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THE CRASH OF 2008 came as a shock to almost every economy in the world. The biggest problem was that it began as a loss of faith in the actions of a few financial institutions. But a few ticking time bombs in the background of the financial world would come together to catch all parties off guard. Basel 2 was the culmination of 25 years of attempts to gather all the worlds lenders under one roof. It was in effect a form of Bretton Woods 2, where there was to be some form of stability and generally accepted ground rules to stabilize the world economy in ways that had not existed since the days when the ineffective actions of President Richard Nixon in 1971 killed off the original Bretton Woods agreement and sent the currencies of the world into a daily spin cycle of market events. Beyond Basel 2, was the fears of liability from the four major accounting firms of the world. Where Enron had caused the collapse of Accenture/Arthur Anderson as an American firm, KPMG was almost taken down by the investigation of its tax shelter business in a federal investigation based out of New York City and may still not survive problems in Australia with its representation of Westpoint, and its actions in respect to the collapse of New Century Mortgage. Pricewaterhouse had its own Internal Revenue Service problems in 2002 for promoting improper tax shelters. Ernst was hit for $14.5 million by the IRS in 2003 and Deloitte paid $51 million because of its actions with Adelphia Communications. In this environment, the major firms felt caught in the knowledge they had of the derivatives markets and the actions taken by the top 1000 firms in the world to gloss over the level of activity that existed and the potential exposures the accounting firms had for not fully disclosing what they knew. In this environment, the FASB in the USA worked hard to push for honest accounting. In so doing, it created a monster in FAS157, a set of rules that required a continued appraisal of the current value of an asset...what came to be known as mark to market. The various federal investigations into the manner in which Insurance firms and Wall Street firms helped to massage earnings for the satisfaction of the 10000 member strong NYSSA(New York Society of Security Analysts) with various derivatives threatened to burst open the entire can of worms that had developed during the beginning of the 21st century, where public firms, in fear of the reaction of the analysts at the NYSSA would do whatever it took to keep earnings within a range expected by those who followed their stock. What began as a small trickle became an avalanche of creative accounting methods and the major accounting firms clearly did not want to be left holding the bag. In so doing, the FASB with out being prompted, created a firestorm in 2007 by suggesting somehow a REMIC vehicle, the type of tax free pass through designation used for Mortgage Backed Securities (MBS), could lose its status if it actually went ahead and did a large number of loan modifications or debt restructurings in the face of any major economic downturn. By the time the IRS sent out rules that clarified the situation, the damage had been done. The two year downturn(Jan 2007 - Dec 2008) paralleled the crash period of 1931-1932, when the World Markets fell apart, with the collapse of the Credit Anstaldt in Austria in May of 1931 and the consequences of the failure of Winston Churchill's attempt to recreate a GOLD standard for the British Pound.

Although for most Americans the idea of a balanced budget is considered an ideal situation, many did not see the collateral damage that would be caused by the limiting of available US Treasury Debt which was and is needed to be used for CAPITAL for the needs of financial institutions world wide.

Basel 2 calls for lenders to have a 12:1 ratio of assets to capital...otherwise stated, the "tier 1" primary capital needs to be at 8% as a minimum. Since in reality there is no where near enough gold on the planet to carry the needs of 175 Trillion Dollar deposit/asset base of the worlds financial institutions, the 5 to 6 Trillion Dollars of capital needed was to be found in AAA rated items. These classifications distributed by the Two major American Rating firms, S&P and Moody's, are the backbone of the world financial system.

As financial institutions found themselves with less and less USA Federal Debt instruments available to satisfy the Capital needs as described by the Basel 2 regulations, they began looking for substitutes. When the Clinton Administration balanced the American Budget and projected a complete payoff of Government Debts, it envisioned the lack of competition from government for access to capital would free American Companies to obtain cheap funds with which to grow and create jobs. The problem was that the Ratings Agencies refused to play along, and did not grant enough AAA ratings to USA based firms to allow them access to capital at advantaged rates. Instead the ratings agencies came up with a marketing plan which would allow them to make money by rating pools of mortgages in a way that would allow them to substitute the US Treasuries. However, as the available pool of quality mortgages began to shrink, financial institutions became desperate for capital as the clock was ticking on the Basel 2 deadlines which saw the start of enforcement beginning in late 2006 with the final rules in the USA kicking in during the spring of 2010. The cascade effect of this need was a lower and lower spiral into weaker and weaker borrowers for the available pool of mortgages. Even the ratings agencies began to have a problem accepting low credit borrowers for AAA rated loan pools. To enhance the "credit profile" of the borrowers in the Loan Pool, the rating agencies insisted that there be guarantors with back up letters of credit. In so doing, smaller lenders around the world were brought in to hand out Letters of Credit, not taking into account the historical shortfall in payments from "sub prime" borrowers.

In the middle of this mess, a group of Large Financial Institutions, known as FM Watch, refused to give up on the hope of breaking up the two gov't created Mortgage Conduit Agencies, Fannie Mae and Freddie Mac. They continued to pay lobbyists to push the American Congress to reign in or disrupt the activities of these two giants, arguing that somehow these institutions had an unfair advantage that allowed the gov't institutions to borrow at a slightly cheaper rate and thus cost the members of FM Watch billions of dollars in profits. This sounds like a large amount of money, but Fannie Mae and Freddie Mac hold or guarantee over 5 Trillion Dollars in mortgages, making up about half of all mortgages in the USA. The losses claimed from lost opportunity added up to less than a 1 % difference.

One of the items that drove down the Stock Market in the USA during the great depression was the capacity for those in the know to short stocks without any controls, commonly known as "naked shorting". During the review of facts after the collapse of the economy in 1933, one of the items that stood out was the shorting that had pushed down the shares of viable companies. This was adjusted and kept in check by what was known as the "uptick" rule. As the fates would have it, the uptick rule was dismantled and companies were allowed to be attacked at will in 2007 and 2008. Only after a number of large financial firms were pushed into the hands of other firms by the actions of short sellers in 2008, did the SEC then roll back the rules to protect financial institutions. By then the damage had been done. Wall Street had vanished. The final two major Investment Banking firms, Goldman Sachs and Morgan Stanley were granted the right to convert to regular commercial banks over a weekend to insure that they would not be shut down on a Monday morning.

Finally 2008 saw the rise and fall of many "hedge funds". But two firms stood out with the actions they took to make a killing on Shadenfreude. Pershing Capital did it's part to destabilize the two major Mortgage and Government Debt Guarantee companies, Ambac and MBIA, creating fear that the entities designed to back stop the mortgage pools would not be around to protect the underlying mortgages. Paulson & Co. worked to crush the financial system from the edges, buying cheap out of the money derivative position, then manipulating public opinion, with the help of some strategic partner quasi-non-profit organizations, ending in the destabilization of Coutrywide Mortgage which was the event that finished off the mortgage market at the end of 2007. Countrywide had been the most aggressive lender and it's elimination shut down the financing industry in its modern form. In mid 2007, the ISDA, the market of derivatives players called a special meeting to deal with the hedge positions John Paulson had taken for his firm. An attempt was made to allow his firm to adjust its trades as they would have a crushing effect on the entire market. He refused. On August 6, 2007, American Home Mortgage filed for Bankruptcy. On August 7, 2007, the world's financial system froze up as the shock of the derivatives problem set in. The concept of mortgage pools was designed in part to insure the orderly winding down of any institution by allowing a "trustee" to have control of the mortgages of a lender where outside investors have bought into the underlying mortgages with use of the pool. A mini version of the problem had set in with the Bankruptcy filing of Delphi, the former subsidiary of General Motors. There, for every dollar in bond debt, there were 10 individuals claiming to own or control that same dollar. In the same fashion, when American Mortgage filed for bankruptcy, all the investors in the pools went to show up and make claims of the trustee, but the trustee found there were a number of individuals all claiming the same set of mortgages. This gave rise to questions around the world as to who had what rights to what instruments. As the questions became louder, rumors swirled around the world causing concerns. Along the way, it was discovered that where some entities which thought they had purchased actual mortgages in pools, but what they had in fact acquired were pools of "options" to purchase debt, such as the CDO squared type of pooled mortgage instruments. These had begun to be exposed with the collapse of two Bear Stearns debt pools in June of 2007. At first, because of the parties involved and the process with which it happened, the executive committee of Bear Stearns chose to ignore the "moral hazard" of allowing something of that nature to collapse and refused to stand behind the debt position. By the time they were forced by public opinion, to cover for the debts, the firm had in effect collapsed and was just being held together by the attempts of the Federal Reserve to not have one of its main broker dealers go out of business so quickly.

to be continued...author has run out of energy Nov 4, 2008

references to be added...

and please if you don't understand finance, do not start chopping this up...already had one knucklehead from kanuk-istan try to bounce this who has no back ground in finance...