The Crisis Explained

Thursday, October 2, 2008, 6:18 AM

A very nice analogy, found here:

Analogies are never perfect, but here's one using horse racing. Don't expect a perfect correspondence to the banking situation, but I think it is close enough for government work.

Joe goes to the track and bets $2 on a horse.

Two guys standing nearby get into a discussion and Fred says to Sam, "I'll bet you $5 that Joe wins his bet."

Next to them are Bill and Bob. Bill says: "I'll bet you $10 that Fred welshes on his bet if he loses."

Next to them is Sally. Sally says: "For $3 I'll guarantee to Bill that if Bob fails to pay off, I'll make good on the bet."

Sally then goes to Mary and borrows the $7 needed in case she has to ever pay off and promises to pay back $8. She doesn't expect to ever have to pay since she believes Bob will always make good. So she expects to net $2 no matter what happens to Joe.

A quick calculation indicates that there is now 2+5+10+3+7 = $27 riding on the outcome of the horse race.

Question how much has been "invested" in the horse race?


$50,000 by the owner of the horse who is expecting to recoup his investment from the winnings of the horse and other future deals. Everyone else is gambling, not investing.

The issue with the home market is that the only "investor" was the person who bought the home. All those engaged in the meaningless derivatives spun off from this are gambling. You can see how quickly the face value of all these side bets can exceed the underlying investment. Who is holding these side bets?  Not the homeowner. It is the people at the failing investment banks, hedge funds and similar enterprises. Notice that the bailout is being directed at them not the homeowners.

The real world is, of course, even more complicated. Over the last 30 years people have been allowed to place bets on everything starting with the value of stock averages. They might as well bet on the temperature in Newark at 8:00 AM.

So when you hear everybody saying this is a crisis caused by the housing collapse, be skeptical. We are in the midst of a classic pyramid or Ponzi scheme and there is no way out except for people to lose a lot of money. All that is different this time is that it is the taxpayers who are being asked for the cash.

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rlee's picture
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A clear analogy

Chris, your analogy is right on the money (no pun intended).  How interesting that it came from the UK!  The underlying issues at hand with the crisis in the system, and the bailout plans being implemented, are soley for the purpose of making more for the banks, and getting it from the population.  To think that the beltway boys aren't being manipulated in this grand scheme would just be naive.  The country is NOT run by our electorate.  It is, and it has been since 1913, run by a very short list of banking families.  The plans have been in place for a very long time, and they seem to be right on track.


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good stuff

great analogy! I know understand just that little bit more how and why the economy is in such a dire strait, leaving out the underlying fact that it has a debt-based monetary system.

cheers again Chris its 7:45pm here in Australia and Im reloading your page to check for updates every hour! haha really appreciate your work.

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Nice analogy

The doctor does it again. Only Chris could explain the entire ponzi scheme within 30 seconds in the most simplistic manner. Sadly such explanations are not available by the media for mass consumption. My experiences have indicated very few folks have a clue what this bailout is all about. One thing is certain. There is ZERO support.

Again ...well done Doc


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Gasoline prices and the bail-out

The price of gasoline is mysteriously low (just before the election) even though there are shortages.

Congress has just now happily given away a trillion dollars of phony money to fund a non-solution for a non-problem.  As Chris noted in the post, we're just paying off the wealthy' gambling debts.  It is better that one million middle-classers are foreclosed than for one billionaire to be reduced (the horror!) to a mere millionaire.

The congressional solution is VERY unpopular with the public. 

It looks like the Republicans are going to lose the White House.

So, what are the chances that after the election:

1)  gasoline gets even more expensive than before (real soon)

2)  the media suddenly starts hammering on thie price of gasoline (much more than before)

3)  the Repubs and the media blame the Dems for wasting a trillion dollars on a non-problem, somehow (speculation?) causing the price of gasoline to shoot up.


1)  Bankers are happy

2)  Oil companies are happy

3)  Repubs can act like heros, insuring a return to power

4)  The public is dumbfounded and screwed 

Note that a trillion dollars with minimal oversight can provide a LOT of political grease. 

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Thats funny, and a little sad
and also a great analogy, very nice find :)
CB's picture
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another aspect of the analogy

I think there is a bit more to this - the person who borrowed funds to buy the horse got a loan with 1% interest for 6mo (the race is in 5mo) that will reset to 8% after that time. He must sell it after the race or he won't be able to make the payments. The horse has a weak leg and is only worth 25k at most. The bank that made the loan to the owner sold the debt to a third party who then counted the 50k + interest (@8%) as an asset and borrowed $1.5 million against it to invest in (or bet on) other horse races. The party that loaned the 1.5 mil then counted that as an asset and... etc. etc. Others sold insurance against any party in the chain defaulting.

Isn't that correct?

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Time for ACTION

Those who can afford $1 to $10 a day - here's a game plan for the election:


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I added a bit to complete the thought.

I added a bit to complete the thought.

 I think there is a bit more to this - the person who borrowed funds to buy the horse got a loan with 1% interest for 6mo (the race is in 5mo) that will reset to 8% after that time. He must sell it after the race or he won't be able to make the payments. The horse has a weak leg and is only worth 25k at most. The bank that made the loan to the owner sold the debt to a third party who then counted the 50k + interest (@8%) as an asset and borrowed $1.5 million against it to invest in (or bet on) other horse races. The party that loaned the $1.5 mil then counted that as an asset and... etc. etc. Others sold insurance against any party in the chain defaulting and will have to pay out millions if the owner of the $25k horse defaults on his $50k loan.

The bailout plan intends to buy the $50k debt for $50k and thus prop up the pyramid of debt based on that loan, but as the horse is only worth $25k there will be a loss of at least $25k for the government. However, lots of other folks also bought over-priced horses and their loans haven’t yet reset - they will also be in default in a few months and more funds will be needed to keep the pyramid intact. Additionally, the government doesn’t have the $50k to loan and must borrow the funds from investors who made bets on the horse race and are angry that they weren’t told that the horse had a bad leg. Proposed rules changes will allow banks to value horses with bad legs at $50k when figuring assets used to back loans and borrowing - yet horses with bad legs can never be sold for $50k, so the banks position will remain unchanged and they will fail if they need to come up with cash (everyone now knows the horses have bad legs).

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A zero-sum game

I appeciated the analogy, and the further analogy by CB.

However, gambling is a zero-sum game. For each loser there is a winner. The sum of the face value of all derivative products, CDS, and so on is huge, but the gamblers are more or less the same (hedge funds, banks, billionaires...). So, if Bear Sterns, Lehman, AIG, WaMu, Wachovia, etc. are the losers, who are the winners?

As regards mortgages, the winners are clearly the houseowners, who took the money and did not repay it to the lender (and the former owners who sold the house and got the money...), but for the huge derivative market built over the mortgage market, who are the winners? Where is the money?



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In the original analogy, Sally, Bill, and/or Mary are the potential losers.  If Bob does not make good on his bet if he loses, Sally will be on the hook to pay Bill the $10 and will still owe Mary the $8.  One of the parties is going to have to take an $8 loss - either Sally, if she pays Mary back, Mary, if Sally defaults, or Bill, if Sally decides to pay Mary back her $8, and only gives Bill $2.  I suppose that it could be that each party takes a partial loss, but the total loss will still be $8.


I hope that this helps,


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degree rather than absolute

I think it might be easier to see this analogy as "losing or gaining" LESS  as opposed to who won or lost (absolute terms).  If we see this in terms as winning and losing then we fail to make a sufficient analogy to the "imaginary" money.  If there is a lot of "imaginary" money out there being gambled with then we cannot physically take or give tangible currency to/from the winner/loser and therefore would not "win or lose" anything except our spirits in the game.  By me, having a home, may have lost LESS than the person who lost millions by gambling upon my investment.  No one "won" the bet but I have lost less "x" in terms of the totality of the economic system we play the game in.... just an idea kicking around in my head...


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How Much Invested?
So if the first $50,000 was borrowed on a 0 down loan, how much was invested in the house and who invested it?
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Price - Not Liquidity Problem?


We are hearing that we have a liquidity problem.  It seems to me that:


  1. This is a distraction.  It is being created by the entities that have the problem, not by the people that don't have a problem.
  2. The real issue is price.  There is always a price at which an asset can be sold to another entity.  That price may even be negative, meaning that additional terms are required to divest the asset.
  3. We need to be careful not to listen and adopt the language that their price problem is our liquidity problem.  This will cloud your thinking and not allow you to think clearly about our situation.  All 'liquidity' problems can be converted to pricing: 
  • The price of money.  
  • The price of labor.  
  • The price of debt. 
  • The price of assets.  
  • The price for a politician to remain in office.


Would you comment? 

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Growing Enterprise, Growing Pains?

Dr. Martenson, thanks for your service info scout!! You have helped educate me on this peak oil phenom and its ramifications. Is it just me or have I correctly identified a significant shift/change about your site? 

The site seems to have gone from the brevity/clarity and content sophistication of a "google" to the clouding/verbose, "anything goes" of say, "" or "CNBC". Perhaps some editorial moderation may be in order. Cool



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"editorial moderation"
NateLowrie's picture
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No change on the site

There really has not been a change in content on the site that I could detect.  Could you site some specific examples to support your argument?  Chris provides very valuable information.  Articles like this analogy and the videos in the crash course are designed to sort through the technical jargon and present the relavant facts in a clear, concise manner to the reader.  None of the articles on here have been very verbose, and I would argue most have been written with clarity for the average Joe.  A few trail off into technical terms, but are still well written.



gyrogearloose's picture
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Zero sum game.... not

Because in real life they are all drawing a fat wage off the profits they are "going" to make, and the racetrack authority takes a % fee on every bet placed ( regardless of the outcome ). All that money has been spent on champaign and caviar


  the Bird & Fortune on the Subprime Mess.


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Fun and analogy to enlight complicated science is a strange mix

but we all need it.  It is up to a reader to select the right one that works for him/her. This example/analogy was really good. I am good at I just started to gather ideas how to answer the question, but I newer really questioned the question. I think the biggest moral here is that you have to question the question. Analogy may can be interpreted as a derivative too, that rely on a person experience. So it must be different for you and for me. Some will work for you some not.

Another analogy to describe credit swap is this:

It is like changing your underwear....................
Exchanging With your coworker.

Shocking, but why a person with a right mind is willing to change his used car (that has problems that he is aware) to exchange it with the coworkers used car that has problems that are not known to him. Because not knowing the problem makes you able to believe for a little while that there is no problem at all.


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Winners ?
It would be you and me. We both living in an extremelly high strange world.  We dont have to know how to kill a chicken to eat.
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Runaway betting, runaway logrolling

The runaway betting process Chris described also resembles the legislative process. An article linked on Drudge says that the original 3-page bailout bill is now up to ... wait for it ... 451 pages.

This 150-fold expansion in page count is a mirror of our deranged monetary process, in which the Federal Reserve has multiplied the quantity of dollars in circulation by several factors of ten in the 95 years of its existence. But now, Ben Bernanke is expanding the Fed's balance sheet by about 20% per week ... while our heroic KongressKlowns expand the word count of the bailout bill by about 20% per day. And my dismay and rage grow by about 20% per hour.

Welcome to Zimbabwe, comrades. Can you spare a million bucks for a cup of coffee? How about a million rounds for my Predator Perforator? Surprised

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Zero Stake
Unfortunately, some idiot made it possible to gamble with money that didn't exist today but was to be repaid tomorrow!
Xflies's picture
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site content

Hi Nate,

It really wasn't the content that Chris was providing that sparked this whole debate.  There are those on the site that see it as a great resource for the general public and what I was a bit worried about and offended by some of the posts that readers like you and I have put up.  Now I completely agree with the whole freedom of speech thing but as someone so eloquently put it, the discussion forums can scare off the general person who may see this as jsut another doom and gloom site and not get past the "riots in front of the museum/library".  The forums could be organized a bit differently and buried further in the site but what should be highlighted is the Crash Course and Chris' comments.  Personally I would like to see more of Chris choosing certain posts who take the other side to his arguments and debating them as we all tend to learn more when 2 intelligent people express their views.  I see all sorts of posts on this site, some of which have great, well thought of points, and others which are just fear mongering or advertising some other doomsayer service.  Personally, I would like to screen those out, have a rating system on posts and the ability to put some on an 'ignore' list since there's no doubt the content on this site is going to grow exponentially.  The good stuff gets buried amongst the not so good stuff and it makes it a more difficult resource to use.

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Another Way Of Saying The Same Thing?


I found your analogy to not only be entertaining reading, but also incredibly accurate. By the way the information on your site is refreshingly prepared and I'm pleased to see that there is a growing number of us researchers who are communicating the deeper understandings that are so necessary at this time of monumental and exhilarating times.

Your videos in fact mirror many of the videos that I have created for my own members . And great use of graphics by the way - keep up the great work!

For those who perhaps seek a more literal (and perhaps graphical) account of "the crisis explained" I offer the following account...

While the U.S government begins its global “sell” on the US$700 billion bailout plan, another untold story missed by the mainstream media is quietly unfolding. While the Fed and the mass media continue to  divert public and investor attention to the housing market bubble as the crisis, another three bubbles are bursting at the seams (and popping) without barely a whisper.

What isn’t being addressed are the exponential problems of outstanding U.S. interest-bearing debts to the tune of $51 trillion as well as derivatives held by U.S. banks totaling $180 trillion.

A large section of the banking and financial sector in the U.S is hanging by a thread. Over 1400 U.S. banks and more than 150 U.S. thrifts are at risk of failure, with total assets of $3.6 trillion.

Over 60 banks and more than 20 U.S thrifts with more than $5 million in assets are extremely exposed to poor or non performing mortgages.

And to illustrate how significant the shortfall is, the Federal Deposit Insurance Corporation’s (FDIC) only has less than 3% of the value of assets of banks on the troubled institutions list.

And that means that if all the troubled banks went into bankruptcy tomorrow there is only enough insured savings to return capital to 3 people in every hundred. And these are not tiny banks.

According to, you’ll see that among the 20 largest, are banks with assets of over $300 billion. So these aren’t small banks. And these are just the 20 largest. As I mentioned earlier, when you add up the total assets of all these banks you get $3.6 trillion at risk - and no trillion dollar bailout plan is going to stop that bubble from bursting.

The most likely effect of a further injection of funds to rescue failed corporate fat cats is a hike in interest rates as the U.S government proposes to purchase bad privacy-sector debt at above fair market values, rather than a significant discount due to the poor liquidity those assets represent.

First There Was The Housing Debt Crisis 

According to the Federal Reserve and the FDIC, private sectors and local governments also own residential mortgages in substantial quantities, so the bailout plan would also have to cover:

The issuers of asset-backed securities who currently hold $2.1 trillion in mortgages,

  • Nonbank finance companies with $426 billion
  • Credit unions with $332 billion
  • State and local governments with $159 billion
  • Life insurance companies with $61.6 billion, plus
  • Private pension funds, government retirement funds and households
Then Came The Commercial Debt Crisis
Then you have to take into account commercial mortgages. There are $2.6 trillion worth of commercial mortgages and they’re now also going bad. And some are also held outside the banking sector.
  • $644 billion held by issuers of asset-backed securities
  • $263 billion held by life insurers
  • $65 billion at nonbank finance companies and
  • $37 billion at Real Estate Investment Trusts (REITs)

While the mortgage crisis in the U.S began with home mortgages they have quickly spread into commercial mortgages, credit cards, car loans and almost any other kind of loan that the private sector could service.

There are now $14.8 trillion in residential and commercial mortgages in America. But beyond mortgages, there is another $20.4 trillion in consumer and corporate debt. This means that mortgages represent less than half of the private sector debt in America.

What else?

How About Local Governments?

Local governments might be an even bigger concern. You see, the Fed currently estimates $2.7 trillion in municipal securities outstanding, most of which have been dependent on a bond insurance system that remains on the brink of collapse.

And is There A Bigger 'Time Bomb' Secretly Ticking Away?

At the root of the global panic after the Lehman Brothers crisis is the derivatives time bomb – the biggest, baddest bubble of them all. And the most feared! Here’s why…

1. It’s the biggest – commercial banks hold over $180 trillion in derivative debt.

2. JP Morgan holds $90 trillion of that – over half of it. It’s no wonder they were so quick to get involved in the other Fed-assisted bail outs.

3. But that’s nothing compared to the total notional value of outstanding derivatives, which according to 
Congressman Ron Paul, now stands at $1.1 Quadrillion - that’s 1000 trillion dollars. Now I don’t know
about you but I don’t think that number has ever been used in financial circles – this is a first!

What Will Happen When This Time Bomb Explodes?

The honest truth is that no-one knows for certain...but what we do know for certain is that if we want to understand how to predict a market we first have to understand that a market is simply a body of human beings - emotional human beings!

And what psychologists and neurologists have learned about how humans behave is that beyond the neural mapping that occurs by the age of two, human beings at the core emotional level don't change much throughout their lifetime.

Well, they’ve learned that virtually everything that determines how we think and feel was hard-wired, through our conditioning, by the age of two. And that since that age (at the core) people don’t change very much over a lifetime.

What happened when Bush and the Fed proposed its $700 Billon dollar bailout and told the world that if this Bill wasn’t passed the entire global financial system could collapse?

What happened was that gold soared $98 during trading that day, to finally close $84 higher – the single-biggest jump in the price of gold in one day - in history!

Now Congressman Ron Paul isn’t an investment analyst but even he has echoed what investment analysts have known for decades. That, in times of fear and uncertainty people move out of risky investments into the old safe haven – Gold!

Perhaps that's a clue...of course only time will tell.

Are We On Track For The Black October Crash of 2008?

And isn’t timing an interesting thing?

We are now into the month that brought about the Crash of ’29 and the Crash of ’87, so I see it as no coincidence that we are entering another possible Black October – I guess, again, we'll have to wait and see. The writing is however, well and truly on the wall and this government bail out attempt plus everything that doesn’t exactly spell good news for the month.

Right now the world’s paper-money system is risky. It depends on faith and trust. And because there is no trust in banks, financial institutions or government leaders, what we can inevitably expect is a bust!

People in the U.S are angry. And so they should be. Each U.S tax payer will have to carry an additional tax burden of just over $5,000 simply because greedy, failed bankers couldn’t run their companies properly.

The extra 'bailout-burden' is about what the U.S. has spent so far in direct costs on the entire Iraq war – which tax payers are also paying for. And to put that into perspective, that's equal to the combined annual budgets for the Departments of Health, Education and Human Services.

That’s where the current financial system is headed and I don’t believe any miracle can prevent it. Bailouts may stall the inevitable but the system is in need of a major overhaul and it must fail for the birth of a new system to come into being.

I certainly don't see the Fed cartel having a “mission-impossible-moment” and picking the right colored wire, one-second before the bomb goes off. The fact that they still have time to stall and distract with these smaller bailout strategies seems to be clear evidence that the real time bomb is still ticking.

Senen Pousa
Echelon Research Limited




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Another analogy - betting on the house burning down

Some of us never go to race tracks, and find a "fire insurance" analogy easier to grasp. This was from a Q&A session at the Washington Post website

Washington Post business columnist Steven Pearlstein was honored with the Pulitzer Prize
recently for commentary for his columns about mounting problems in the financial markets.
Pearlstein was online Wednesday, April 2, 2008 at 11 a.m. ET to discuss financial regulation
reform and lessons from the current crisis.

A reader in Thoiry, France: I have, in an amateur manner, tried to explain to my wife the basic principles of the $45 trillion credit defaults swaps market: Imagine that instead of going to a regulated insurance company we insure our house with a neighbor. We do this without knowing if our neighbor has sufficient funds to pay us if our house burns down. Our neighbor goes down to the local bar and (without telling us) sells the insurance contract to a stranger without making sure that he has funds to cover a fire in our house. Ten other people in the bar decide to get in on the action and sell and buy among themselves five contracts insuring our house against fire (i.e. making bets that our house will or will not burn down). In the end there are six insurance contracts on our house between people who do not know each other and who may or may not have funds to cover a fire. Imagine the mess if the house burns down...My wife does not believe that anyone would be this stupid. I claim that there are thousands of investment bankers and hedge fund managers with million dollar bonuses who are in fact this stupid. Is this correct? And what will happen when companies start to "burn down" in the coming recession?

Steven Pearlstein: You have it precisely correct. I am laughing out loud at reading your comment because I tried to do the same thing with my wife, using the same analogy, and she looked at me as if I was nuts. But it is important for everyone to understand this market, because it is a good metaphor for how we've run off the track. What started out as a legitimate hedging instrument, perhaps, has now morphed into an instrument not only of speculation but unfettered market manipulation (SEC, please note). Moreover, what you didn't explain to your wife is that these insurance contracts are then bought and sold on secondary markets using large amounts of debt--debt that in many cases is given by thevery banks whose "house" was being insured. So you get investors who may be doubling down on their insurance bets by borrowing from the same banks, or from hedge funds that have borrowed from the same bank. That's why this is so complex, why it is so intertwined, and why nobody knows what would happen if one major institution fails, although we can surmise that the ripple effects would be significant and difficult to know in advance.

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