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Friday, September 26, 2008

Keep Your Eyes On The Ball

The blah-blah about Fannie, Freddie, CRA and all these other affordable housing initiatives did not cause this situation. Yes, there are sloppy bits there, and losing loans. But nothing causative. The SEC had a lot to do with it, especially with their action in 2004 allowing leverage ratios to go as high as 40:1 for some funds, but the real problem arose from what the funds were trading with - the underlying investments.

The real source of the problem was the NRSROs. And sure enough, some of the people who worked there are now talking:
Frank Raiter says his former employer, Standard & Poor's, placed a ``For Sale'' sign on its reputation on March 20, 2001. That day, a member of an S&P executive committee ordered him, the company's top mortgage official, to grade a real estate investment he'd never reviewed.
...
``I refused to go along with some of this stuff, and how they got around it, I don't know,'' says Raiter, 61, a former S&P managing director whose business unit rated 85 percent of all residential mortgage deals at the time. ``They thought they had discovered a machine for making money that would spread the risks so far that nobody would ever get hurt.''
...
Raiter and his counterpart at Moody's, Mark Adelson, say they waged a losing fight for credit reviews that focused on a borrower's ability to pay and the value of the underlying collateral. That was the custom of community bankers who extended credit only as far as they could see from their front porch.

`Didn't Want to Know'

``The part that became the most aggravating -- personally irritating -- is that CDO guys everywhere didn't want to know fundamental credit analysis; they didn't want to know from being in touch with the underlying asset,'' says Adelson, 48, who quit Moody's in January 2001 after being reassigned out of the residential mortgage-backed securities business. ``There is no substitute for fundamental credit analysis.''
There certainly isn't. I strongly urge you all to read the article excerpted above, and then follow with this one. Because the NRSROs would give this stuff investment grade ratings, the major companies in the business (think New Century, a new type of blue chip!) just kept loosening their credit standards.

This thing did not bust until the first non-agency MBS started popping up with payment defaults on the first and second payments, and long after many independent brokers had realized that appraisal fraud appeared nearly universal in some outfits. Unfortunately, a lot of commercial mortgage backed securities were written very loosely at the end, and corporate debt is somewhat better but not much.

I am so glad Lehman's dead. It was one of the worst. It deserved to die.

And in the wake, there's a global crisis, and the reason that there is a global crisis is that unfortunately, a bunch of lenders elsewhere were doing the same thing they were doing in the US. The US alone couldn't do this.

Japan's in recession - with a trade deficit in August, nothing's going to help very much. Singapore's in recession, China's going to try to spend itself away from a growth recession, and is now loosening stock investment rules, as well as buying into their main banks. Shipping rates are collapsing. Australia's government is already buying their own RMBS. UK banks want a government bailout, Fortis is in trouble (big trouble). Deutsche Bank and others had to cancel their planned sales of yen-denominated bonds. This is rather grim, because the European banks are over-leveraged in comparison to the big US banks. Before I am accused of partisanship, read what the European economists have to say about it:
European banks face greater capital shortages than their U.S. counterparts, but have become too big for any one European country to save, according to an article published Saturday by European economists Daniel Gros and Stefano Micossi on the Centre for European Policy Studies’ Web site.
...
The “overall leverage ratio” - a measure of total assets to shareholder equity - of the average European bank is 35, compared with less than 20 for the largest U.S. banks, the economists say, and relatively small writedowns on their assets could have a devastating impact on a bank’s capital.
More:
Daniel Gross, director of the Centre for European Policy Studies in Brussels, said euro-zone lenders are heavily exposed to the fall-out from the US credit crisis, describing the Paulson plan as a de facto rescue for the Euopean banking system.

It has emerged that French finance minster Christine Lagarde was one of those pleading with US Treasury Secretary Hank Paulson last week to bail out AIG, which had insured over $300bn of credit derivatives to European firms.

Mr Gross said Deutsche Bank deploys fifty times leverage and has liabilites of $2,000bn, equivalent to 80pc of Germany’s GDP. Fortis Bank has liabilities of 300pc of Belgian GDP. These dwarf the burden of any US bank on the US government balance sheet. He said EU states do not have the means to bail out these banks. Any rescue would have to come from the European Central Bank, yet it is not allowed to carry out bail-outs under the Maastricht Treaty law.
The war for money is entering the final stages. The crappy corporate debt in Europe is unbelievable, and the banks can't write it down properly.

If some sort of bailout plan isn't passed this weekend, it's very likely that one or more of the banks in Europe will roll over, and if one does, a bunch will.

So don't get petty about bailouts. There's no need to stuff money in Wall Street executive pockets, but the situation does warrant government infusions of capital.

I'm posting this after the European markets have closed. It's dire.

Comments:
So where's the pan-European bailout plan? Seems to me that if their banks are far more overlevered and exposed, they ought to be getting proactive about dealing with their end of the mess.
 
MoM, what did you think about the debate?
 
John - I think our bailout plan is supposed to serve them as well?

Viola - Neither one has much of a clue about economics. McCain is slightly more clued in than Obama. I laughed at the expression on Lehrer's face when he couldn't get a definitive answer from Obama on what parts of his spending would be modified to deal with the bailout costs.
 
MoM the problem with any Bailout from DC is that it will be written by K street lobbyists,and any thing positive eventuating from it will be accidental.Bloomberg had an article on it,and this is the biggest feeding frenzy of lobbyists in history.I watched the debate and learned that MCCain has a better haircut and Obama looked tired.Did Palin's interview with couric impress you?
 
Tom - I'm somewhat scared of the legislative sausage myself.

I didn't see the Couric interview. I just haven't had time.
 
Is the amount of money being destroyed going to
far out weigh the bailout proposed ? This should
imply deflation like we haven't seen before correct ?
 
Yes, we are going to see a substantial deflation in asset prices as the supply of money gets absorbed into covering bad debts.

We already are seeing some of it.
 
MOM, there is a comparison of the Dodd/Frank plan and the final plan here:
http://www.dcexaminer.com/opinion/blogs/TapscottsCopyDesk/Comparison_of_original_Paulson_bailout_to_compromise_proposal.html

If this is true it appears the final plan will be shorn of the pork for ACORN and extreme punishment for execs.

Hope it can work. Your view of the situation in Europe is scary.
 
Terrifying, actually.
 
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