The financial monster and the loan sausage factory

Germany's President Horst Koehler has denounced the world financial market as a "monster" using "highly complex financial instruments" to make "massive leveraged investments with minimal capital". Koehler, formerly head of the International Monetary Fund, seems perplexed about the causes of the present crisis, but I can explain them in a way any German can understand. Derivatives are like sausages. You take the low-quality parts of the pig that you don't want to look at while you are eating them, and grind them up into a package that seems more appetizing.

The German financial system wanted to consume low-quality American assets, but did not want to look on what it was eating. German banks have written down about US$25 billion in securities derived from low-quality ("subprime") American mortgages, and doubtless will lose a great deal more.

But it is silly to blame the sausage-grinder. Why didn't the Germans and all the other overseas investors buy mortgages in their own countries, instead of scraping the bottom of the credit barrel in the United States? It is because there aren't enough Germans, or Italians, or Frenchmen or Japanese starting families and buying homes. There weren't enough Americans, either, and therein lies a tale.

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The world kept shipping capital to the United States over the past 10 years, however, because it had nowhere else to go. The financial markets, in turn, found ways to persuade Americans to borrow more and more money. If there weren't enough young Americans to borrow money on a sound basis, the banks arranged for a smaller number of Americans to borrow more money on an unsound basis. That is why subprime, interest-only, no-money-down and other mortgages waxed great in bank portfolios.

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boomtown said:

Thats hilarious.

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The world kept shipping capital to the United States over the past 10 years, however, because it had nowhere else to go.

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The Federal Reserve has sought to devalue its way out of a financial crisis, giving foreign investors all the less reason to buy American risk-assets, although foreign central banks continue to buy American government bonds for lack of an alternative

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