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Craig Custom Builders
New Jersey custom home builder of luxury homes and major remodeling projects. Areas served include Bergen County, Passaic County, Morris County, and Essex County.

Services Area: Home construction 
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From: New Jersey Contractors
Rating: 10.00 from 5 users
Information Assumed Accurate On: May 18, 2006
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By: Sunil
CIndy,What clott is saying is that the fancniial crisis is so wide spread an so deep that no one actor can address it. Regardless of whether that actor is a state a country of a school teacher.Q.Why?A. There are about 700 800 trillion is global derivatives in the global market right now. The global GDP is approx 65 trillion. The root cause of the fancniial crisis is that the global fancniial system is currently holding 800 trillion in derivatives that were valued at that price based on homes appreciating in value at 10%/yr. The creation of these derivatives assumed that such growth rates would continue for the life of the derivatives (years, decades). As long as everyone agreed that homes would indeed continue to increase in price at such a rate then banks would loan money to each other based on the value of the derivatives. As this behavior continued the banks found that the more money they invested in these instruments, the more they would make. And even prudent banks were forced into this as they could not compete with the banks that were doing it, if they stayed out of the derivatives. The end result is that just like the consumer, the banks spent all of their money and then borrowed more money so that they could keep spending (investing) in these derivatives. Now banks are required to hold a minimum amount of cash in its vaults, a rrequired reserve rate. US law states that the required reserve rate for commercial banks is 3%. So if a bank has $100 in checking and savings accounts, then they are required to keep $3 in the bank and can loan out or invest the other $97. It gets more complicated. If the bank does not have the 3% as required by law the bank can borrow it from the FED in the form of a loan at a certain interest rate. As of Spring 2008 100% of cash reserves in ALL of the US banks is borrowed money. All of the banks in the US combined have $0 of their own money in their vaults. Every dollar they have, every dollar that they hand you when you withdraw money is money that has been borrowed from the federal reserve and must be paid back with interest. There is yet another component. Just like you and me, banks must make minimum payments of the loans that they have taken to buy derivatives. And like credit cars, the payments that the banks have to make can change based on certain criteria such as credit rating ( i.e moodies rating a derivative AAA).Now how does all of this come together? The 800 trillion in derivatives can be seem as collateral for a set of loans ( a huge number of loans between a huge number of banks around the world). Remeber that the 800 trillion value was based on 10% annual home price increase. Well homes are now decreasing in value so those derivatives are no longer worth 800 trillion. Well now the banks have a problem. they loaned out 800 trillion (not exactly but this is a rough overview)on the basis of 800 trillion worth of derivatives as collateral. The collateral is now worth pennies on the dollar based upon the few transactions that have actually taken place. This means that if i dont pay the bank the 800 trillion i owe them now along with an interst rate, they will take the derivatives and sell them in order to recoup their money. But the derivatives are only worth 100 trillion. the only way i was able to pay the bank back was to use that 800 trillion to buy homes ( as an example and then sell them for more then i bought them in a very short period of time ( i.e flip them). Well i can no longer flip houses as there are not enough people who have enough money or make enough more for me to sell them homes ( the problem of 1st time buyers being priced out of the market). Now i can no longer pay back the bank of the 800 trillion so the bank may take all of my derivatives and sell them, similar to a foreclosure. But the banks has a problem too. It will not get 800 trillion for the derivatives because the same problem that caused me to not be able to pay the bank causes the bank to not be able to cell the derivatives. The bank has now lost 700 trillion. But the bank owes that 700 trillion to its account holders ( people with checking and savings accounts) and to the FED (or their national equivalent). We have all lost money. The only way to replace the 700 trillion is to print it. but that would cause massive inflation and all of the money you got back would actually be worth less then what you originally gave the bank due to inflation.lets recap: I put $100 in the bank. The bank bought $100 worth of derivatives ( i.e loaned someone the money). But by law has to have 3% reserves so the bank borrows $3 from the FED. Housing prices stop increasing at 10% and start to drop so the person who borrowed the money has lost it and cannot pay it back. The bank can only sell the collateral for $20 but owes me $100 and the FED $3. Now the borrower has lost $100, the bank has lost $80 but still owes me and the FED a total of $103I walk to a bank and deposit $100Start of cycle (assets and Liabilities):Bank: $+100Borrower: $0Step 2, Bank loans money to borrow for a $10 fee and borrows from the FED to cover its reserve requirement:Bank:(-)$103 negative $103 due to its reserve being borrowed money and owing me my account balance, but it would be booked as a positive value as the borrower owes the bank $110. The bank accounts for this as a net positive $7Borrower:$100Step 3, homes lose value:Bank:(-)$3 + collateral _+ FeeBorrower:$0 (he cant pay his bill, the principle $100 of the $10 fee, so the bank takes the derivatives as collateral)Step 4 bank tries to sell collateral and only gets 20% of the original value:Bank:(-)$103 + $20 = (-)$83Borrower: $0Step 5 who does the bank pay back?FED: +$2Me: +$81bank: $-20the bank now owes me money and if it cant pay me then i lose $19, and the FED loses $1 even though i did not take part in the loan cycle directly
Date: Oct 5, 2012 | Contractors | Suppliers | Real Estate | Regional | Resources | Home Projects
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