How Bear Sterns fails?

If someone don't know how the financial compaines are facing the credit crunch, here is I am trying to explain what happens.

In 2003, when household person went to refinance their loan to Loan Broker.

Household: Hi Mr Broker, I want to refinance house, because the rate is very low, I will save lot of money in my Mortgage. (Household spend the money and economy went up, Thanks to Mr. Greenspan)

Broker: Sure thats way to go. But, hey do you want to buy another house for investment, since the rate is low, and when you rent it you will have positive cash flow.

Household: But I don't have down payment or monthly income that I can get loan

Broker: You don't worry about it, we will manage it. Congratulation, you are just qualified for $400k loan.

Now he goes to real estate agent to buy $350k house

Household: I want to buy this house, I have my loan approved.

Real Estate Agent: Sure, but you have to bid 50k higher, as there are many interest in this property.

Household: No problem, my loan is approved for $400k, here is my offer for $400k.

Real Estate Agent: Congratulation, you got the house.
Broker: Congratulation, you got the loan, with 0% down, and 1% loan for 2 year, and it is interest only, the payment is less than the rent you get, so you get a really good deal.

In 2004...

Household: Wow, my house has gone up to $500k, I have a profit of $100k, with no money to invest, this is GOLD

Next time broker call for Equity Line of Credit

Mr Broker: Hey bro, do you want to take equity from the home? You have 100k in there that you can use either to buy home or spend for vacation. Its like an ATM card, where you can get the money when you want.

Household: Can I do that?

Broker: Sure, here it is, spend any way you like.

I guess lot of people did this way...year goes by.

Now lets see what happend on the back side, where consumer has no idea what's going on.

In 2005...

Brokerage Firm: In there team meeting they tell the Business Situation. We have $xxx Billion of open order to buy AAA securities, don't we have anything to fill this order? Also we have lot of MBS that we just finance. Guys lets work on it. They decided to work on this and come up with, new financial instrument, called CDO, Corporate Debt Obligation. The biggest scam of the century. Its a structured investment instrument, which is 80% backed by Mortgage (so called subprime mortgage) and 20% is the tranches, which makes its rating AAA by major credit agency such as Moody's and S&P. To understand this tranches you have to read 80,000 pages of document. I never understood what it is. They start filling the order from the banks, so here is what happend:

Mr Hedge Fund Manager: I have a fund, if you invest it gives you 8% return and it is AAA, fantastic deal.

Mr. Bank : Wow, that's cool. I am very must interested in it. How do you do that? I want $100 securities, so I will get $8. How about If I want to buy more.

Mr Fund Manager: Sure, give me more money, I have to buy more CDO, that will give this return. Basically its a Mortgage backed bond.

Mr. Bank: Sure, I want to lend you money, you just pay me 6% of that money and you keep 2%, how about If I lend you $3000?

Mr.Fund Manager: Wow, so for $3100, I get $248, and if I pay you interest i.e 180, I keep $68 on my original $100 investment. i.e. 68% return, my customer will be very happy with this return. Lets do it.

Times goes by...2006... the house price fall because mortgage rate reset after 1 or 2 year and the new payment household cannot afford. Still get money so its worth to sell, so lot of inventory and price fall further more. Economy 101, supply and demand.

So, In 2007 this is what it happen.....

Banker: Hey Mr Hedge Fund Manager, remember I lend you money $3000 at 6% ? I still have a promissory note. Can I get $1000 back as we think that most of the mortgage that CDO has will go bad.

Hedge Fund Manager: Dude! The price of CDO is already down 5%, If I sell bond to get you $1000 then I would get $50 loss (1000*.05) . So for $100 of my original investment I h ave $50 loss, which 50% lost on investment. And, I have to mark to market and need to report to my investor.

Banker: Well, we really need our money back, at the value of the underlying document is not worth that much.

Hedge Fund Manger: Damn! Everybody else doing just like you. If I keep selling this bond, the price of the bond will go 20% down. Which mean I have to take $200 loss, and I just invested $100. That means now only I wiped out but you also loose $100. And if you want all your money back then you will lost $600 of your $3000 investment too.

So banks has taken the hit and write off in the next earning.

Below is the description of the character described above:

Household: Person living somewhere in Atlanta and has job in Mcdonald. Many of them are in forclusure. I personally was one of them back in 1997, back then I didn't have any credit, nor much down payment and they got me house.

Real estate Broker: Toll Brothers, Lennars, Pulte, Dean Horton etc.. They all struggling to sell the houses.

Loan Broker: Countrywide, Washington Mutual, Fremont Bank etc, atleast 90 of them went bankrupt already. Many of them wind up with real estate so call REO.

Hedge Fund Manager: Carley Group Fund, Bear Sterns, Lehman, some I don't remember, and more are coming. Some of them are bankrupt already, and some in severe trouble.

Bankers: Citigroup, all major banks, international bank from Europe, China, India, Japan, and so forth. Most of them are expected to write off.

They borrowed 2.5Trillion loan in last 3 years, if you count the value of the underlying security lost by 20%, then there is $500B loss some or all combined has to take. So far, they have declared $185B, so $315B loss still to go....