Banks and the Probability Fire Department

Reading Baysage on Banks:

http://whatpowderfingersaid.blogspot.com/2011/09/outrageous.html

and he is rightly upset at the $5 fee Bank of America is slapping on the use of their Debit Cards. The bank blames the cost of doing business brought on by the financial reform passed after the 2008 debacle.

(My interest is pure academic, because my wife and I have exactly one debit card, it is not from Bank of America, and we have never used a debit card in our entire lives; credit cards are swiped freely and with a swashbuckling finesse, but never a debit card.)

The 2008 Financial Unpleasantness was NOT caused by the folks that contracted into the sub-prime mortgages.

It was caused by the financial system itself which effectively hid the sub-primes in bundles of financial instruments called Derivatives:  once the sub-prime was bundled, trying finding that needle in the derivatives haystack!
Foreclosure cannot begin if you cannot find the mortgage, and recall that many times the paper work associated with mortgages (Florida comes to mind) could not be found anywhere!

If the sub-prime had been left alone as individual mortgages, they would have gone bad, they would be real losses on the books of  banks, they would be easily identifiable, foreclosures would have been instituted. It would have been unpleasant, but it would work the way it was supposed to work.
In other words, the whole process following on a mortgage gone bad would have occurred. The problem became finding where the bad mortgages were hidden. Nothing about this part of finance could work the way it was supposed to work any longer.
It reached the point in 2008 where banks would not loan to other banks, because there was so much bad paper, and no one knew where it was.
That's why reform was needed. That's the usual scenario: a system breaks down, you fix it.

The process was a lot like this:
There once was a large city with many, many buildings, all wooden structures built closely to each other.In the old bygone days, when a fire call came in, the caller gave the exact location of a fire. The fire fighters went out to that address and took care of the blaze.

In the good modern days just before 2008, it was determined that it was too expensive to actually sit on the telephone, talking to the caller, and writing down the location of a fire. So a new fire-call system was instituted, and now when there was a fire, a red light lit up, and the fire department had to guess where the fire actually might be.

They could draw addresses from a hat and use a fair coin to toss and chose among them.
Then they went out to battle the blaze. If they found it, they fought the fire the exact same way they always had.
The worst part of the whole fire fighting process was finding where the fire was.
--