Subprimes and such

[Al_U_Card]

And when the crux of the issue becomes indebted servitude? We owe our souls (and bodies and futures) to the company store (corporations/banks).

 

The largest growth industry in the US lately? Prisons and prison service providers. And they haven't started to throw debtors in.....yet.

[Al_U_Card]

Which means that the Dow will see under 10K again.....right?  (Japan's SI having sunk almost 50%)

The "Dow" is an average of industrials, I don't expect it to drop quite that far. Close.

 

http://finance.yahoo.com/q/bc?t=5y&s=%5EDJ...5EIXIC&c=%5EDJI

 

Both the Down Jones Transportation and the NASDAQ more than doubled since 2003. Wouldn't surprise me a bid for them both to drop down to half their summer values.

 

S&P 500 and Dow Jones Industrials...maybe 70% of their current values.

Here in Canada we have the TSX which is more broad based. There is also a large component in raw materials and resources.

 

Unfortunately, the banking/financial sector is also very large.

 

10,000 sounds about right to me.

[pdmunro]

Quotes re subprime crisis:

 

"These sorts of things are what's known to the academics as "endogenous to the system"--that is to say, they're normal. They happen usually every three to five years. So we had a freezing up of the market for corporate credit in the summer of '02. We had an equity bubble just before that. In '98 we had Long-Term Capital. In '94 we had a mortgage collapse like we're having right now. In 1990 we had an S&L collapse. In '87 we had a stock market collapse. These things flow through the system, and they're part of the system."

 

Bill Miller, Chairman and chief investment officer, Legg Mason Capital Management

http://money.cnn.com/galleries/2007/fortun....fortune/5.html

 

 

"Gary Shilling’s 12 Investment Themes:

 

1. The housing bubble has burst.

2. The Fed will ease; meanwhile, the yield curve will remain flat inverted

3. U.S. stock prices will fall, perhaps below the 2002 lows, in the midst of a major recession

4. China will suffer a hard landing due to domestic cooling measures and U.S. recession

5. Weakness in the U.S. and China will spread globally, dragging down economies and stocks worldwide

6. Treasury bonds will rally

7. The dollar will rally, but not before the recession is global

8. Commodity prices will nosedive

9. Maybe global and chronic deflation will commence

10. Maybe U.S. consumers will start a long-run saving spree, replacing their 25-year borrowing and spending binge

11. Maybe deflationary expectations will become widespread and robust

12. Speculative areas beyond housing may suffer in 2008. "

 

Gary Shilling, Forbes magazine columnist

http://store.digitalriver.com/store/es_764...illing_FDC_Edit

[Al_U_Card]

Sort of the 12 "daze" of christmas....Gormenghast style... :D

[Al_U_Card]

You can almost smell the brimstone...

 

http://market-ticker.denninger.net/2007/12...look-ahead.html

 

 

a lot of interesting info about what has been discussed on this thread as well as cogent advice.

[hrothgar]

You can almost smell the brimstone...

 

http://market-ticker.denninger.net/2007/12...look-ahead.html

 

 

a lot of interesting info about what has been discussed on this thread as well as cogent advice.

I wouldn't take advice from anyone using the "Raving Lunatic" style sheet...

[jtfanclub]

I wouldn't take advice from anyone using the "Raving Lunatic" style sheet...

Their history is pretty much spot on, from what I know. I have no idea if their predictions are reasonable or not...

 

but I am going to see if my 401(k) has a T-Bill Fund.

[Winstonm]

You can almost smell the brimstone...

 

http://market-ticker.denninger.net/2007/12...look-ahead.html

 

 

a lot of interesting info about what has been discussed on this thread as well as cogent advice.

I wouldn't take advice from anyone using the "Raving Lunatic" style sheet...

Depends on the definition of "raving lunatic". The Goldilocks crowd (Larry Kudlow, etc.) have been calling NYU economics professor Nouriel Roubini a "permabear" for a long time, but other than being about 3 quaters early in his projections, he has been pretty much spot on about economic developments.

 

Contempt pror to investigation does not help find facts or truth.

[Winstonm]

Back in July 2007, Countrywide Financial's stock was trading in the low 40's.

They have now agreed to be bought out by Bank of America for $4 a share.

Countrywide is a Federal Reserve primary dealer and the largest mortgage lender in the U.S.

 

A drop in share value of 90% and a forced sale of a primary dealer gives an idea of the impact of the unwind of the credit bubble instigated by Greenspan and Co.

 

"Too big to fail" just became an inoperative phrase. The Fed can create liquidity, but they cannot create capital - all that balance-sheet asset growth due to faulty valuations that was leveraged to buy more faulty products is turning out to be mothing more than "ficticious capital", and it is disappearing faster than it was created.

 

Maybe a better term is "mirage capital", as the ones riding in to the rescue with fresh capital infusions are from the deserts of Abu Dhabi and Saudi Arabia.

 

Edit: Late-breaking news 1-12-08:

 

AP

WSJ: Citi May Get Cash From Saudi Prince

[Winstonm]

I categorize this from The Washington Post in the "must read" category concerning this economic/housing mess:

 

http://www.washingtonpost.com/wp-dyn/conte...0402186_pf.html

[pdmunro]

What are these derivative things? How much are they going to magnify the damage of the sub-prime crisis?

 

Let's pretend I'm an investment banker in 2006-2007. In early 2006, house prices are rising so people are paying their mortgages and the value of my CDO's look secure. But in the knowledge that some of these CDO's are riskier than stated on the package, I take out a CDS, where someone else pays up if the mortgagees can no longer make their payment.

 

Now it's the trading in those CDS's that I am interested in. Does the CDS have a lifetime of say 50 years and were they put into the derivatives market where they are traded over a much shorter time spans of, say, 90 days?

 

Look I am really completely ignorant on all this. I have never traded an option in my life. What sort of option position is taken? How do I gain/lose money?

 

Here are a number of quotes to read. Of course, the final quote from Warren Buffet is the most insightful.

 

In principle, credit default swaps help banks and other investors pass along risks they don't want to keep. But in the case of sub-prime mortgages, the derivatives have magnified the effect of losses, because they allowed bankers to create an unlimited number of CDOs linked to the same mortgage-backed bonds. UBS Investment Research, a unit of Swiss bank UBS AG, estimates that CDOs sold credit protection on roughly three times the actual face value of sub-prime bonds rated triple-B.

 

The use of derivatives "multiplied the risk," says Greg Medcraft, an Australian who is chairman of the American Securitisation Forum, an industry association. "The sub-prime mortgage crisis is far greater in terms of potential losses than anyone expected because it's not just physical loans that are defaulting." 

From an article I posted earlier from WSJ.com

 

2) Tired of trying to sell the riskier investments?  Then keep the CDO and its cash stream but take out an insurance policy.  This insurance policy is called a credit default swap (CDS).  The underwriter of the CDS gets a big return at the cost of having to pay up if the mortgagee defaults on his loan. 

 

Interestingly when a number of CDS's are combined, they are called "synthetic CDO's" which better reflects their origin.

From a paraphrase I attempted in an earlier post.

 

"And it doesn't stop there. CDO losses now threaten the AAA ratings of a number of insurance companies that bought CDO paper or insured against CDO losses. And because some of those insurers also have provided insurance to investors in tax-exempt bonds, states and municipalities have decided to pull back on new bond offerings because investors have become skittish."

From Winstonm's article immediately preceding this post.

 

I recalled reading, in Warren Buffett's Berkshire Hathaway reports, less than complementary comments about the derivative positions they inheried when they purchased Gen Re. I have found a very interesting analysis in his 2005 report. It follows.

 

'Long ago, Mark Twain said: “A man who tries to carry a cat home by its tail will learn a lesson that can be learned in no other way.” If Twain were around now, he might try winding up a derivatives business. After a few days, he would opt for cats.

 

We lost $104 million pre-tax last year in our continuing attempt to exit Gen Re’s derivative operation. Our aggregate losses since we began this endeavor total $404 million.

 

Originally we had 23,218 contracts outstanding. By the start of 2005 we were down to 2,890. You might expect that our losses would have been stemmed by this point, but the blood has kept flowing.

 

Reducing our inventory to 741 contracts last year cost us the $104 million mentioned above. Remember that the rationale for establishing this unit in 1990 was Gen Re’s wish to meet the needs of insurance clients. Yet one of the contracts we liquidated in 2005 had a term of 100 years! It’s difficult to imagine what “need” such a contract could fulfill except, perhaps, the need of a compensation-conscious trader to have a long-dated contract on his books. Long contracts, or alternatively those with multiple variables, are the most difficult to mark to market (the standard procedure used in accounting for derivatives) and provide the most opportunity for “imagination” when traders are estimating their value. Small wonder that traders promote them.

 

A business in which huge amounts of compensation flow from assumed numbers is obviously fraught with danger. When two traders execute a transaction that has several, sometimes esoteric, variables and a far-off settlement date, their respective firms must subsequently value these contracts whenever they calculate their earnings. A given contract may be valued at one price by Firm A and at another by Firm B. You can bet that the valuation differences – and I’m personally familiar with several that were huge – tend to be tilted in a direction favoring higher earnings at each firm. It’s a strange world in which two parties can carry out a paper transaction that each can promptly report as profitable.

 

I dwell on our experience in derivatives each year for two reasons. One is personal and unpleasant. The hard fact is that I have cost you a lot of money by not moving immediately to close down Gen Re’s trading operation. Both Charlie and I knew at the time of the Gen Re purchase that it was a problem and told its management that we wanted to exit the business. It was my responsibility to make sure that happened. Rather than address the situation head on, however, I wasted several years while we attempted to sell the operation. That was a doomed endeavor because no realistic solution could have extricated us from the maze of liabilities that was going to exist for decades. Our obligations were particularly worrisome because their potential to explode could not be measured. Moreover, if severe trouble occurred, we knew it was likely to correlate with problems elsewhere in financial markets.

 

So I failed in my attempt to exit painlessly, and in the meantime more trades were put on the books. Fault me for dithering. (Charlie calls it thumb-sucking.) When a problem exists, whether in personnel or in business operations, the time to act is now.

 

The second reason I regularly describe our problems in this area lies in the hope that our experiences may prove instructive for managers, auditors and regulators. In a sense, we are a canary in this business coal mine and should sing a song of warning as we expire. The number and value of derivative contracts outstanding in the world continues to mushroom and is now a multiple of what existed in 1998, the last time that financial chaos erupted.

 

Our experience should be particularly sobering because we were a better-than-average candidate to exit gracefully. Gen Re was a relatively minor operator in the derivatives field. It has had the good fortune to unwind its supposedly liquid positions in a benign market, all the while free of financial or other pressures that might have forced it to conduct the liquidation in a less-than-efficient manner. Our accounting in the past was conventional and actually thought to be conservative. Additionally, we know of no bad behavior by anyone involved.

 

It could be a different story for others in the future. Imagine, if you will, one or more firms (troubles often spread) with positions that are many multiples of ours attempting to liquidate in chaotic markets and under extreme, and well-publicized, pressures. This is a scenario to which much attention should be given now rather than after the fact. The time to have considered – and improved – the reliability of New Orleans’ levees was before Katrina.

 

When we finally wind up Gen Re Securities, my feelings about its departure will be akin to those expressed in a country song, “My wife ran away with my best friend, and I sure miss him a lot.”'

 

page 10, Berkshire Hathaway Annual Report 2005 (released in early 2006)

http://www.berkshirehathaway.com/reports.html

[mike777]

Actually...everything is a derivative...everything........

 

World is shocked..shocked...

 

something called sub prime goes bad...shocking......

[Winstonm]

World is shocked..shocked...

 

something called sub prime goes bad...shocking......

 

It goes further than simply subprime loans going bad - the problem was the speed at which they failed, the magnitude of total subprime loan failures, and the subsequent loss of value of the underlying assets.

 

The brilliant Wall Street minds at S&P admited in a conference call that their subprime model was based on a permanently rising value of housing assets, that if housing prices fell, their models would fail - and they were rating the CDO tranches based on this model. Go figure.

 

Add to this the shadow banking system that by securitizing housing loans has for the past few years replaced traditional mortgage lenders, and you end up with tons of undercapitalized, highly-leveraged hedge funds and market makers who are still sitting on mountainous losses that they cannot pay. The other side of those trades are sitting on profits they will never collect - fictional profits.

 

Bill Gross of PIMCO estimates losses of $250 billion just in the CDS obligations.

 

There are still billions of dollars on the books that have not been marked-to-market, meaning that tremendous amounts of capital assets are only mirage - meaning we are a long, long way from getting ourselves out from beneath this monster's foot.

 

Which is why Citigroup and others are having to raise capital by selling off pieces of themselves to our Abu Dhabi and Saudi friends - OPEC banking at its best.

[Mbodell]

It is amazing what happens when you let people be paid on commission and fee for each deal but then expect these deal facilitators to be the experts and advisors on if people should engage in these deals and also the ones most knowledgeable to self regulate.

 

The whole mess is sickening and it continues to get worse and worse. I think it is safe to say few people realize how bad the situation is.

[mike777]

It is amazing what happens when you let people be paid on commission and fee for each deal but then expect these deal facilitators to be the experts and advisors on if people should engage in these deals and also the ones most knowledgeable to self regulate.

 

The whole mess is sickening and it continues to get worse and worse.  I think it is safe to say few people realize how bad the situation is.

YOu seem to infer that the retail end is the problem.....as usual it is not......

 

btw what is the size of subprime mkt...assume 20% is worth zero...

[Winstonm]

btw what is the size of subprime mkt...assume 20% is worth zero...

 

That, Mike, is the problem - this credit bubble unwind is no longer contained to simply subprime mortgage lending.

[Gerben42]

Part of the real problem is that the banks are just like one big bank, they all help eachother out whereas the common folks don't have this opportunity.

 

If some things lose their AAA status that's only because they didn't deserve it in the first place. This will raise the honesty level of the ratings, so this is good news.

[Gerben42]

1. The housing bubble has burst.

2. The Fed will ease; meanwhile, the yield curve will remain flat inverted

3. U.S. stock prices will fall, perhaps below the 2002 lows, in the midst of a major recession

4. China will suffer a hard landing due to domestic cooling measures and U.S. recession

5. Weakness in the U.S. and China will spread globally, dragging down economies and stocks worldwide

6. Treasury bonds will rally

7. The dollar will rally, but not before the recession is global

8. Commodity prices will nosedive

9. Maybe global and chronic deflation will commence

10. Maybe U.S. consumers will start a long-run saving spree, replacing their 25-year borrowing and spending binge

11. Maybe deflationary expectations will become widespread and robust

12. Speculative areas beyond housing may suffer in 2008. "

 

So what does this mean for ME?

 

The "economy" is always such an abstract thing which I don't care about as long as my personal economy is doing fine.

 

The dollar will rally, but not before the recession is global

 

This already means that whatever $ I win at online poker loses value about the speed that I earn it, keeping my balance in € constant :)

[y66]

For some years I have wondered along these lines, first with credit cards where people that were in way over their heads could still get new ones and then with these mortgages. I think I have sort of an estimate of what happens.

 

In the model we all have in our heads, the loan officer represents the bank and is expected to make sound loans or else the bank loses and the loan officer gets fired. In actuality this is, or so I gather, far from the truth. The loan gets "bundled" (I have no clear idea of what this means), sold to someone, then used to back securities, folks buy shares, and so on. Presumably someone loses money somewhere, and there was this head of one of the investment firms that got fired, assuming a multi-million dollar severance package is called being fired. But the chain from borrower to loan officer to bank to God only knows where is long and obscure and it is not entirely clear that the bank loses anything or that the loan officer gets fired.

 

One simple to state solution, although I doubt it really is one, is to forbid this sort of transfer of responsibility. Make a bad loan or give a credit card to a deadbeat, you are out the cash. I'm sure that it is not that simple (Paulson is a smart guy and has no doubt thought of this and many other things) but I do think that this long chain of responsibility has something to do with the problem.

Maybe this will help if it goes through:

 

Senator Elizabeth Warren on Thursday introduced an aggressive piece of legislation that intends to take the financial industry back to an era when there was a strict divide between traditional banking and speculative activities.

 

The bill, which is also sponsored by Senator John McCain, Republican of Arizona, and two other senators, is named the 21st Century Glass-Steagall Act. Its intention is to create a modern version of the seminal Glass-Steagall legislation from the 1930s, which placed firm limits on what regulated banks could do. It was fully repealed in 1999, laying the groundwork for the mergers that created some of the biggest banks of today. If passed, it could force many of those banks to let go of their trading operations.

 

During the era of Glass-Steagall, there were no systemic banking crises like the one that occurred in 2008. The restrictions the bill put on the financial sector did not seem to do much wider harm. According to analysis of government gross domestic product statistics, the American economy grew an average of 4 percent a year from 1933 until 1999, when Glass-Steagall was in effect. Even some who championed repealing the act, like the former Citigroup chairman Sanford I. Weill, have since called for the breakup of the bank behemoths.

 

If nothing else, this will give McCain a boost with old white male voters who prefer blondes.

 

http://www.bloomberg.com/image/ikcUol3ttWWk.jpg

[kenberg]

A 2008 post? I had figured anything from 2008 had probably hit the shredder.

 

I have since noticed other structural features suggesting that the gov is a slow learner. A couple of weeks back the Post ran a story concerning loans the government gives to parents for college education. The article particularly spoke of HBCUs (Historically Black Colleges and Universities) but it seems to me the problem is universal. I gather many parents have great difficulty paying back the loans, and quite a few default. This needs some re-thinking. A particular college was cited where the yearly tuition plus fees is $22,700. This is not including housing. Many parents cannot afford this. It goes like this: The kid wants to go to a college he cannot afford. No problem, the parents can take out a loan. Often it is pretty clear that there is scant chance that the loan will be repaid. Effective result; The government gives $22,700 per year per student to the college. It is euphemistically called a loan, but a loan that won't be repaid is properly called a grant or a gift. The parents get stuck with bad credit, the taxpayer gets stuck with the lost funds, the college gets the money.

 

My oldest granddaughter will be a senior in college this fall. When she was applying, her parents sat her down and explained where they could afford to send her, and where they could not. She is going to a good school, progressing well, and she will be graduating without her parents, or her, being in debt. This is similar to my own college experience, or at least more similar than not.

 

I have no complaint about private schools. For the most part I think that they are a waste of money ( CalTech, MIT, Stanford, a few others are the exception to this statement) , but as long as it is the student's money or the parent's money, it's their business. And borrowing money is not a sin. But in large amounts, for people of limited means, it is often unwise to borrow and unwise to lend. And to lend it when really, for all practical purposes, it's a gift to the school that will be repaid by no one, is pretty close to fraud. It is totally unneeded. I went to the University of Minnesota. Tuition and fees (in 1956) was $220 a year. I took Math courses from Avner Friedman, Lawrence Markus, Hugh Turritin, Eugenio Calabi, Hillel Furstenberg, James Serrin, and others. You can look them up. They knew what they were talking about.

 

If I help someone with a gift, we will never speak of it again. If I help someone with a loan, I expect it to be repaid and I don't make such a loan unless I believe it is a reasonable expectation that it will be repaid. I would like the government to see things in a similar manner. Gifts are gifts, loans are loans, the guy dispensing the money is supposed to be able to tell the difference.

[Winstonm]

For those opposed to regulation and who still claim Fannie Mae caused the financial meltdown and Great Recession: Source

Everyone should read and understand the implications of these two sentences from the 2011 report of the Financial Crisis Inquiry Commission (FCIC).

 

“From 2000 to 2007, [appraisers] ultimately delivered to Washington officials a petition; signed by 11,000 appraisers…it charged that lenders were pressuring appraisers to place artificially high prices on properties. According to the petition, lenders were ‘blacklisting honest appraisers’ and instead assigning business only to appraisers who would hit the desired price targets” (FCIC 2011: 18).

[awm]

A 2008 post? I had figured anything from 2008 had probably hit the shredder.

 

I have since noticed other structural features suggesting that the gov is a slow learner. A couple of weeks back the Post ran a story concerning loans the government gives to parents for college education. The article particularly spoke of HBCUs (Historically Black Colleges and Universities) but it seems to me the problem is universal. I gather many parents have great difficulty paying back the loans, and quite a few default. This needs some re-thinking. A particular college was cited where the yearly tuition plus fees is $22,700. This is not including housing. Many parents cannot afford this. It goes like this: The kid wants to go to a college he cannot afford. No problem, the parents can take out a loan. Often it is pretty clear that there is scant chance that the loan will be repaid. Effective result; The government gives $22,700 per year per student to the college. It is euphemistically called a loan, but a loan that won't be repaid is properly called a grant or a gift. The parents get stuck with bad credit, the taxpayer gets stuck with the lost funds, the college gets the money.

 

My oldest granddaughter will be a senior in college this fall. When she was applying, her parents sat her down and explained where they could afford to send her, and where they could not. She is going to a good school, progressing well, and she will be graduating without her parents, or her, being in debt. This is similar to my own college experience, or at least more similar than not.

 

Cost today for University of Minnesota: Tuition and fees $13,620 for Minnesota resident, plus $8,312 for room and board on campus, plus $1,000 for books and an estimated $2194 for miscellaneous expenses. That's $25,026/year. Of course it's possible to save a bit on that especially if you can live at home, but Minnesota's a big state and commuting may not be feasible for a lot of students. These high costs that most parents can't afford aren't just for expensive private schools. Education opens a lot of doors in life (I think Ken Berg's life is a good example!) and if we don't want to close those doors for a really significant percentage of the population we need to address this issue.

[kenberg]

Adam, I think that we could agree on a lot.here. The escalating cost of tuition at public universities is a great shame. I, for example, could not have gone.

 

Need based scholarships exist so the sticker price and the actual price may be different but still...

 

Anyway, I would like to see kids be able to afford education at a public university. If a scholarship is needed, I had one and I would hope for one for others. If a loan is needed, I hope the tuition and fees are such that the graduate is not singing "I owe my soul to the company store" when he graduates.

 

There is something fundamentally crazy about offering huge loans to a kid so that he can go to an unaffordable private school when he could very well manage a public university, perhaps with modest and manageable debt. I finished grad school with some debts. It took about a year to pay them off. A reasonable objective.

[y66]

Elizabeth Warren won a debate scholarship to George Washington University at age 16. John McCain went to the Naval Academy (no tuition).

 

I see that Warren has also introduced legislation to reform the federal college loan program:

 

It would tie the interest rate on federal Stafford loans to the rate banks receive from the Federal Reserve, lowering student loan rates from as high as 6.8 percent to 0.75 percent, and saving students thousands of dollars.

 

Warren's proposal has received a groundswell of support since she first announced the legislation on May 8, including more than half a million signatures on several online petitions: 487,000 on a MoveOn.org petition, 106,000 on a Democracy for America petition and 81,000 signatures on a Progressive Change Campaign Committee petition.

 

Her bill also received the endorsement of the American Association of University Professors, American Federation of Teachers, the United States Student Association and the Young Invincibles, a millennial advocacy group.

 

A recent poll conducted by Public Policy Poling showed widespread support for lowering federal student loan rates, with 60 percent of respondents saying they back Warren's idea, including 56 percent of Republicans.

 

What will she do next?

[awm]

There is something fundamentally crazy about offering huge loans to a kid so that he can go to an unaffordable private school when he could very well manage a public university, perhaps with modest and manageable debt. I finished grad school with some debts. It took about a year to pay them off. A reasonable objective.

 

I'm not convinced this is really the case. Private schools are somewhat more expensive than public ones, but it's not the massive gap that it may once have been. Is the federal government giving way more in loans to people attending private schools than they would need to attend a comparable public school? Many private schools themselves offer aid, in order to get a more diverse student population or to attract the best and brightest. Sometimes this aid takes the form of loans. Basically schools (like many other businesses) want to move towards a model of charging people "what they can afford to pay" -- this is usually done by having a high "sticker price" and then offering discounts to "desirable" people who can't afford it.

 

Anyway I will agree that it'd be nice to have a publicly funded system of high-quality universities which qualified students can attend at a very low cost (i.e. a cost they could afford by working part-time at a minimum wage job). We seem to have had such a system back when Ken Berg was in college, but we have been moving away from it for quite some time now. If we had such a system, then the government could be out of the business of providing student loans.