In the course of a few days, two storied investment banks effectively ceased to exist and a massive global insurer was taken over by the government—and all this came on the heels of a taxpayer bailout of Fannie Mae and Freddie Mac couple of weeks ago.
Here’s the story in a nutshell:
What happened this week
The carnage began last Sunday when Bank of America agreed to buy Merrill Lynch, a huge name in finance that read the writing on the wall and knew it was losing money so quickly that it couldn’t conduct business independently anymore. Merrill sold for $50 billion—61% less than what it was worth a year ago.
Then early Monday, Lehman Bros., a 158-year-old financial services firm, filed for bankruptcy.
By Wednesday the government stepped in with $85 billion to rescue the nation’s largest insurance company, AIG, from the brink of collapse in an effort to stem a world-wide economic meltdown.
Finally, on Friday, with markets still panicky, the Feds played their trump card, proposing a far-reaching program to help prop up the nation’s banks. Details are still to come, but the plan is shaping up to be the biggest government bailout in generations.
What in the world is going on?
Quite simply, Merrill, Lehman and AIG are all victims of bad loans made in the housing market—the latest dominoes to fall.
You’ll remember that we wrote about this in August 2007 when the markets first started reeling from the sub-prime mortgage crisis (watch this hilarious but foul-mouthed animation for a good explanation) and the collapse of the housing bubble. Basically, bad home loans were packaged up into securities (called mortgage-backed securities, or MBS) and were bought and sold by finance giants around the world.
When home prices began falling and people couldn’t meet their loans, the value of these securities fell. Companies with large exposure to these securities were left holding bad assets with no one to buy them—like a stock that was worth $10 that’s now worth 10 cents. The accountants had to “writedown” the value of the securities on company books. Merrill Lynch, for example, has recorded a whopping $51 billion in writedowns, meaning it revalued those soured assets to lower prices, cutting directly into its profit.
What we are seeing now is the impact of the losses created by those sickly securities. It’s literally sinking firms.
The big picture
Stock markets around the world zigged and zagged. Investors searched for any place safe to park their money, fleeing to commodities like gold and government bonds. Meanwhile, for the first time in years, a major money-market fund—generally the safest of investments—actually lost money. Questions continue to swirl about the government’s decision to bail out the nation’s ailing finance industry.
If people agree on anything, it’s that this rollercoaster won’t slow down until the housing market reaches rock bottom—and we aren't there yet. Until then, keep your seatbelt fastened…
Comment below... Is the government doing enough? Too much? Are you worried about your finances?
