Background On Credit Default Swaps

There's a really great article running on Newsweek on the history of the credit default swap, the instrument that ultimately got us into the fiscal calamity that has us teetering on your actual brink.

They even cover that "tranche" is the French word for "slice".

There are two thoughts that have crossed my mind about this whole mess.

One - maybe the Muslims are right that lending money for interest is inherently evil. Not for the reasons that they think, but, say, for the sake of simplicity, if you lend someone $100 and ask for $110 at the end of the year, where is that $10 going to come from?

Yes, pretty much, no matter how you slice and dice it, you're going to have to print that $10, so now $110 is worth the same as $100 was a year ago so you didn't make anything anyway.

My great-great grandfather was right - the credit system is a curse - not only to the buyer but to the seller as well.

The second thing is that no one can predict the future. Oh, you can try - you can come up with huge actuarial tables based on the past experiences of thousands or millions of people and make a good ATTEMPT at pricing risk, but, guess what - just about every time if you wait long enough some new variable will enter the situation and all your old statistics will end up utterly worthless.

Yep ... we're in bad, bad trouble, boys and girls ...

CNBC Reporting Fed Takeover Of Fannie And Freddie - All Shareholders Likely Wiped Out

CNBC is reporting that top executives and board members were meeting in Washington today with regulators and that an announcement is expected tommorrow detailing the restructuring of Fannie Mae and Freddie Mac.

ALL shareholders - common and preferred - are expected to be WIPED OUT or diluted beyond recognition.

I'm thinking I remember reading somewhere that stuff like this was what precipitated the Great Depression.

I'm also beginning to wonder if my favorite Conspiracy Nut friend might have been right.

Had the Fed not gone on that rate-cutting spree after 9/11 the conditions that led up to this may have never happened ...

Related:
Fannie Diving After Hours - CNBC Video

Taxpayers Bailing Out Freddie And Fannie?

Every now and again someone brings up discussion about the Federal Government owning stocks outright.

Usually people lose they minds within seconds of the subject being breached.

The usual way this enters conversation is when people try to figure out a way to save Social Security.

You see, there are some pretty huge pension funds in this country - CalPERS, TIAA-CREF, and so on, who DO own pretty signifcant equity positions (stocks) and arguably do a better job providing for their retirees than Social Security ever will.

However, there's word floating around just today that the Federal Government just might buy stock in Fannie Mae (FNM.N) and Freddie Mac (FRE.N) to keep them from COLLAPSING.

Yes, boys and girls - pretty much what has happened is that the collapse of the housing market has finally taken ol' Fannie and Freddie by the throat. Sometime Wednesday going into Thursday various anlayst comments started making the rounds that these two are completely, utterly, and absolutely INSOLVENT. There's a particular Barron's article that seems to be the commentary of record on this topic - Failure Is Not an Option For Fannie and Freddie". It, in turn, appears to be based on commentary from former St. Louis Federal Reserve President William Poole who calculated that Freddie and Fannie owe $5.2 billion more than their assets are worth under fair value accounting rules.

There was pretty much NOTHING else on CNBC all day Friday.

Now, there's been an implied, although certainly not statutory, guarantee that if these two ever did start to go under that the Federal Government would bail them out and it looks like that's exactly what's going to happen.

But, let's consider precisely what this means.

Now, in the event of what's looking to be an unprecedented financial storm where people are losing their houses at a faster clip than they were in the Depression, you'd think the Federal Government would respond at least to the extent that they did at Katrina - at least provide some trailers or something of the sort.

Oh, NO - this bail-out is not about HOME owners, it's about BOND owners.

You see, with the explicit support of the Federal Government, Freddie and Fannie have been selling bonds based on mortgages that have very little remaining value at this point. For starters, alot of people don't have work to pay their mortgages. If people can't pay their mortgages, Freddie and Fannie can't pay their bond holders.

Now, is the Federal Government going to set up a program to help people pay their mortgages so that Freddie and Fannie can, in-turn, pay their bond holders?

HELL no.

They're going to pay these mainly super-rich bond holders DIRECTLY to keep them from going into an uncontrollable panic and completely seizing up the economy.

Of course there's only one way to do that - pretty much by printing money.

You think $4/gallon gas is bad?

You think $2.50/loaf of bread is bad?

You think $3/gallon milk is bad?

You ain't seen NOTHING yet.

I'm betting we see $10/gallon at the pump by July 4, 2009.

We may very well be headed for a Germany/Yugoslavia style hyperinflation.

This government has sent the undeniable signal they're going to keep pumping money into this system as fast as the fat-cat investors can waste it.

If we had the slightest bit of guts, we'd cut them ALL off. Get someone's hopes up that they can afford a nice house when they really can't? These investors DESERVE to be ruined and standing in the bread lines with the people they tricked.

Every last one of them.

Related:
Feds Open Credit Window to Fannie, Freddie - CNBC
Treasury, Fed to help prop up mortgage giants - MSNBC
Fannie and Freddie Update! Judgement Day Tomorrow - The Housign Time Bomb

Suburbs Becomming Slums?

There is a really GREAT article running in The Atlantic saying that due to the sub-prome mortgage crisis and various other demographic forces that, as eerily predicted in Back to the Future II many areas now or recently considered to be affluent, suburban areas may quite soon become the new slums.

With foreclosures leaving 25% or more of neighborhoods unoccupied, squatters and all sorts of seedy characters are moving into once affluent neighborhoods.

On the other hand, in some areas, inner cities are being redeveloped and are thriving.

With gas at $3.50/gallon and rising one can see how rational people might want to move a little closer together.

However, people in Cincinnati of course are NOT rational.

They'll hold off on decent public transportation as long as humanly possible until every last one of us has to file Chapter 7 over gas to get to work.

But, such, I guess, is the "charm" of Cincinnati ...

Barack Obama On How To Cure The Sub-Prime Mortgage Crisis

Pets Caught Up In Sub-Prime Mortgage Crisis

In those old sci-fi stories you used to occasionally read about some sort of tremendous plague that would come through and kill all the people but leave the pets wandering aimlessly.

Well, looks like this sub-prime mortgage crisis is something like a plague, and pets are getting abandoned all over.

• A starving pit bull found in an abandoned and trashed house.


• Dogs dumped on farm grazing grounds.


• House cats taking up with wild cat colonies.


• Abandoned dogs tied to trees in back yards.


• Cats left in garages.


• Turtles, rabbits and lizards still in children's bedrooms.

It almost makes a person wonder - where ARE all the PEOPLE going?

Has there been a noticeable uptick in suicide rates?

Are rental properties being flooded, causing rents to increase?

One thing is certain, it really IS starting to sound like a new Great Depression ...

Related:
Forclosure crisis leaves pets abandoned - 27News

The Subprime Mortgage Wasteland

Back when we were kids we used to read science fiction stories about nuclear wars and plagues turning whole cities into ghost towns.

Of course we did actually get to see a little bit of that at Chernobyl, but who would have thought something as simple as bad lending practices would lead to whole neighborhoods being abandoned?

Apparently there is a suburb of Cleveland called Shaker Heights that has largely been evacuated due to the sub-prime mortgage crisis.

This story goes on about squatters all over the place, a nearly abandoned grocery store, one last resident about to get thrown out due to a botched 2003 refinancing.

It sounds like those old science fiction stories.

Or The Depression.

Or worse.

It's not QUITE so bad around here.

Yet.

But you do see a disturbing number of abandoned older houses while driving around.

Seems that the banks are holding on to them in the hopes that the real estate market will recover.

I wonder what happens if it doesn't - if the banks for forced to write down a trillion dollars worth of property.

Perhaps that all-out nuclear war would have been a more preferable fate after all ...

The worst market crisis in 60 years: George Soros

For those of you who were around during the Thai Bhat crisis of the '90's, the Dot-Com implosing of the turn-of-the-century, and the utter financial pandemonium that followed 9/11 and you're thinking there's something uniquely troubling about this current "Sub-Prime Mortgage" triggered financial upheaval, you're not alone.

None other than George Soros is calling our current situation "the worst market crisis in 60 years".

Pretty much he seems to be saying that some of the financial instruments that have been invented in the past 20 years or so are hopelessly too risky.

Actually, I got to thinking about that myself back when I got MY mortgage.

All of the research I did seemed to indicate that the only way you could get a "normal" mortgage was to make a 20% downpayment.

I found myself wondering why this was. Partially I wondered why it was 20% instead of 50% or 5%. But of course also I was wondering why you needed a downpayment at all.

Some of the opinion pieces I read said that, "If you have 20% of your own money in the house, you're more likely to try to stay in it."

Well, maybe.

I really got to thinking there must be a more concrete answer than that.

A mortgage, hypothetically, is supposed to be backed by the property its buying. With real estate prices generally having gone up over the long run, one might think that appreciation would cover the risk of default in a mortgage.

Turns out not.

Although I never did find the exact historical evidence for this, I got to thinking that the reason you need a 20% downpayment to get a "conventional" mortgage is that at any given moment the housing market is susceptible to sudden, unpredictable 20% dives and if the banks don't have a 20% aggregate downpayment THEY are subject to a '20's-type domino-style collapse and that is JUST what we are seeing.

Yes ... this one is going to be ugly ... way ugly ...

Jim Cramer Predicting 2000 Point Stock Market Drop

I just saw Jim Cramer a few minutes ago on MSNBC and he was saying something along the lines that if the government didn't bail out the mortgage insurers that we were looking at a 2000 point drop in the Dow at some point.

This is pretty much what I was telling this one buddy of mine who is only a few years from retiring who insists on putting GINORMOUS amounts of money in the equity choices of his 401(k) and then comes to me sounding suicidal when the market drops a couple of hundred points.

I think Cramer's right.

I think we're looking at hundreds of billions of dollars worth of exposure that only something the magnitude of the federal government can even attempt to bail out.

Unfortuantely with the political pressure, you can't bail out the home owner's without also bailing out the bond holders so that whole thing will probably be allowed to implode and then we're looking at real 1930's-type conditions - real starvation, real hopelessness.

Crying shame the power won't probably be on often enough to even blog about it when it hits ...

Related:
Is a mortgage insurer crisis imminent? - Don't Mess With Taxes

And On That Note:

Greenspan Suggesting Cash Infusion For Mortgage Crisis

Former Federal Reserve Chairman Alan Greenspan seemed to suggest today that a direct cash infusion might be the best solution to the mortgage crisis.

"Cash is available and we should use that in larger amounts, as is necessary, to solve the problems of the stress of this," Greenspan prattled on ABC's "This Week."

This seems to be interpretted that Greenspan is suggesting a tax cut or something of the sort as opposed to fixing home prices or interest rates.

Greenspan also sees the very real possibility of 1970's-style stagflation on the horizon - a condition marked by a BIZARRE combination of economic growth stagnation and high inflation.

Basically the problem is - if you're going to manipulate the ecomony and the markets at all, you need to make specific interventions.

Basically the only tools the Fed has available to it are nuclear in scale. If the economy is freaked out over 9/11, the ONLY thing you can do is pump in these massive amounts of money at the highest levels of the banking system. Since everyone was already freaked the f*ck out over Enron, Worldcomm, and other stock scandals, all the new money started going not towards capital investments, but real estate. It formed a bubble JUST like the Dot-Com's and now the real estate bubble is bursting, and looking to do even MORE collateral damage than the Dot-Com implosion.

No - if you see a problem that has formed due to lack of oversight or just plain stupidity and you want to lessen the burden on common folk, you need to DIRECTLY address the problem.

Don't pump all this money into the broader economy and trigger off $10/gallon milk, $12/gallon gas and all that mess - put the money DIRECTLY where it is needed.

Yes, if the government had the SLIGHTEST bit of intestinal fortitute, they would lend EVERYONE enough to pay off their current mortgages at 6.5% for 40 YEARS.

Period.

End of story.

THAT would fix the problem.

Case closed ...

Don't Own The Mortgage? Then Don't Foreclose

Looks like Hamilton County Common Pleas Judge Steven E. Martin figured out a way to delay the foreclosure on a North College Hill house by ruling that Wells Fargo Bank couldn't even prove the owned the mortgage.

Similar rulings have been handed down in other parts of Ohio in the past month.

Of course once nasty thing about the mortgage business is that very often mortgages are sold and resold after they are originated. And, increasingly, the companies that "service" the mortgages - handle the actual payments and whatnot - are not the same companies that actually own the mortgages.

Looks like the judges are starting to rule on the side of the consumers and maybe will be able to help slow down some of the abuses that have been going on in the mortgage business ...

Congress Working On Bill To Let You SUE Your Creditors For Getting You In Unrealistic Mortgages

Looks like Congress is working on passing a bill that would allow you to SUE the predatory S.O.B.'s that got you into mortgages you couldn't possibly ever pay off.

The legislation, introduced by Representative Barney Frank, Democrat of Massachusetts and chairman of the House Financial Services Committee, would require mortgage lenders to - [[gasp]] - verify that the borrower has a “reasonable ability to repay” based on documented income, credit history and debt level.

What I want to know is how in the HELL it ever got to the point that people could get mortgages without passing those criteria?

Another feature of the proposed bill would allow borrowers who patently never had the ability to repay their loans to sue their original lender and/or the mortgage "repackagers" for a better deal.

Oh yes.

Actually, I'd love to see a bill that goes beyond that.

Basically if the Congress had the slightest bit of testicular fortitude they would do what might have the SLIGHTEST prayer of keeping a great many people from being thrown out on the street.

Yes, each and every currently outstanding residential mortgage should be refinanced DIRECTLY by the government for the next 40 years at 6.5%.

Period.

Then everyone involved in the mortgage business since 9/11/2001 should be hunted down and executed I swear to GOD ...

Conspiracists Against The Rate Cut

My favorite conspiracy nut friend has been sending me a steady stream of articles via IM about why she thinks that that the recent decision by the Federal Reserve to cut the Fed Funds rate by a half-point was a really bad idea.

Actually, there are some side effects to this rate cut that do deserve some discussion.

Basically, the mechanism by which the Fed lowers interest rates is by flooding the short-term credit market with more money. Any time you inject more money into a system, it tends to cause inflation. Basically it causes anything denominated in US Dollars to increase value in dollars, and causes the value of the dollar itself to decline, particularly in relationship to other currencies. For instance, for the first time in many years, the Canadian dollar is approaching equity with its US counterpart.

But, despite the rate cut, Fed Chairman Ben Bernanke is still warning of subprime defaults surging in the coming months and actually encouraging "lenders and loan servicers to identify and contact borrowers who, with counselling and possible loan modifications, may be able to avoid entering delinquency or foreclosure."

Wow.

As much as people hate to think about it, there may ultimately be no choice but a massive government bail-out on this one.

The Fed Funds rate cut is good, but it is only a band-aid. It helps with adjustable rate mortgages, but it also fuels the inflation fire. It basically floods money into the system indiscriminately.

What the Fed needs to do is actually lend money DIRECTLY to people with adjustable rate mortgages. They need to set up 30-year fixed-rate loans at about 6.5% to anyone with a currently variable mortgage.

And of course going forward they need to set it up so that someone applying for a variable rate mortgage has the income to cover the payments on that mortgage if it adjusts to its MAXIMUM rate.

This, ulimtately, is the ONLY way to stop the chain reaction of chaos that is almost certain to continue under present conditions ...

Motley Fool Predicting Oncoming "Alt-A" Mortgage Crisis

The Motley Fool has a really interesting article running where they are predicting that the Sub-Prime Mortgage melt-down is only a taste of a really monstrously bad situation coming down the pike - the "Alt-A" mortgage implosion.

In addition to these "sub-prime" mortgages, apparently quite a number of banks have been making "Alt-A" loans like drunken sailors over the last few years. These include "stated income" loans which are affectionately known as "Liar Loans" because it turns out that something on the order of 60% of stated income borrowers overstated their incomes by more than 50% when applying for mortgages.

Ah, yes ... these banks and mortgage companies during the low-interest period of the mid-2000's sure figured out new and creative ways to take money from hedge fund investors and lend it to people that didn't have a PRAYER of paying it back.

I used to see those "stated income" loans on the wholesale mortgage sheets and they used to crack me up. Although I suppose technically almost all credit cards are "stated income" - we're usually talking about - what? - $5000 structured to, hypothetically, be paid back over a five-year period or so? A MORTGAGE can be several hundred thousand intended to be paid back over DECADES.

Ten years ago a friend of mine was trying to buy a house and they asked for the original DEGREES of she and her husband and now you can buy a house based on how much you CLAIM to make???

A certain Lou Ranieri, fingered as the founder of the mortgage-backed securities industry is expecting $100 billion in defaults between subprime and Alt-A.

Nice.

Real nice.

Predictions are that this downslide will affect such places as Home Depot, but P&G might not be that affected because people will still need soap and diapers.

Well, maybe ...

I remember the freak-out fest that followed 9/11. It wasn't pretty.

Unless Bernanke cuts, cuts deep, and cuts soon, we may be in for a repeat ...

“Stands Ready To Take Additional Actions As Needed”

"Mr. Bernanke avoided any specific promise to lower the central bank’s benchmark federal funds rate ..."

We need a half-point cut.

We need it NOW.

I'm not KIDDING here, people ...

However, apparently Fed Chair Ben Bernanke did add that conditions are changing quickly enough that the Fed might act even before the next policy meeting on September 18th if the next batch of economic data still looks unfavorable.

You don't need to look at the next batch of economic data.

There are people out there that don't just have ARM's that adjust every couple of years.

There are people out there with mortgages that index to prime EVERY FLIPPING MONTH and prime is usually tied DIRECTLY to the Fed Funds Rate.

Not the flipping "discount rate".

Not "LIBOR".

Not a number you randomly pulled out your kazoo.

Fed f*ck*ng Funds.

For all intents an purposes, Mr. Bernanke, your agency, the Federal Reserve, is lending money to millions of people for their ONLY SHELTER, and, until the President and the Congress and the mortgage industry can straighten out this unholy MESS they have gotten all of us into, quite frankly only YOU can prevent a STAGGERING number of people from missing payments, leading to the inevitable credit score reductions, leading to the inevitable foreclosures and people becomming unemployable because, yes, more and more employers are checking credit ratings.

The President was quoted yesterday as saying, “It’s not the government’s job to bail out speculators, or those who made the decision to buy a home they knew they could never afford.”

No, the BANKS and MORTGAGE COMPANIES let people buy homes they could never afford.

How could some of the products that were being offered a few years ago even be LEGAL??

Of course, in an ideal world, you'd hang the speculators out to dry. These rich S.O.B.'s who were investing heavily in hedge funds that were buying up variable rate mortgages like there was no tomorrow deserve to lose their shirts. They deserve to be incarcerated and executed. It's like giving a four-year-old a toy and then yanking it back from him.

However, in this case, the results of the hedge fund investors' poor decisions is that certain people left REALLY f*ck*ng nice apartments where EVERYTHING was taken care of and invested in sh*tty g*dd*mn real estate that needed SO f*ck*ng much work that they had to both tap out home equity lines of credit AND credit cards just to make the f*ck*ng place LIVEABLE.

I tell you what - if we're going to have a Federal Reserve that is constantly d*ck*ng with the market anyway, they need to set MULTIPLE rates.

If the economy is overheating, they need to cut back on money going into COMMERCIAL PAPER and that sort off stuff.

However, at the same time, if you clearly have a mortgage crisis going on due to STUPIDITY and people FALLING ASLEEP AT THE SWITCH, the LEAST you could do is pump enough money DIRECTLY into mortgages in order to get them into a manageable level.

Yes, Mr. Bernanke, you need to directly lend ME enough to pay off my second mortage.

You need to lend me that money at 6% amortized over 40 years.

I'm straight up serious.

Bypass the banks. Bypass the mortgage companies. *I* am the one who needs the money.

Because, believe you me, you do NOT want me getting put out on the street becasue I may have to come bunk with YOU for a number of YEARS and I can assure you I make a lousy house guest ... :)



Related:
Bush’s FHA Plan May Only Reach 10 Percent of At-Risk Subprime Borrowers - Housingwire
Treasury Three-Month Bill Yields Fall Most Since 2001 on Credit - Bloomberg

Subprime Relief - Too Little Too Late?

Yeppers ... the very same President Bush who brought you Afganistan and Iraq is now pledging to try to save your house.

[[Laughing uncontrolably to the point of coughing up blood ... ]]

"Reforming the tax code"?

"Rigorously enforcing predatory lending laws and strengthening lending practices"?

How about putting the bit on Bernanke for a half-point Fed Funds cut NOW?

And how about setting up some sort of maybe federal agency that can simply buy up these messed up mortgages and rent back to the original borrowers so that PEOPLE AREN'T GETTING THROWN OUT IN THE STREET??

And how about BANNING these sub-prime mortgages in the first place? There's a REASON you shouldn't lend money to people with bad credit you know ...

So Long, Mortgage Industry ...

Is it just me, or does this whole mortgage business put anyone else in mind of the 1999-2001 Dot-Com Implosion?

Countrywide May Face Bankruptcy

Up until now, many of the names being tossed around as filing bankruptcy over the sub-prime mortgage crisis were not very well known.

That has changed rather abruptly as an analyst from Merrill Lynch suspects the biggest U.S. mortgage lender, Countrywide Financial Corp., may be facing "effective insolvency".

That's heavy.

Countrywide is HUGE!

Yes, at this point this whole thing is putting me in mind of the Dot-Com bubble detonation of the late 1990's.

Of course the Dot-Com bubble itself was similar to the Dutch Tulip Bulb crisis of several centuries ago.

Basically what happens in an open market is that occasionally certain items get "hot", prices get way overinflated and then, quite suddenly, prices of those items plunge precipitously.

Only problem is with these mortgages there were a great many other things that were backed up by those mortgages - primarily business investments.

All this leads to what's called a "liquidity crisis" - basically people start getting hesitant to lend money and the next thing you know you have a deadly sprial on your hands that can cripple an entire economy.

The Federal Reserve is generally late to the game in trying to get such a situation under control. Only an even the magnitude of 9/11 seems to cause them to get their act into gear and do one of the few things that might help at all - lower interest rates.

Yep ... we may all be in deep, deep trouble ...