A cartoon primer on the subprime debacle:
Here. Informative and amusing.
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A cartoon primer on the subprime debacle:
Here. Informative and amusing. |
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I see clients agree to things all the time that I don't like. No risk, no reward.
"It's just unfathomable how this could have occurred."
Good to see my education was useful for something.
On a related note, I'd love to see some blogging on the Bear Sterns situation, and in particular whether what the Fed did has implications under the Takings Clause. If the Fed basically ordered the Bear Sterns shareholders to sell to JP Morgan Chase at $2 a share, isn't that a taking?
Of course, JPM did this for a reason. One way or another they think this is in their best interest.
I'd say "follow the money" but I'm not sure just where that leads.
If the alternative was Bear Sterns' bankruptcy, the $2/share could be considered a gift.
The Fed hasn't ordered the shareholders to sell. Its given them the option between getting $2 per share instead of nothing.
Bear Stearns was suffering a run, and lacked cash on hand to pay their creditors and depositors. What they DID have was an enormous pile of mortgage backed securities that nobody is currently willing to buy at a price anywhere near what BS (what an unfortunate acronym) needed to cover its liabilities.
In short, they had a severe liquidity problem. They were heading for Bankruptcy Court...within hours. And the shareholders of a financial services business are highly unlikely to get ANYTHING back after the trustees are through with it.
The Fed was worried that letting BS go into bankruptcy would spread the crisis to other somewhat less wobbly firms. So they offered to temporarily take BS's big stinky pile of mortgage backed securities as collateral for a 30 Billion dollar loan _IF_ somebody stepped in to buy BS and cover its obligations.
Apparently, JP Morgan is the only one willing to give the shareholders ANYTHING. $2 a share. Is the shareholders reject the deal, BS is almost certain to go into Bankruptcy court where they will get nothing.
My own suspicion is that the Fed is perfectly happy to see BS shareholders get sheared. It provides powerful incentives for financial industry firms to straighten out their balance sheets rather than doubling down on their bets and hoping for a fed bailout if things go even further south.
that's what I referred to in my subject line when I emailed it around.
How about Fed tells JPM: "If you do this we'll help your brokerage house clients &swap partners get through the now inevitable rough patch by letting them borrow directly from the Fed window for a few months."
It's like betting on the underdog in a boxing match. If you lose, you shouldn't be crying about it.
Many lenders (and bond purchasers) thought it was _impossible_ to lose more than a few months interest payment because, after all, the USA real estate market was never, ever, EVER, going to experience a sustained drop in prices.
A significant fraction of buyers of these securities knew the above was nonsense. But most of these people bought into another line of nonsense: that when a real estate market correction occurred, they could simply liquidate their holdings of mortgage-backed securities before they fell too far in price.
Problem is, when the correction happened in the real estate market, no one with any sense was willing to buy the securities, because nobody knew if they were worth anything at all, let alone how much. The "market" simply evaporated.
If you've been watching the US auto industry's problems for the past few years, and want to fully understand them, just read his 1980 book -- he accurately predicted it over 25 years ago.
The same mentality then was applied to the US Defense Department when McNamara's number crunchers took over there. For the result, I suggest reading Strategy for Defeat: Vietnam in Retrospect (c) 1978, by Admiral U. S. Grant Sharp (who had a ring side seat).
Is there any wonder that BS and, likely, other brokerage houses, are in trouble? c.grey is correct:
Of course, that that is exactly what happened to housing in the Oil Patch in the 1980s, which collapsed the real estate market there and caused the failure of multiple S &L's (and prosecution of quite a few attorneys, appraisers and S &L officers and directors), was a lesson largely forgotten. Inflated prices, even in real estate, eventually are subject to reality.
Too bad Halbersham is dead. He could have explained it in terms that even MBAs and politicians could understand.
I saw that yesterday. My favorite slide too is the Office of the Accountant Czar's response to a request for accounting rules that promote greater transparency regarding these transactions: "Blow me."
I don't remember the Chief Accountant of the SEC saying that when I worked there, but you never know.
--|PW|--
It's a little more complicated than the latter explanation. In a lot of the securitization transactions there are mortgage pool delinquency and default performance triggers that cause the rating agencies to downgrade the related bonds. Once that happens, a lot of the insurance companies and pension funds (and maybe small Norwegian villages, as in the presentation) that are required to invest in only investment-grade paper must sell their holdings. Of course, since there was a small pool of buyers and no ready secondary market, it is difficult/impossible to actually value the paper. Worse, many banks and other institutions that use "mark to market" accounting are required to periodically adjust the book value of their assets to the market price. So even if, as you suppose, the actual and expected default rates are not in the catastrophe zone and the bond holders would get a healthy return if the bonds were held to maturity, the book value of some of the assets is zero because there is no secondary market for them. Also, on the insurers: insured deals are rated on the credit risk of the insurer, not the issued securities (in the case of asset-backed securities) or the issuer (in the case of regular corporate or sovereign debt). If the insurer goes under or if the rating methodology is thrown into serious question, the whole thing goes out the window.
I can't speak for all banks, but in my area the banks definitely cherry-pick. When I bought a new house in 02, it was made clear to me that the bank would personally service my loan. They used it as a selling point in fact. About the same time, one of my wife's friends got a mortgage from the same group at the same bank, and they apparently sold her loan immediately to some company in Texas (who sold it to some other company a year later). I've heard similar stories from other people I know.
I suspect the way it works is that most of the local banks have a "commercial" group who does business loans and such. When the mortgage group finds someone who looks solid and they expect to make payments and not default, they probably use the commercial staff to service the loan locally since that staff is already doing similar work. And then instead of just making a quick commission for selling the loan to someone else, they make a rather nice taking over the life of the loan (and honestly, they continue their relationship with you which may lead to other good things for them in the future) :)
--|PW|--
I don't think I want to know what would happen if Wall Street types found out about imaginary numbers.
Where have you been for the last 200 years?
You mean their balance sheets?
And the federal government's...
Until someone with cash is convinced that 1) the housing market correction is over and 2) that _nobody_ responsible for administering the arcane, multilevel mortgage-backed securities has any financial skeletons in their closet, X appears to be very close to 0.
2) is probably going to prove a huge obstacle to unraveling this mess. Nobody is certain who owes who money and who owns what share of any given defaulters debt. They are also unsure if the organizations they buy insurance from to deal with this kind of uncertainty are going to survive the shakeout.