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The financial crisis explained in a simple way

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Recently, severals articles are talking about the very much discussed European financial crisis. It is not that easy to entertain all audiences with such an issue, as not all of us is dealing with finance, stock exchanges and markets, but we still can not help but just talk about it. The fact that very few of us are really understanding what’s going on seems less important than actually talking about it.

When in 2009 I read about the Leopoldo Abadia’s theory of crisis, which is already super famous in countries where Castilian language is spoken, I finally found a theory easy to understand, to be re-explained in a very simple way and also easy to make jokes about. It was sometimes criticized for being too simplistic and a bit naive, but it is still a brilliant theory, funny and feasible to anyone with no idea of why we are in such an economic situation, boys and children included.

I did some research and it seems that there are no official Italian or English translations for his brilliant “Theory Of Ninjas”. To explain the success of the theory, just during the first week of publication hundreds of thousands of people visited the author’s blog, reaching now an average of several millions.

Leopoldo Abadia is an industrial engineer, professor and writer who has taught for 35 years in the IESE Business School in Navarre, Spain. Following the success of the on line publication of his theory, which explains the economic crisis in Spain from the mistakes made by U.S. banks, he published the book “La crisis Ninja y otros misterios de la economía actual”, which in Spanish-speaking countries made him famous and gave him the opportunity to be invited by the famous TV conductor and comedian Andreu Buenafuente to his program.

Below I enclose the hilarious video of Abadía explaining the theory in front of Buenafuente. I suggest that this could be helpful during this period of elections and crisis, even though it is referred to a dialogue happened few years ago. I find it still useful to understand the actual period we are living in.

http://www.youtube.com/watch?v=WB9pExuXvl8

I hope that you could smile a bit while understanding it, and for a moment stop to feel lost as we normally do into this financial drama we are trapped in.

Since then, Abadía did more and he also has written new books. In his last one, you can find excellent advice: “El Economista Esperanzado. Urgencia Manual para salir de la crisis”- The hopeful Economist. Manual of emergency to stop the crisis.
His innate irony and contagious positivism appear as one of the best cure for the economic confusion we are living. To the question “Do you think that we now can still have hope?” he replies: “Clearly, yes!” And introducing his last book he states: “It is a dictionary including the best of everything I think … I focus in particular on the concept of “giving hope” in the sense that I can “make clear to anyone that we can get anything we really want.”

In the meantime, let’s start understanding the origins of the crisis:

THE THEORY OF THE NINJAS

1. U.S. banks decrease interest rates. They need to sell and create wealth but with low interest rates they can not.

2. So they decide to look for the right people to offer loans to. They are embodied as “ninja people”: the classic example of a person who has no income, no job and no properties. Basically the kind of person that you would not give 5 euros.

5. The banks begin offering loans to ninjas, explaining them: “I give you this house worth 70,000 € but you get 100,000″ The ninja obviously says: “Terrific!” And the bank then adds: “I need to charge you an interest rate a bit higher than 1%.” Where the ninja: “Should I care about it? Of course not!”.

6. So, with the difference of money the ninjas have received, which is 30,000 euro value, they make holidays, buy a car, make gifts to the family, or even invite other ninjas for parties and dinners.

7. The banks believe that the market will continue to grow and if the ninjas can not pay the loan, they could always resell the house whose value worth € 200,000 after. The problem is solved.

8. The market is creating wealth, but the banks need more money to lend. Where to find them? Easy, around the world. Otherwise, why would we need globalization?

9. The money will be then produced by taking properties loans which have been already sold and then reorganized in small packages. Three different types of loans will be created: good loans, regular loans and rubbish ones.

10. Once these little packages are well mixed, the banks can begin selling rubbish loans around the world. Better said, U.S. banks go to the other international banks and sell packages of rubbish. Of course, if a bank says to another one that it is selling rubbish the deal is unlikely to happen, so rather than saying rubbish the banks introduce the concept of “Mortgage Security Pack” (MPS). At this point the deal is guaranteed.

11. In this way banks around the world begin to sell rubbish to each others so that all of them start getting rubbish but none knows exactly how much.

12. But knowing at least that each bank has rubbish, nobody trusts anyone. So they begin to lend money every day (through the interbank market) with a specific interest rate, called Euribor (Euro Interbank Offered Rate). Now, if the reader was having fun at the beginning of the explanation because he was considering himself far enough from the ninja persona, now the word Euribor makes him feel a little bit closer to the problem. Since the Euribor is the rate of interest that determines the value of all our European properties loans.

13. Well, since banks do not trust each other, this interest rate (Euribor) continues to grow causing that at the end of the month we pay more. Sadly, what we were considering funny at the beginning of the story now is not that funny anymore!

In the video, Buenafuente asks at this point with an hilarious note: “Let me please understand, the bank where I relied all my entire life, the one based in my neighborhood, the one where I always find my very kind cashier, it does not know itself is failing?” Abadia replies: “Exactly, and even the bank manager actually doesn’t.”

14. Specifically, the bank manager knows that he is in a full international expansion, which means he is investing in a very good fund owned by the bank of Oklahoma (just a fictitious name). Nobody knows where this fund is based exactly but the name here in Europe sounds really good. So the bank of Oklahoma supposedly sell back this rubbish all over the world.
Therefore, even the little bank of my little village, that I trust blindly, has bought this rubbish. When I ask then where my money go, the banker will explain me that they go to the bank of Oklahoma in 5-10 seconds time. And in turn, after just 15 seconds, the money will be immediately offered to another ninja.

15. This means that nobody really knows what will happen in the world, because if I do not know how much rubbish I have and I don’t even know how much you have, we can not know how much rubbish is effectively circulating.

16. The International Monetary Fund said initially (we’re talking about few years ago) that the dimension of the crisis is between 10,000 and 500,000 million dollars. A difference that explains how little they know about it.
Then they said that the scale of the crisis was 700 billion dollars, which coincide with 700 billion invested by Bush. And then again it was said that the size was instead of a billion.

17. Abadia finally ends: lately it was written that the two big investment companies Fannie Mae and Freddie Mac have sold rubbish around the world for a value of 5.3 trillion dollars, and even if we would like to calculate this value mentally with pesetas or euros, certainly we couldn’t do it.


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