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The Crisis of Credit Visualized

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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 did it 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 through the financial system a bunch of banks and brokers commonly known as wall street Although it might not seem like it these banks on wall street are closely connected to these houses on main street. To understand how le't's start at the beginning Years ago the inverstors were sitting on their pile of money looking for a good investment to turn 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 bust and september 11th Federal reserve chairman Alan Greenspan lowers interests rates to only 1% to keep the economy strong One percent is a very low return on investment, so the investors say 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: In a 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 giving 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 leverage 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 mortgages here is how it works a family wants a house so they save for a down payment and contact a mortgage broker mortgage broker connects the family to a lender who gives them a mortgage 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 mortgage the lender sells it to him for a very nice fee the investment banker then borrows millions of dollars and buys thousands more mortgages and puts them into a nice little box this means that every month he gets the payments from the home owners of all the mortgages in the box then he sets 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 mortgages if some owners don't pay and default on their mortgage 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 that 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 mortgages the lender calls up the broker for more home owners but the broker can't find anyone everyone that qualifies for a mortgage already has one but they have an idea when home owners default on their mortgage 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 mortgages 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 Mortgages they started to get some that were... well, less responsible these are Sub-Prime Mortgages this is the turning point so, just like allways the mortgage broker connects the family with a lender and a mortgage making his commision the family buys a big house the lender sells the mortgage to the investment banker who turns it into a CDO and sells slices to the investors and others this actually works out nicely for everyone and makes them all rich! no one was woried because as soon they sold the mortgage to the next guy it was his problem if the home owners were to default they didn't care they were selling out their risk to the next guy making millions like playing hot-potato with a time bomb not surprisingly the home owners default on their mortgage which at this moment is owned by the banker this means he forecloses, and one of his monthly payments turns into a house no big deal he puts it up for sell but more and more of his monthly payments turn into houses now there are so many houses for sell on the market creating more supply the there is demand and housing prices are not rising any more in fact they plummet this creates an interesting problem for the home owners still paying their mortgages as all the houses in their neighbourhood go up for sale the value of their house goes down and they start to why they are paying back their 300 000 dollars mortgage when the house is now worth only 90 000 dollars they decide that it does not make sense to continue paying even though they can afford to and they walk away from their house default rates sweep the country and prices plummet now the investment banker is basically holding a box full of worthless houses he calls up his buddy the investor to sell his CDO but the investor isn't stupid and says 'no thanks' he knows that the stream of money isn't even a dribble any more the banker tries to sell to everyone but nobody wants to buy his bomb he is freaking out because he borrowed millions, sometimes billions of dollars to buy this bomb and he cant pay it back whatever he tries, he cant get rid of it but he is not the only one the investors have already bought thousands of these bombs the lender calls up to try and sell his mortgage but the banker won't buy it and the broker is out of work the whole financial system is frozen and things get dark everybody starts going bankrupt but that is not all the investor calls up the home owner and tells him that his investments are worthless and you can begin to see how the crisis flows in a cycle welcome, to the crisis of credit.

Video Details

Duration: 11 minutes and 10 seconds
Country: United States
Language: English
Producer: Jonathan Jarvis
Director: Jonathan Jarvis
Views: 3,335
Posted by: mirone on May 26, 2009

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 my website at or email me at: [email protected]

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