“But I am utterly baffled (maybe somebody can help) as to how giving a bunch of bad loans could lead to WORLDWIDE financial market collapse”
This is what I’ve been asking. I know Fannie and Freddie bundled bad loans with good loans and sold them as securities (I think). How are they worthless now?
Also, when congress was trying to pass the bailout half the money wasn’t going to subprime debt but to “other bad loans.” Riddle me that.
They're not worthless, but under new SarBox regs, they have to be valued today instead of longer term. That's the problem. SEC was going to revisit this "mark to market" reg.
Way back in the olden days, you'd go to your friendly local bank and get a mortgage for your home. The bank would collect the mortgage payments, escrow payments, and make your tax and insurance payments on the home for you out of the escrow account. Banks would occasionally buy and sell mortgages to each other, but generally if you took out a mortgage with Joe's Bank and Trust, the loan stayed with Joe.
Then some clever fellow (Roosvelt when he created FNMA) figured out that you can take a bunch of these mortgages, and create sort of a stock certificate called a "Mortgage Backed Security." In theory, you could sell the securities like stock or bonds, and the 'value' would be backed by the bundle of mortgages. Since the return rate of these MBSs were greater than a T-Bill, and since the mortgages were backed by real estate and 'guaranteed' by FNMA, they were considered safe investments with good returns.
Once the idea caught on, everybody wanted to buy MBSs, so there needed to be a bunch of new mortgages to bundle and sell. Since most people who could afford a home already had one, the only way to get more mortgages into the market was to open up the "sub-prime" market. Since FNMA (Fannie Mae) and FHLMC (Freddie Mac) would buy these mortgages, and congress 'encouraged' writing loans to disadvantaged people, banks started to issue questionable mortgages including no money down deals, then selling them to Fannie and Freddie the next day.
Now you've got MBSs that are backed up by mortgages that could be solid, could be shaky, or could default and leave behind real estate that is worth less than the value of the loan. All of this has brought about uncertanity in the value of MBSs, and uncertanity means nobody wants them anymore.
If nobody wants them, the price plummets. Uncle Sugar is now offering to buy up to $700 billion worth of these MBSs, thereby creating a market and shoring up prices.
That's my layman's understanding of the situation. If I'm wrong, I'm sure I'll hear about it by a helpful FReeper.