Lately, the mortgage and credit crisis that brought down several financial companies to their knees has been in the news. The negative impact of this crisis on the stock market and economy in general was enormous. With all the talk of mortgage-backed securities, CDOs and some other acronyms that were flying around, the whole issue was quite nebulous to me. Guess who came to rescue me from all this confusion… My favorite radio show: This American Life. The recent episode that was broadcast last week, “The Giant Pool of Money”, explains the whole situation very clearly. It is a must listen if you were confused like me and want to know more. They basically took an individual on every rung of the chain from the mortgage borrower to banker to broker to wall street guys and used their personal stories to illustrate how things worked and how they went down. It is almost funny to hear how the requirements for mortgage approvals became more and more relaxed. It is very nicely done.

    Some interesting points:

  • Creators of CDOs, the very instruments that caused all this trouble, received an award for creating a novel financial vehicle for investment.
  • There is US$70trillion (that is right with a 't') in fixed income savings worldwide. That is more than all the transactions that happen all around the world in an year. Fixed income savings means money for investing in very low-risk investments such as US treasury bonds. They don't want to lose even a penny of that principal. This crisis made a huge chunk of that money disappear.
  • The financial companies and bond rating agencies calculated the risk for these investments using wrong data.