Even sub-prime loans have some collateral.

US unsecured (credit card) debt is currently $763 Billion.

Then again, some might walk away from an upside-down mortgage, but they aren't gonna risk losing their shopping privileges.

Posted by: Semanticleo at September 21, 2007 11:59 AM | Permalink to this comment

BD, calm down. Like many media commentators, the author of your excerpt shows a fleeting understanding of the financial markets. Just enough to be inflammatory. A few points to help you regain your healthy skepticism. Mortgage securitization is one of the oldest parts of the securitization market. Banks funded loans on balance sheet 10 years ago? Yeah, right, and every night the bank manager puts my savings account money in his vault. The vast majority of the asset-backed commercial paper market is not only secured by collateral, it is also supported by letters of credit (absorbing the first 1%-3% of losses) and liquidity back stops (e.g., there's always a buyer of last resort when your CP matures) from highly-rated banks. Not a single holder of bank-supported CP has lost a penny in this market. Finally, isn't GDP a periodic number (e.g., Global GDP of 2006) while "outstandings" is a cumulative number? Why shouldn't the number be greater?

Posted by: TP at September 21, 2007 02:32 PM | Permalink to this comment

TP: I'm not saying we're on the cusp of the Great Depression. And it might have been a bit much for thestreet.com's journalist to make it appear the mortgage securitization industry simply didn't exist pre '95 or such (though there wasn't as much contagion-risk given less preponderance of exotic conduits like SIVs and SIV-lites and the rest of it--though yes, there are far fewer SIV-lites and SIVs themselves are less often exposed to the riskiest of the subprime, I'll grant you...)

But what do you mean exactly by "bank-supported CP"? Is that statement meant to incorporate the entire asset-backed cp market? B/c if you're trying to tell me that not a single penny was lost in the ABCP market this summer which basically shut down and where all kinds of mark-downs occurred I'm afraid I remain unpersuaded, certainly if you look at tangential knock-on effects where people lost $$ in, say, the S&P--given issues arising from subprime contagion, stalled ABCP market, etc). Regardless, with additional ABCP paper maturing, more ugly surprises are likely in store...indeed, I wouldn't be surprised to see a few more bank failures a la Northern Rock...

Again, the very Gates of Hell might not be opening in terms of some massive financial cataclysm, but there is huge froth still rolling through the financial system (compare to LTCM, which was just a single hedge fund, after all!). Bernanke's rate cut only delays the inevitable, imho.

Plus, inflationary pressures still appear rather worth noting. Oil is at historic highs and even adjusted for inflation we're a big spike or two away from testing inflation-adjusted historic highs. Meantime agricultural commodities are surging, another risk factor vis-a-vis inflation. Given the horrific state of the housing market, the asset bubble, weak dollar and inflation risk, if you were a portfolio manager, would you not be counseling clients to increase allocations in cash and gold, like I (in somewhat facetious manner) suggested above? Or is Dow 36,000 beckoning? Sorry, but I think the bears have the stronger case just now...

(Related, of course, one wonders, might the almighty American consumer, debt-ridden as he or she is, buckle under soon give all the above...?)

Posted by: Greg Djerejian at September 21, 2007 04:38 PM | Permalink to this comment

NINJA AAA Mortgage (No Income, No Job, No Assets, Alt-A Adjustable rate Mortgage).

Shouldn't it be "No Income, No Job, Assetless, Alt-A Adjustable rate Mortgage).

PS... is Edward Djerejian who is quoted in today's WP your dad?

Edward Djerejian, a former U.S. ambassador to Syria and founding director of Rice University's Baker Institute for Public Policy, said that when he was in Israel this summer he noticed "a great deal of concern in official Israeli circles about the situation in the north," in particular whether Syria's young ruler, Bashar al-Assad, "had the same sensitivity to red lines that his father had."

http://www.washingtonpost.com/wp-dyn/content/article/2007/09/20/AR2007092002701.html?hpid=topnews

Posted by: p_lukasiak at September 21, 2007 08:00 PM | Permalink to this comment

BD,

Just to be clear, I'm a bear in this market. I've been bearish on the RMBS and ABS CDO side since mid-2006. I am a portfolio manager in this sector. I agree with nearly all of your concerns listed in your second post (although I counsel cash, Euro and Yuan-linked assets - not gold!). My point was to expose how the Street.com commentator was repeating a misconception about what is going on. SIVs have been around since the late 1980s. As you point out, most SIVs have relatively little exposure to subprime RMBS. Still, SIVs have been caught up in a broad market panic surrounding asset-backed commercial paper (ABCP) because, IMHO, most of the buyers of said paper (and the average investor who purchases money market funds) didn't understand the difference between structures. In the late spring, a Bear Stearns hedge fund suffered significant losses and underwent a forced liquidation (it held a lot of RMBS and ABS CDO paper). Market participants began to question the value of their own holdings. Then the Rating Agencies came out in July with a large scale downgrading of many RMBS securities and ABS CDOs that had purchased the securities. It all hit the fan.

As prices went south, a lot of vehicles that are run on mark-to-mark rules (like SIVs) started to suffer NAV deterioration. Several ABCP conduits that did not have liquidity support were forced to extend the maturity of the issued-CP. CP conduits that do not have bank support (e.g., 100% liquidity credit line that will redeem CP as it comes due) are a small fraction of the overall ABCP market. However, when the extensions occurred (and this had never happened before) people panicked. They didn't "sell" their CP but they allowed paper to mature and fewer and fewer buyers appeared for newly issued paper. If you are in a SIV or another MTM vehicle, this is a double whammy - assets decline (triggers at risk) and liabilities come due. The SIV-lites have been hit hardest and some are in liquidation.

Sorry for the digression but this is to address the question of bank-supported CP. Most of the ABCP market is backstopped by highly-rated ('AA' and 'AAA') banks that will ensure that all CP is redeemed when due. Essentially, the price declines and credit risk of the assets become the problems of the banks (reason enough for bank regulators to be concerned). If the banks were unprepared for the sudden liqudity draw (see Germany) a rescue is needed. Now most ABCP is bank-supported so the risk described by the commentator was over-blown. Not "non-existent," because this risk does hit the banking system, but over-blown. The result was a panic. A "bank run" on the ABCP market. At the same time, mind you, these same banks that supported the ABCP (Citibank, ABN Amro, HSBC are some of the largest) were funding in the UNSECURED money markets at levels well inside of the collateralized ABCP market that only existed with their explicit support. Go figure.

Posted by: TP at September 21, 2007 08:43 PM | Permalink to this comment

TP: Sounds like we're actually in broad agreement, all told, though your last comment appears (perhaps I'm misreading you) to construe the CP issues as largely behind us, while I believe quite a few going forward issues are looming (even if there was some irrationality with the 'panic' you describe, when, say, BNP Paribas can't value several of its own funds, and if similar events occur in the future, a rational actor will become more risk averse too).

Additionally, as you acknowledge, there is also at least some ABCP out there that isn't bank supported, and regardless, further stress on various banks (which I think is still coming, Lehman and Goldman results this week notwithstanding, for instance) will cause market gyrations and impact sentiment, I believe.

I agree w/ you on yuan-linked assets (and to a lesser degree, perhaps with a shorter time horizon, the Euro) but why are you bearish on gold? Do you think it's overpriced around $740? Or? I see more upside for it in the short to mid-term (inflation hedge, safe haven/geopolitical risk--say another Bush blunder pre Jan '09 w/ Iran--which I'd say is a 25-30% chance all told, etc etc). Your view here appreciated. Thx

Posted by: greg djerejian at September 21, 2007 11:22 PM | Permalink to this comment

Cribbing from Wikipedia, a shorthand guide to some of the acronyms used in the useful and interesting discussion above:

CP --Commercial paper is a money market security issued by large banks and corporations. It is generally not used to finance long-term investments but rather to purchase inventory or to manage working capital.....Commercial paper essentially can be compared as an alternative to lines of credit with a bank. Once a business becomes large enough, and maintains a high enough credit rating, then using commercial paper is always cheaper than using a bank line of credit.

SIV -- structured investment vehicle can be imagined as a virtual bank. It borrows money using the commercial paper...[and] then uses the money to purchase bonds - effectively lending it out much as a bank would provide loans. The bonds usually selected by an SIV are predominantly Asset-Backed Securities (ABS) and hence the SIV is effectively providing the funds for mortgages, credit cards, student loans and similar products.

RMBS --Residential mortgage-backed securities are a type of bond commonly issued in American security markets. They are a type of Mortgage-backed security, but are backed by mortgages on residential rather than commercial real estate.

LTCM --Long-Term Capital Management was a hedge fund founded in 1994....Initially enormously successful with annualized returns of over 40% in its first years, in 1998 it lost $4.6 billion in less than four months and became the most prominent example of the risk potential in the hedge fund industry. The fund folded in early 2000.

As a lay reader who himself works in a field replete with acronyms and terms mystifying to people who do something else for a living, I thought the above might be helpful. TP's observation upthread, to the effect that SIVs have lately been caught up in a panic because some purchasers of a specific kind of commercial paper didn't fully understand what they were buying, strikes me as sound. It goes double (or more) for the general public, which it seems to me adds a significant potential risk factor. An economy that depends too much on transactions most people don't understand is more vulnerable to panics both financial and political. I don't know enough to say how much is too much, and know enough to understand that this is not the main thing driving markets now. But that may just be because enough things haven't started going seriously wrong.

Posted by: Zathras at September 22, 2007 07:34 AM | Permalink to this comment

Echoing Zathras' point above, I thought he'd enjoy this op-ed from a day or so ago by FT columnist Philip Stephens (excerpts below):

King concedes that those outside the financial services industry must have watched recent events unfold with “utter bemusement”. A bemusement, he might add, that fully explained the anxieties of those in the queues outside Northern Rock.

I am not sure, though, that bemusement is quite the right word. Justified suspicion might be better. Perhaps the crowds sensed that nothing is straightforward any longer. The reason why the crisis crossed the Atlantic, after all, lay not so much in the scale of the subprime losses but in the calculated opacity of today’s financial markets. The squall became a hurricane because the risks of subprime lending had been carefully concealed in the mortgage securitisation market and then scattered to the winds. No one knew where they had come to rest.

I can already hear the sophisticates sigh. What should we expect? A return to a world where every bank deposit is marked in a ledger against a precisely matched loan? What, apart from anything else, would the commercial banks do with all their highly paid mathematicians?

In one respect this is obviously right: it is too late, even if we wanted to, to roll back the frontiers of financial innovation. The integration of global economies and markets may feed our insecurities, but it also makes us richer. But plainer folk, and I include myself here, are likely also to draw another conclusion. Why should we trust anyone?

And, all told, isn't it fair to say that Central Bank ministrations (read: moral hazard) really only excacerbate this mistrust in the long run? Yes it's much more complicated than that, but it's a topic that merits more attention, I'd suggest...

Posted by: greg djerejian at September 22, 2007 09:22 AM | Permalink to this comment

Yes, we're in agreement. Sorry if I came across otherwise. I was dwelling on the details because I think they may give some clue as to what happens next.

I think the CP "panic" is behind us. There are at least three more issues looming (probably more but I can only worry about so much at a time). My first concern is that CP will be repriced. Maybe six months or so ago, a lot of ABCP traded slightly wider than corporate CP with the same rating (hence the attraction to money fund managers) but in a very narrow band. ABCP with a bank backstop did not yield much less than SIV CP, extendible CP and CP that supported portfolios that were marked-to-market. Now that it is VERY clear which is which, I expect ABCP to be wider (a higher rate of interest) than the CP of very highly-rated corporations. I expect extendible CP (maybe it matures in 30 days, maybe I make you wait another 60) to be much wider than non-extendible CP. I question whether market value driven CP is viable in the near term. SIV-Lites (a very basic type of SIV that focused much more on ABS and RMBS securities that were less liquid) may be gone. I believe that there were less than 10 outstanding as of June 30th and one or two are currently in liquidation.

This is the threat to the SIVs. I do not manage a SIV (though I am familiar with them). My limited understanding (based on published bank research) is that the SIV portfolios were less exposed to subprime RMBS and ABS CDOs. That would be because SIVs are very leveraged and very dependent upon daily marks and net cash outflow tests (basically, do you have enough cash coming in to meet debt coming due in the next, say, five days). They tend to have portfolios with shorter durations and greater liquidity. However, they were also fond of bank capital notes (usually very liquid, highly rated and "yieldy"). The current crisis put stress on ABS and finance companies, including banks. So, my second concern is that SIVs, like hedge funds, start to liquidate holdings under pressure. The equity (sometimes called Capital Notes or Income Notes) holders will take a loss. In a more dire scenario, the CP holders at the top will take a loss because SIV CP typically only has a bank backstop for 10-15% of the notional.

This is all manageable but not pretty and, with the exception of the CP that may be held in money market funds, the losses will be incurred by so-called "big boys."

My third concern, which BD has articulated better than I can, is that the real driver for all of this, large losses tied to consumer debt, has not yet been realized. I think it has been reported that foreclosures are up significantly. So are delinquencies. Projecting forward, this means that a lot of losses are still embedded in the system.

I don't believe that this poses a direct threat to the solvency of any U.S. bank. I'm not a bank analyst and I don't know how much any given bank has on its balance sheet. However, the whole point of securitization is not only risk transfer but risk dispersion. From a regulator's point of view (not a politician's) it is far better for a billion dollar loss to be spread out than to be incurred by one or two banks. As I understand it, LTCM was perceived as a threat because a small group of banks was exposed to significant losses. [Insert here the old joke about "if I owe the bank $100 I have a problem...].

So, while losses may not topple any U.S. banks (European banks and Asian institutions who invested significantly in the equity and lower-rated tranches of this stuff are another story), they will severely impact the U.S. People losing their homes is bad. People struggling to pay off massive amounts of debt is bad. People in these situations reduce their spending which means lower production, lower job growth, more pressure on already stagnant wages, etc.

In one sense, this is typically what happens at the end of any bubble. Because housing, mortgage capital and consumer debt are such key drivers of our economy, the outcome here could be particularly dire. I don't see much that the Fed or Washington can do to soften the blow. As you may have noticed, Fed rate cuts don't immediately translate into lower costs of interest on your credit card, car note or mortgage. It usually means more profits for lending institutions who borrow funds linked to Fed rates.

To your point about what can be done, I think you're right that pulling back on the frontiers of financial innovation is not a useful path to follow. I would point out that much of what drove the growth of the bank-sponsored ABCP market were bank capital rules that allowed banks to hold little to no capital against cp conduits that they were supporting. If liquidity is actually drawn, they incur capital (this could be what happened in Germany). Otherwise, its a very attractive business, low risk assets, cheaply financed, no capital. New rules being implemented under the Basel II accord will likely change that (banks will hold capital against conduit exposure) so growth in the ABCP market will likely slow down and the impact on banks of a "panic" such as this will be muted.

Another suggestion is improved oversight on the part of financial regulators. As another poster pointed out, SIVs are very much like banks in that they borrow money to invest elsewhere. In fact, I'd argue that the asset/liability duration mismatch of a SIV (or a non-bank-supported conduit like that run by mortgage lenders) is not that different in theory from that of a bank. However, most banks have a much more diversified base of assets *and* liabilities. They also incur much more significant oversight regarding any mismatches. Who regulates SIVs and mark-to-market cp vehicles? The rating agencies who are paid by those same entities. I do not for a minute question the integrity of the rating agencies, I simply note that in most industries, we don't allow the regulators to be directly compensated by the regulated entities. It is worth asking if conduits or SIVs of a given size should be regulated by a more centralized authority (some of these entities are over $10 billion USD in size). Similarly, its worth asking if Northern Rock was overly reliant on short term funding given its size and whether the applicable regulatory authority (the FSA?) should have noticed. I don't think of these as radical changes. If anything they put institutions that engage in similar activities on similar footing.

Finally, on gold. I don't fully understand it so I lack confidence in it. It can be used as a store of value, I suppose, but it doesn't "earn interest" and its alternative uses (consumption) are rather limited compared to other commodities (say, oil). I am only tangentially familiar with the long term studies regarding its value and real prices but my understanding is that it is *very* volatile in the near term and somewhat unlinked to broader economic activity in the longer term. Granted, this is a layman's view but I tend to prefer investments whose fundamentals I understand. (So, for example, after the 2004 U.S. election results, I shifted towards yuan and oil-related assets - as well as RMBS. If you can't fight City Hall, what hope do you have against the White House?)

Posted by: TP at September 22, 2007 01:44 PM | Permalink to this comment

TP;

Clearly you are conversant about insider strategies and have the necessary concomitant of optimistic short-term groupthink, but I wonder if you are too close to the story.

Heuristics is a concept that is difficult to define with common language, but I believe it is something summed up simply. It is common sense, or instinctive intelligence.

Is there any financial game plan in the Industries you would be comfortable describing as 'Long Term'? Short sells and profit-taking
seems the only genuine goal. Oh, you can claim there are long term health provisions that can be extrapolated within each band-aid presented, but everything is predicated on next quarters report providing enough growth to keep the ball rolling. Can any present 'feel good' be trumped by a distant benefit which, overall, creates a more healthy financial organism?

The Saturday preceding Black Monday I bet a financial planner who was predicting DOW to reach 3500, that it would drop 500 pts before that ever happens.

I avoided the dot.com (without regret over lost opportunity) bust because it didn't feel right. I have a similar feeling about this period of uncertainty. Institutional pressure from Boards and Stakeholders forces decisions that are certainly not in my interest, but run counter to their long range health, as well. Jim Kunslter says it better than I can;

"You will hear about central banks and hedge funds and derivatives and mortgage backed securities, and all kinds of jargon, but the issue will really come down to matters other than finance. Are we building a society with a future? Does our culture affirm life or yearn for destruction? Are our daily ceremonies and rituals meaningful or empty? Are our hopes and dreams consistent with what reality has to offer? Can we look in the mirror and say that we are upright people?

I think we are in trouble with all these things. But I doubt we can give up our current behavior without going through a convulsion. The psychology of previous investment is, for us, a force too great to overcome. We will sell the birthrights of the next three generations in order to avoid changing our behavior. We will blame other people who behave differently for the consequences of our own behavior. We will not understand the messages that reality is sending us, and we will drive ourselves crazy in the attempt to avoid hearing it."

http://jameshowardkunstler.typepad.com/clusterfuck_nation/2007/09/crunch-time.html

Posted by: Semanticleo at September 22, 2007 02:18 PM | Permalink to this comment

TP,

So, while losses may not topple any U.S. banks (European banks and Asian institutions who invested significantly in the equity and lower-rated tranches of this stuff are another story), they will severely impact the U.S. People losing their homes is bad. People struggling to pay off massive amounts of debt is bad.

Isn´t that pretty US-centric?
You don´t think that such events (European and Asian banks in danger of toppling) would make European and Asian banks a bit more wary about accepting US financial papers/securities in the future?
Especially since some of that faulty "Mortgage securitization" papers were rated pretty high? Down-grading stuff seems to have happened only recently?
Wouldn´t that result in mistrusting the rating agencies generally?

I think I´ve read that the USA is now a net-borrower? Shouldn´t a borrower be concerned about his credit rating?

Posted by: Detlef at September 22, 2007 04:25 PM | Permalink to this comment

Semanticleo, I agree that I may be too close to this at the moment. I hestitate to consider myself an "insider" though. I am not a mortgage expert and I'm not a quant. I work with RMBS investors and analysts so I am conversant in some of the jargon but my own analysis relies on long term comparisons. For example, Shiller's analysis of the real estate market several years ago showed a fundamental dislocation between historical growth rates and recent ones. It was one of the reasons I have not been an optimist about this sector for awhile.

There is a large part of the financial industry that is, in my view, "long term." Most banks, for example, focus on making loans at one interest rate and funding them (through deposits, medium term notes and equity) at lower rates. They don't trade their assets (loans) and they don't securitize them. Most CDOs are buy and hold vehicles. The assets are relatively illiquid fixed income securities and loans so there isn't much upside to be gained. Even conduits and SIVs are generally long term vehicles in that they accrue their earnings over time though they fund with shorter term liabilities.

That said, there is a significant portion of the market that is compensated on a near term basis. Most originators of securitized product (residential and commercial mortgage, credit cards, student loans, etc.) have an economic interest that is somewhat front loaded. Investment banks and rating agencies are usually paid when the deal closes, whether it performs well later or not. I agree with the suggestion that a near term economic interest can lead to aggressive and sometimes reckless behavior.

Detlef, I agree. My comments were very U.S.-centric as I was following the general theme of the original post (also, I have limited knowledge of the holdings and strength of non-U.S. institutions). I agree with your observations of the impact all of this might have on the U.S. in general and on the value of the dollar, specifically. To that, I would add that, IMHO, the credit crunch, is essentially the reaction to an asset bubble (cheap mortgage rates and easy lending terms led people to bid up the value of residential properties and the increase in value led people to speculate on future increases). This asset bubble was probably not confined to the U.S. as the post 9/11 environment and dot-com crash caused central bankers to lower interest rates in much of Europe as well. Markets such as Spain may experience a slowdown in housing growth and an increase in defaults (the recent comments of the PSOE's finance minister that such thing is "unthinkable" notwithstanding). Just my two cents.

As far as the "recent" nature of the downgrade and potential distrust of the Rating Agencies, I disagree that the alarm bells were only sounded recently. Market participants I work with have been discussing the poor quality of 2006 mortgage originations since the 3rd quarter of last year. All three major agencies were voicing concern about the mortgage market by the first quarter of 2007. As a result, the ABS CDO market slowed down significantly and spreads widened. People were nervous. A website went up tracking the seemingly daily demise of one mortgage originator or another. The originators, the bankers, the investors and the agencies all saw the signs that "something was afoot" but, as is often the case on Wall Street, no one wants to be the first to leave the party, especially if you can't "short" the market. Traders and Hedgies can short. Bankers, lawyers, rating analysts and most "buy and hold" investors cannot. They tend to keep playing until the music suddenly stops.

Posted by: TP at September 22, 2007 06:29 PM | Permalink to this comment

TP,

no disagreement here. :)

I am a bit outraged at some German/European banks who did buy this crap. I mean, I was reading American blogs warning about the subprime and Alt-A mortgage dangers months ago. I´m at a loss why someone would still buy it in late 2006, much less early 2007. Probably greed blinded some people.

So I wouldn´t be hurt if some investors/institutions really lose some money here. Unfortunately, that probably means that some deserving good credit risks won´t get approval either.

Although on the other hand, German banks did seem to have different rules for domestic loans ( we need lot´s of security here) and buying anything Wall Street offered. Being a small business owner in Germany, I can´t help feeling a bit resentful towards German banks....:)

So while I would be wary about most US investments right now, it doesn´t mean that I trust German banks that much.

And you´re certainly right about the dangers of the housing boom in Spain or Ireland. I wonder how the ECB will deal with that.

Posted by: Detlef at September 22, 2007 07:48 PM | Permalink to this comment

As a lay reader who got out of mortgage banking after the real estate down-turn of the 1970's, I am not particularly concerned about the financial markets by themselves or even about them in combination with a normal recession. However, a perfect storm could develop from the combination of an unregulated global financial system, a recession, and a dramatic spike in oil prices, triggered, say, by an attack on Iran and an Iranian retaliation on Gulf export terminals. My guess is we'll almost certainly know if this is in the cards by the end of April, 2008.

Posted by: JohnH at September 22, 2007 08:41 PM | Permalink to this comment

This thread certainly stands as good enough reason to keep the comments section alive, Greg. Very informative. Perhaps even too much so for someone whose most valuable asset is a '93 Honda Accord.

Posted by: FGF at September 23, 2007 10:30 PM | Permalink to this comment

I have really enjoyed this thread. I think the major macro issue that needs addressed is the potential tectonic shift in investor risk preferences. Markets do not move in straight lines typically and the shockwave of this summer should be taken seriously in my opinion. The Fed moved to cut rates aggressively, as well as other market actions, with stock market indexes within 5% of all time highs and the latest GDP report at 2%+ and employment close to what most mainstream economists consider full employment.

I think it is very clear that the Fed and Treasury people understand that the global economy has been rising on top of a credit inflation induced frenzy and that targeting asset prices is the only way to try and keep the house of cards from crashing a global credit contraction from developing. Gold is breaking out in ALL MAJOR CURRENCIES - even the Japanese Yen. This is not suggestive of inflation but rather concern over fiat currencies and central banks that are willing to devalue - it appears to be a race to the bottom.

Of course, creating credit and targeting asset prices will not force people to want to take more risk. The Japanese failed at that game for 15 years. I personally believe that the risk cycle has peaked and that the pendulum is swinging back towards risk aversion. That is deflationary and the worst fear of inflationist central bankers. They will do anything they can to try and prevent it - including devaluing the US dollar. Many smart people like Jim Rogers contend that the US is already in recession in real terms, as the reported CPI figures are total fiction. It is only when nominal GDP contracts that the gov't would be in trouble and a large scale credit contraction would likely take hold.

This grand monetary experiment should be truly something to behold. The world has never seen the global reserve currency in fiat form come from a nation as indebted as the US. All other nations without that reserve status have seen their currency regimes collapse long before where the US has reached. It will be interesting to see how it all plays out and over what timeframe. However, I personally believe that owning gold is a CRITICAL hedge against these risks. Many are mistaken that gold is a hedge against inflation. In reality gold has performed best in deflationary periods, as they have been the most disruptive to banking systems.

Posted by: James at September 24, 2007 06:17 PM | Permalink to this comment

Thanks for the glossary above. It is helpful.

I do not work in any sort of financial industry, but I can tell you that from the outside, it kinda looks like the money guys don't know what the hell they're doing. It just seems foolish to invest in loans made to people who very likely won't be able to pay them off (and that part of it seemed clear from the beginning - no money down loans that "reset" after a year or so - that just doesn't seem smart). Maybe it's my college intro to economics understanding, but it seems to me that when there are deficits at one end of the equation, so to speak, there have to deficits on the other end, ie, someone's losing a crapload of money. And I have a feeling it won't be the money guys. I fear (someone tell me how likely this is) that some idiot in Congress will suggest that another bailout (sorry, "cleanup") is called for and the sob stories of people losing their homes will cause all the spineless pols to vote for such a thing.

Someone please feel free to correct me if I'm wrong, on any of the points above.

FYI, I live in the Dallas area, which, despite being among the better markets now, is still seeing kind of eye-popping increases in foreclosures. But they're still building stuff. So someone still has money. Or the appearance of having money.

Posted by: LL at September 24, 2007 06:52 PM | Permalink to this comment

Why don't we just take all of the Bush/Cheney clan's wealth away? That should help some. After what they've done and stolen to us I would think they deserve it.

Oh, also the Hague.

Posted by: MNPundit at September 26, 2007 08:41 PM | Permalink to this comment

And I had the misfortune(?) of having my letter to the FT begging Berspankme to not cut rates print a few days prior to the 50. I wasn't nearly as witty either as I invoked Dr. Gloom.

Great comments from TP, but I would add it seems to me many of the SIVs were simply set up by banks to move those assets off balance sheet. That they now are the backstop shows the goodies never really left. Second, briefly touched upon, is that many(?) of the SIVs were just as mismatched as the S&L's were in the 80s. Had they better matched the assets and liabilities (while giving up profit) the ship would be in much better shape today.

Last, people need to understand the problems were not with the securitization of loans per se, thats been done for oh.. 20 years? The problems came with a failure to see the pools were becoming more highly correlated and the failure to fully understand exactly what one was buying. I mean, didn't we go through this in 1994 with CMO's? Toxic waste is a term that came long before 2007. And lets not forget greed. CPDO's? Yeah.. great way to pick up some extra yield. People forgot with reward comes risk.

Posted by: mike at September 28, 2007 12:54 AM | Permalink to this comment

This is also the same sort of shake-out that Japanese banks had in the '90s, where they (painfully) discovered that some things are riskier to invest in than others, and you'd better have a handle on it.

Here, the quants sliced and diced the stuff so you would theoretically take a whole bunch of low-rated stuff, stuff it into a CDO, and through the magic of statistics end up with something with much less risk that they could slap a AAA rating on.

Problem is, everyone ignored what would happen when all the correlations go to one....

Gas molecules never scream and stampede into the corner of a box; humans often do.

Posted by: grumpy realist at September 28, 2007 09:32 AM | Permalink to this comment