How to lose a trillion dollars
The simple answer. Take financial risks and leverage your risk to the maximum.
Now, a little more detail.
Let's use the Case-Shiller index that shows that homes have declined in value by approximately 15% across the country in the last year. Of course, regular readers will know that I think Case-Shiller overstates the decline by focusing on the largest housing markets and is heavily weighted toward some of the most distressed markets including California and Florida rather than the more modest 3% declines seen in the Charleston real estate market but for this discussion, let's go with a 15% annual decline.
RealtyTrac reports foreclosure information each month and the latest report indicates that 1 out of 416 homes across America is currently in some stage of the foreclosure process.
OK, so every house in America has not gone into foreclosure nor has every home in the country declined to zero. There are 50 million homes with mortgages and 70 million homes in the country. So how did some financial institutions manage to lose so much money.
Let's make an assumption of what went on. Instead of simply loaning money, they leveraged their loans by 10 times, 20 times or were even more highly leveraged. So let's say that if you packaged mortgage backed securities and leveraged your risk by 10 times, that one house in foreclosure of 416 is now one house out of 41.6. And if you leveraged your risk by 20 times, well, now it is one house out of only 21. That's a lot of foreclosure activity and mega financial losses to have on your books. And with no transparency and very opaque balance sheets that accountants and attorneys far more knowledgeable and financially sophisticated than me have no idea of the real value.
Now if you bought stock in one of the firms that have declined by about 99% thus far this year, you could have lost a lot of money but probably a little less than a trillion dollars (unless you really bought a lot of shares). Even if you own a very diversified portfolio of stocks or a mutual fund, the declines have been so sharp and across the board that it's likely you are feeling some serious financial pain.
On the other hand, if you bought a house, while you may not have made any money in the last year and you might have lost some value, your home isn't worth zero and in my opinion, it won't ever get near that low (and if it did, we have far bigger problems than anyone could ever imagine).
Who would have thought when we first heard that some subprime borrowers were getting behind on their mortgage payments about a year and a half ago that so many major financial firms would get into so much financial hot water.