The Balance Sheet

The first reduced the capital thus hampering credit creation as the leverage at 33.5:1 was too high. The second case transfered the risk to the insurance companies. There no due diligence in ensuring that the certificates were genuine and properly checked. Those mortgages were iffy as most of them were from low income home owners. When the homeowners couldn't pay, walked away or filed for bankruptcy the mortgages turned into losses as the housing market was flooded and the value of the homes dropped dramatically. The third thing was the excess executive pay bonuses was depleting the capital base of the banks.

I still don't understand WHY this (multiple insurances on bad mortgage debt) is causing huge GLOBAL repercussions.

Did some foreign country call in their debts? Did someone print a lot of money?

Personally, I think it is something else going on, which we will never find out about. But maybe I read too much fiction stories of foreign countries taking down the world economy.

imo when the insurance companies realized that they were insuring financial paper that had little or no value , the crunch got much worse .
i'd compare it to a fire insurance company insuring a house that's already burned down - well , many houses that had already burned down .
the insurance companies were relying on the judgement of "some" rating agencies that had declared the papers as "sound" (some rating agencies had refused to rate the paper - their "non rating" should have been a warning , but was apparently ignored ) .

read in european business news today , that europen suppliers to the big three automakers cannot line up insurance to guarantee payment of the shipments they are making to the big 3 .
so what are they going to do now : either , ship anyway and HOPE they'll be paid , or don't ship and let the stuff sit in their warehouses ?
the problem is spreading and spreading ... ...
hbg

Actually, a change like this lets them more money than ever, whether they have the money to lend, or not. They got to collect interest on money that didn't precisely exist. It's a great act, kind of like juggling 7 clubs at once. Great, so long as they can keep them all in the air at once. When the first one hits the ground, they've got a problem.

Here is the simplified calculation on credit created by banks:

The normal Net Capital Rule is that there should be a 15:1 loan to cash ratio. The crisis occurred as the SEC changed the ratio to 33:1 which double the banks' exposure. With $65 trillion troubled certificates the required cash at hand would be $1.97 trillion or $2 trillion for bad loans. To get back to the normal 15:1 ratio would require another $2 trillion cash (liquidity).

The ratio is really a risk factor. If a bank had deposits of $1000 it can lend out $15,000 credit. Suppose the bank lent out $1000 to 15 borrowers if one fails and files bankruptcy $1000 is lost but the remaining 14 borrowers return the capital of $14,000 plus 5% interest ($700). The bank lost $300.

Suppose we used the 33:1 ratio. With 15 borrowers each receiving $2,200 for a total of $33,000 credit. The bank would have $1000 at hand. If one borrower fails then $2,200 is lost. The remaining 14 borrowers return $30,800 with 5% interest ($1,540). The bank lost $660.

With 15:1 net capital rule, or cash to credit ratio, the was $300 while at 33:1 the loss was $660 so the loss is greater if one of the loan default i.e. firm that got the loan fails. The capital of $1000 is at greater risk with 33:1 cash to credit ratio than at 15:1.

The mortgage based certificates were bought by foreign banks and were seen as assets i.e. income producing from the mortgage payments. However, many of the mortgage holders were low income people or those who lost their jobs or even speculators caught with too many real estate projects unsold. Those certificates when defaulted turned from assets into losses. It could also be that many companies were going on a leveraged buyout binge and when the banks couldn't convert those certificates into cash there was a problem for the banks. They realized they didn't have the money.

The deregulation brought about by Phil Gramm by sneaking in 282 pages at the 11th hour without anyone's knowledge allowed the 'credit default swap' in which mortgage based certificates were insured. If the certificates turned out bad the insurance company would have to pay. There were so many bad certificates that the biggest insurance got caught with these dud certificates that the losses threatened to bankrupt the insurance company thus the bailout of AIG insurance company.