Sub-prime Bail Out

[Big Red]

http://ml-implode.com/

that includes mortgage co. and banks such as bank of america whole sale

[xoxoxoBruce]

Don't foreclose, or drop the rate, lengthen the loan.

[tw]

This topic has two different aspects. First are the many homeowners who carry a sub-prime loan and were 'surprised' by their new interest rates; be that a teaser rate loan or other Adjustable Rate Mortgages.

Second are the various financial organizations who invested in these mortgages using various instruments such as SIVs, conduits, bonds, etc.

Many in the first aspect may have been foolish. Of them, some must indeed be punished by bankruptcy. But also may have been many banks that took those mortgages and are now stuck with homes worth even less. Or are they?

Whereas banks were once storage houses for mortgages; today, banks have become mortgage moving companies. Banks had less incentive to review an applicant's financial stability because the bank would bundle those mortgages into a bond. Sell the whole package off. Existing are many NINJA loans - "No Income, No Job Apparent".

Who would buy such risky investments? Welcome to a world where what you do today looks profitable today on spread sheets while risk can be ignored to only appear four and more years later on some future spread sheet. Many of these mortgages were sold to large investment houses such as hedge funds. According to bond rating firms such as Moody's and S&P500, these financial instruments had an AAA rating. After all, they were mortgages - and mortgages were always predictably stable investments. Few bothered to look inside; learn the details of these mortgages. Instead these mortgages were bundled in complex financial structures defined by 150 page complex legal and monetary agreements. Sure some would default. But few understood the time bomb implanted in these mortgages. Rather than study the product, too many 'geniuses' were too busy grasping the complex legal overhead. Few bothered to learn why so many banks (and mortgage companies) were ignoring the risk (i.e. Ninjas). Few bothered to instead look inside to learn details of those mortgages.

Many who bought these financial instruments expected even higher profits when interest rates increased. So many were even rewarded with bonuses. Four some years later, the losses fell upon the financial institutions. The guy who did not do his homework had profited already and may have been long gone. (Many of the corporate presidents responsible for the mess were fired with $200 million type severance payments.)

This second aspect is a story of major financial institutions now caught in a major liquidity crisis. Not a shortage of capital - a severe liquidity crisis. Well some, such as CountryWide Financial, took precautions. CountryWide hedged their risk by purchasing $hundreds of million in credit lines from major banks. IOW the liquidity crisis created by so many homeowner defaults moved through companies such as CountryWide Financial and ended up on the banks were underwriting these organizations and never expected the sudden demand for cash.

Other banks (such as Citigroup) attempted to become a full service institution. So they bought and held riskier mortgage packages since those (should) pay better in the long term while requiring no additional 'cash on hand'. This liquidity problem was supposed to be addressed by Basel 2. Riskier investments would have required banks to keep more 'cash on hand' for riskier investments. But Basel 2 never got instituted. Banks could reap higher profits for the same 'cash on hand' by purchasing riskier mortgages. According to their financial experts (and S&P 500, Moody's, etc), there was no higher risk. These were mortgages.

Not all banks did this. But more irresponsible organizations include Citigroup, Bank of America, and JP Morgan Chase did. These three banks just announced a 'slush fund' (it has many different names including MLEC) so that a bank can borrow. Remember, the sub-prime loan mess does not create a shortage of capital. All banks (including Britain’s Northern Rock) had sufficient capital. But with so many defaults, the banks needed some liquidity while liquefying other assets. Unfortunately for Northern Rock, the British version of a Fed may have accidentally created a run on that bank. A liquidity crisis - not a capital shortage - undermined that institution.

These three American banks want others to join. But why? European and other American banks were not so promiscuous. Why would they want to join a fund that underwrites other bean counters that do not do their job? It is their job to identify risk four and more years before that risk can appear on any spread sheet. Instead these promiscuous types created off-balance corporations to mask their risks even from stockholders.

Because Citigroup's was so negligent - only investing in these sub-prime loans based only on financial returns rather than on risk - then Citigroup may be broken up. Citigroup may be worth more in pieces than as the unit once created by Sandy Weil. Critics note that no financial institution has ever succeeded in creating a 'one stop for everything' store. That is what Citigroup tried to be. The sub-prime mess may be the "camel's straw".

Merrill Lynch was once one of Wall Street's most conservative and stable organizations. It was never a most profitable company; but always a benchmark of good safe investing. Their new executive started pushing for higher profits; take more risks. The strategy looked good. Merrill Lynch profits were better. So executives were well paid with bonuses based upon yesteryear's spread sheets. Never forget how economics works. The spread sheets report things that happened 4 and more years ago. Today's spread sheets are now reporting those ignored risks created by financial managers investing in these SIVs or conduits. Another reason why those investments looked good? They were carried in off-balance entities - similar to how Enron masked massive losses.

In theory, these off-balance entities were only profit centers that also required no 'on hand cash' to be maintained. In reality, these off-balance entities would only suck liquidity out of the company without warning - because off-balance entities need not appear on the company reports to stockholders. Money games that are legal? Just another example of mistakes made so many years ago never appeared on spread sheets until today. How many of those executives prospered with $millions in bonuses long before the spread sheets could actually report reality four and more years later?

Merrill Lynch suddenly *discovered* an $8billion loss. If the SEC is not investigating, then the ghost of Harvey Pitts remains in the George Jr administration. Speculators believe Merrill may have another $10billion loss coming. Yes the loss was created many years ago when genius financial experts did not bother to study the risks - did not even know the details inside those investment packages. But they so clearly understood the 150 page complex agreements attached to those financial instruments. Only today - many years later - are those bean counter oversights actually appearing on spread sheets.

Again, this is not a financial crisis - a massive shortage of capital such as in the 1920s. This is only a liquidity crisis. The Fed has made loans more available for these institutions. But ... welcome to what happens years later when these actions eventually appear in the economy.

Remember, the stock market crash of the late 1920 did not appear in the economy until 1933/4. Economics has a bad habit of taking revenge when people solve problems using money games. Providing too much easy money can create other problems. Sharp increase in inflation (if you did not notice prices have risen far higher than 'core inflation' numbers). Other problems could be higher precious metal (gold, copper, etc) prices. Dropping dollar. Higher oil prices. And if too much currency in other nations is in dollars, then a worldwide dumping of dollars which only makes those problems even worse again. Eventually Americans (and government Treasury) must sell off assets to pay for these problems. Which American companies must become foreign owned? How many more treasury bonds must the government sell (mortgage your future) to pay its bills?
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[tw]

[continued from previous post]
Does this all sound drastic? That is jumping to conclusions. All these things are happening or will happen. Just will not happen catastrophically. For example, whereas the dollar once bought one Euro, it may soon require $1.50 to buy a Euro. $100 per barrel oil? That is all but inevitable. $3+ gallon gasoline is no longer the worry. When gas was under $2, most never imagines $3 gasoline. Currently realistic is $4 gasoline due to many reasons including the quickly falling dollar. The government has been playing money games with debts. China has all but been financing "Mission Accomplished". Reducing taxes while spending wildly will come back years later when debts come due. And when those debts do not result in profits, also expect higher inflation.

So what can we expect? Clearly many organizations starting with major financial institutions must fire employees or sell off parts of America to foreign investors. Bear Stearns has already accepted massive Chinese investment. That is followed in the next decade by lower living standards. After all, when those profits start going to new overseas owners, well, who has less income?

Whereas government numbers mysteriously claim near zero inflation, well, the average lunch that once cost $5 when George Jr took office is now closing in on $10. Inflation, that must result from spending today without yet paying the bills, is coming. Taylor says interest rates should have been rising in 2003 to keep inflation in check. Instead we dropped interest rates - made easy money - keep the economy out of recession. We did the equivalent of ''ripping up the front lawn and reseeding it'. That created economic activity; makes higher GDP numbers. But when the profits do not appear years later and the debts come due - starting about now - four years later. If Taylor is correct, then expect the economy to punish for living too easy.

Has the sub-prime loan mess started the downfall? Was it just another example of money games to make the economy appear temporarily better? Something like 70% of the CA home loans were sub-prime. Using the housing market to make the economy appear healthier, does economics start taking revenge four years later?

This is not even a primer. More like snap shots of the many valleys and mountains in a country called ‘Sub-prime Crisis’. Appreciate how widespread a problem well beyond homeowners. Will it create a recession? No. Is it a precursor to recession? We will only know how much damage to the economy has occurred during George Jr’s tenure too many years from now. Has a major economic catastrophe been averted? I believe so. Apparently the majority of bad loans have conjugated in some badly managed institutions where bean counters only saw profits and completely ignored all risks.

One final note. Equifax claim they are not as risk. Equifax says they have something unique - risk analysis programs that do more than just measure default. It also measures liquidity risks. S&P, Moody’s, et al are said to have started creating similar products. These bond rating firms claim their ratings ignore time factors (sounds almost like admitting crime without being guilty). IOW a few defaults every year in an instrument is expected – still gets a high rating. But many defaults simultaneously is possible with higher rated bonds. That is a completely different risk problem.