....Last fall, the house of cards finally collapsed. For those who might have heard the "blame the victim" propaganda emanating from the free marketers whose philosophy lies in a smoldering ruin alongside the economy, the report sets the record straight: consumers are not to blame for this debacle.

Not those of us who used credit in an attempt to have a decent quality of life (as opposed to the tiny fraction of people in our country who truly got ahead over the last decade). Nor can we blame the Americans who were offered amazing terms for mortgages but forgot to bring a Ph.D. and a
lawyer to their "closing," and later found out that they had been misled and could not
afford the loan at the real interest rate buried in the fine print.

Rather, Americas economic system is at or beyond the verge of depression today
because gambling became the financial sectors principal preoccupation, and the pile
of chips grew so big that the Money Industry displaced real businesses that provided real
goods, services and jobs. By that time, the amount of financial derivatives in circulation
around the world $683 trillion by one estimate was more than ten times the
actual value of all the goods and services produced by the entire planet. When all the
speculators tried to cash out, starting in 2007, there really wasnt enough money to
cover all the bets.

If we Americans are to blame for anything, its for allowing Wall Street to do what it calls a "leveraged buy out" of our political system by spending a relatively small amount of capital in the Capitol in order to seize control of our economy......

Of course, the moment the Money Industry realized that the casino had closed, it turned as it always does to Washington, this time for the mother of all favors: a $700 billion bailout of the biggest financial
speculators in the country.

Thats correct: the people who lost hundreds of billions of dollars of investors money were given hundreds of billions of dollars more. The bailout was quickly extended to insurance companies, credit card companies, auto manufacturers and even car rental firms.

In addition to cash infusions, the government has blown open the federal bank vaults to offer the Money Industry a feast of discount loans, loan guarantees and other taxpayer subsidies. The total tally so far? At least $8
trillion.

Panicked by Wall Streets threat to pull the plug on credit, Congress rebuffed efforts to include safeguards on how taxpayer money would be spent and accounted for. Thats why many of the details of the bailout
remain a secret, hiding the fact that no one really knows why certain companies were given our money, or how it has been spent.

Bankers used it pay bonuses, to buy back their own bank stock, or to build their empires by purchasing other banks. But very little of the money has been used for the purpose it was ostensibly given: to make
loans.

One thing is certain: this last Washington giveaway the Greatest Wall Street Giveaway of all time has not fixed the economy.

Meanwhile, at this very moment of national threat, the banks, hedge funds and other parasite firms that crippled our economy are pouring money into Washington to preserve their privileges at the expense of
the rest of us.

The only thing that has changed is that many of these firms are using taxpayer money our money to do so..."