The Crisis of Credit

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Duration: 7 minutes and 32 seconds

Country: United States

Language: English

License: CC - Attribution Non-commercial No Derivatives

Genre: Animated

Producer: Jonathan Jarvis

Director: Jonathan Jarvis

Views: 239 (22 embedded)

Posted by: arturogoga on Feb 24, 2009

The Short and Simple Story of the Credit Crisis. By Jonathan Jarvis. Crisisofcredit.com The goal of giving form to a complex situation like the credit crisis is to quickly supply the essence of the situation to those unfamiliar and uninitiated. This project was completed as part of my thesis work in the Media Design Program, a graduate studio at the Art Center College of Design in Pasadena, California. For more on my broader thesis work exploring the use of new media to make sense of a increasingly complex world, visit jdjarvis.com Or email me at jonathan.jarvis@gmail.com

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the crisis of credit visualized
what is the credit crisis?
It is a worldwide financial fiasco
involvig terms you probably heard like
Sub-prime mortgages
collateralized debt obligations
frozen credit markets
and credit default swaps
Who is affected?
Everyone.
How then happen.
Here's How.
The crisis of credit brings two groups of people together
Home owners and investors
Home owners represent their mortages
and investors represent their money
These mortages represent houses
and these money represent large institutions
like pension funds, insurance companies
sovereign funds, mutual funds etc.
These groups are braught together to the financial system
a bunch of banks and brokers commonly known as
wall street
Although it might not seem like it
these banks at wall street are closely connected to these
houses at main street.
To understand how le't's start from the beginning
Years ago the inverstors were sitting on their pile of money
looking for a good investment to turn it into
more money
Traditionally they go to the US Federal Reserve
where they buy treasury bills
believed to be the safest investment
but
In the wake of the dot com bust and 11 september
Federal reserve chairman Alan Greenspan
lowers interests rates to 1% to keep the economy strong
One percent is a very low return on investment, so the investors said
no thanks
On the flip side this means banks on wall street can borrow
from the Fed for only 1%
add to that general surpluses from
Japan, China and Middle East
and there is an abundance of cheap credit
This makes borrowing money easy for banks
and causes them to go crazy with
LEVERAGE
LEVERAGE is borrowing money to amplify the outcome of a deal
Here is how it works:
Ina normal deal someone with 10 thousand dollars
buys a box for 10 000 dollars
he then sells it to someone else for 11 000 dollars
for a 1 000 dollars profit, a good deal
but using leverage, someone with 10 000 dollars
would go borrow 990 000 more dollars
getting him one million dollars in hand
then he goes and buys 100 boxes
with his one million dollars
and sells them to someone else for 1 100 000 dollars
then he pays back his 990 000 plus 10 000 in interest
and after his initial 10 000, he is left with 90 000 dollar profit
versus the other guys 1 000
levrage turns good deals into great deals
this is a major way banks make their money
so Wall st. takes out a ton of credit
makes grate deals and grows tremendously rich
and then pays it back
the investors see this and want a piece of the action
and this gives Wall st. an idea
they can connect the investors to the home owners
through morgages
here is how it works
a family wants a house
so they save for a down payment
and contact a morgage broker
morgage broker connects the family to a lender
who gives them a morgage
the broker makes a nice comission
the family buys a house and becomes home owners
this is great for them because housing prices
have been rising practicaly forever
everything works out nicely
one day, the lender gets a call from an investment banker
who wants to buy the morgage
the lender sells it to him for a very nice fee
the investment banker then borrows millions of dollars
and buys thousands more morgages
and puts them into a nice little box
this means that every month
he gets the payments from the home owners of all the morgages in the box
then he (seeks?) his banker wizzards on it
to work their financial magic
which is basically cutting it into three slices
safe, okay and risky
they pack the slices back up in the box
and call it a Collateralized Debt Obligation
or, CDO
a CDO works laike three cascading trays
as money comes in, the top tray fills first
then spils over into the middle
and whatever is left into the bottom
the money comes from home owners paying off their morgages
if some owners don't pay and default on their morgage
less money comes in and the bottom tray may not get filled
this makes the bottom tray riskier
and the top tray safer
to compensate for the higher risk
the bottom tray recives a higher rate of return
while the top recives a lower but stil nice return
to make the top even safer the banks will ensure it
for a small fee called a Credit Default Swap
the banks do all of this work so the credit rating agencies
will stamp the top slice as a safe, triple A rated investment
the highest safest rating there is
the okay slice is triple B - still pretty good
and they don't bother to rate the risky slice
because of the triple A rating
the investment banker can sell the safe slice
to the investors who only want safe investments
he sells the okay slice to other bankers
and the risky slices to hedge funds and other risk takers
the investment banker makes millions
he then repays his loans
finaly, the investors have found a good investment for their money
much better than the 1% tresaury bills
they are so pleased, they want more CDO slices
so the investment banker calls up the lender
wanting more morgages
the lender calls up the broker for more home owners
but the broker can't find anyone
everyone that qualifies for a morgage already has one
but they have an idea
when home owners default on their morgage
the lender gets the house
and houses are allways increasing in value
since they're covered if the home owners default
lenders can start adding risk to new morgages
not requiring down payments
no proof of income
no documents at all
and that's exactly what they did
so, instead of lending to responsible home owners
called Prime Morgages
they started to get some that were... well, less responsible
these are Sub-Prime Morgages
this is the turning point

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