All of this money had to go somewhere. Where did it go? Or did it just go around in circles, with every seller of crap CDOs using the proceeds to buy more crap CDOs?

Jeff: To answer your question, here is the bonus pool for 2007 (just one year) for the 5 former investment banks (Goldman, Morgan Stanley, Lehman, Merrill & Bear Stearns):

$32 billion

"here is the bonus pool for 2007 (just one year) for the 5 former investment banks (Goldman, Morgan Stanley, Lehman, Merrill & Bear Stearns): $32 billion".

I'm not proposing that these people should be putten under a gillotine in a big square somewhere. Nothing of the sort. I'm not a Jacobine or a Revolutionary. And I underline that.

I would just be happy if those billionaires were obliged to give back their money to the community in some sort of compensation scheme. And I don't mind if it was gradual.

PS: I'm actually beginning to be scared with the downfall of the markets. Nothing, absolutely nothing seems to work.  

Actually I'm for the guillotine approach. Also acceptable is the Chinese justice system's way of dealing with pirates-they line them up, bound and kneeling and shoot them in the back of the head.

No. The guillotine approach is no good. If not for anything else because one would double hate to see these scoundrels transformed into victims of fast punishments.

$32 billion is a lot of money, and the managers have a lot to answer for, but that's still a long way from a few trillion dollars. So I think my question still stands. Where did the huge sums that now appear as holes on balance sheets go? I am leaning toward the upward spiral of increasing speculation on worthless pieces of paper (drawing bonuses off each loop), but is that really right?

"Where did the huge sums that now appear as holes on balance sheets go?"

I think they didn't come from anywhere and they didn't go anywhere. It's called financial engineering. Welcome to the 21st century...

I'd guess that the bulk of those sums do not represent real stock of anything-- not specie, not hard assets, not real property.

All the more reason that the rescue plan should be focused on solvency, not assessing and buying up crap mortgages. If the mortgages really are the problem-- which btw undermines the Dem talking point that F'n'F weren't at the very center of the mess-- then just swap out the underwater mortgages, all $300b or so of them, with new 30-year mortgages at some suitable rate (Glenn Hubbard of Columbia B-School proposes 5.25%).

But if the problem is the capital ratios of the financial firms, ie, assessing the proper degree of capital cushion needed now that so much of our financial base is illusory, then a different approach is needed-- specifically, deleverage and recapitalize the banks, aka start over as if in a bankruptcy.

Would that our elites could * at least * define with some clarity and intelligence which problem it is they're trying to solve now...

Actually teplukhin2you, these bits of paper reflect claims on real assets- company's earnings and real assets, individual's wages and residences, etc.- just like every other financial asset out there. Collectively they are a significant portion of assets on the books of entities with myriad and considerable liabilities (be they deposits, repos, cp, debentures, etc.). Therein lies the problem.

It is for this reason that 'buying up crap mortgages' was considered one way to ease the systemic strain, (in particular by financiers). The thinking is that these institutions simply cannot unload any of this stuff, whose risk profile was continuously deteriorating and calling for greater regulatory capital and more forced deleveraging of the kind of (liquid, valuable) assets the banks don't want to sell, because there's simply no market in it any more. $700 billion buys a market in the paper. That gives the banks the ability to unload the deteriorating credits and screw over current bond holders by playing good bank bad bank, all without completely diluting shareholders or having more executives lose their jobs or control of their empires (did I mention it was written by Hank Paulson for Hank Paulsons?).

This problem cannot be subdivided into sectors of the debt market, residential real estate or otherwise. The problem is the sheer scale of the pyramid of claims this economy is teetering on, ($2.5tn non-financial debt growth 2007, on a $1tn pace as of last quarter), none of which is news to people with the gumption to investigate it before the tsunami hit. 7% of GDP current account deficits against negative savings rates* and huge recycling of dollar surpluses into an exponentially leveraging and ballooning dollar debt market. Wheee!!!!

It's the same thing on climate change- ignore all the evidence and overwhelming case and be shocked the day when the long forecasted consequences hit home. Well, they're here now, and sorry to be the bearer of bad news, but it is far too late to get out of this by way of bailout. There simply is no magical solution out there- massive job losses, wealth destruction and a dramatically lower standard of living are the price of refusing to acknowledge inconvenient problems; of buying into convenient slothful ideology.

If you want villains, start with the one in the mirror.

* Large current account deficits are considered reasonable if they are used to fund investment- ours manifestly was not.

Walt Kelly rules

Somewhat off-topic, but if you want good bloggy coverage of the economy, I recommend reading Calculated Risk ( calculatedrisk.blogspot.com ) and Naked Capitalism ( www.nakedcapitalism.com ) -- every day.  Both are very good at covering important events and also providing intelligent opinion and context.  I've found them invaluable.

Also, if you want to explain the financial crisis to your dog, look here: scienceblogs.com/.../the_kibble_bubble.php

The first blog post is very informative.  It, and all of the other information that discusses the problem in depth, put the lie to the claim that the real problem is the bad residential mortgages supported by Freddie and Fannie.   (If people are even making that claim.  Sometimes I wonder if politicians are simply using the words "root" and "real" interchangeably).  

We should have know this intuitively.  How much would it cost to pay off the bad portion of every bad mortgage in the country.  The bad portion being the amount left on the mortgage above the value of the house and a bad mortgage being one that is not paid upon?

One thing I will say for the robber barons of the 19th century.  Yes they were rapacious, they exploited labor, they brided elected officials, and they trashed the environment, they attacted labor unionists in the street. At the end of  day there were still mills, rail roads, oil refineries, and a multitude of new patents.

Pray tell, what patents, or lasting contributions have  these barons of high finance given the world?  Other than perhaps huge mansions in Greenwich, CT.

Just such a scandal

Did Cohen place the leverage in the wrong spot?  I think so.

The first post introduces investors with too much cash: "investors in Asia and Europe ... recycled the cash ... into these CDOs"   Fine, those investors bought the AAA-rated tranches of the $2T of CDOs and they'll suffer losses.

But the other $18B of leverage doesn't exist.  The 10x leverage refers to the creators of the CDO, and the amount of underlying equity protecting the more senior debt.

Note that it wouldn't make any sense for the buyers to borrow money: as the blog says, they've got the "too many dollars" problem, for which they were seeking dollar-denominated assets with attractive returns.

davefl999 is right.  The 2nd blog entry by Cohen was very difficult to follow, and points to an article dated "March 13", which took me a while to figure out is really 3/13/07 (not '08).  Anyway, as dave says, the 13x leverage refers to how the creator of the CDOs paid for the assets it bundled.  This means that the (if all the CDOs had this leverage), they consist of roughly 2 trillion in assets (mortgages, loans, etc), that were purchased with only $142 billion of investor money and another 1.86 trillion in debt (with the CDO being the borrower).  So, there is not another "20 trillion" hole.  Also there is no reason to assume that the "avg" CDO leveraged that much.  Given the inconsistencies in Cohens blog, it's hard to give too much weight to any of it.  I'm scared to death as it is about the 2 trillion, but no need to fuel it with nonsense that decent fact checking and editing should prevent.