The meltdown of major US financial institutions

Yeah, but that's just the amount they are brave enough to tell you about. It is estimated to really be up to 3 times that. If you want to take into account the national debt (which every citizen owes as well) its about 12 times that! The US is technically bankrupt. (the government, that is.)

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Mat 16:6

This week I haven’t been keeping track of the developments in the financial sector’s crisis, but I did happen upon a few relevant news items. Although I am greatly tempted, I’ll try not to stray into my own theories in this post.

There is something called a credit default swap that is intended to protect a lender against a loan default. The issuer of a credit default swap ensures that you will get the value of a loan no matter what, in exchange that you make a regular payment to the issuer.

Apparently, many of these badly troubled banks and financial companies are in big trouble for insuring subprime loans through credit default swaps. What they did is that they issued credit default swaps to individuals who didn’t even own the loans; thus, enabling anyone to buy insurance for whatever crappy loan they can find, the crappier the better (since you have a better chance of getting a payout.) For example, if I made a loan to someone, you can then come and buy a credit default swap on the loan from a major bank; although, you really have nothing to do with the loan. This is a setup for certain destruction of that bank.

The ridiculous practice extends way beyond the well-being of financial companies. Major investors (you know, the ones behind the scenes) use credit default swaps to gauge the health of a company. If too many credit default swaps exist on the debt of a company, it is an indication that the company is not doing so well, and is expected to default on loans made to it. And we know what happens if it defaults: forced liquidation or bankruptcy. But that’s not the end of the reach of credit default swaps.

Credit default swaps and subprime mortgages can make financial statements misleading of an issuing financial company. A company can show a trillion dollars in assets when hundreds of billions of its assets are worthless. A company can show significant income from credit default swaps that are certain to cause a much more significant loss in the future. Shareholders just don’t have a chance in this environment.

Now the FBI and DA’s are investigating for crimes committed. Accounting standards are rightfully being reworked.

http://www.cfo.com/article.cfm/12286366/?f=rsspage
http://biz.yahoo.com/rb/080926/busin...ebiz.html?.v=1

A government with a printing press (computer) can't technically go bankrupt. Ask Mugabee, he can "splain you.

whereisthetruth I think a discussion of capitalism vs whatever is more appropriate on a thread of its own. I’m not saying I’ll participate there. I just don’t like participating in debates on the Internet; although, I enjoy reading certain types of debates.

What was your previous post? It is certainly in the vein of the thread, as was mine.

The thread certainly allows for a discussion of the benefits and weaknesses of the (so called) capitalist system that is currently in meltdown.

For the record, I am pro-capitalism. That is, capitalism that is genuine (ie. the use of capital - excess assets and production - to be invested for the benefit of the owners and those employed in it's increase.) But true capitalism is not what the Global Financiers are about. The 'capitalism' that is at work today is actually 'legalized' criminal activity. Your fine post demonstrates this.

However, I agree that a separate thread may serve well to allow for this discussion more fully.

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Mat 16:6

Bro of JC,

The credit default swaps are sometimes issued by investment banks. Look at the City of Bermingham AL for an example of how these bankers sold default swaps to some criminaly nieve local business managers. When things went south the city (almost?) went bankrupt.

However, in the mortgage industry, the default swaps are often issued by insurance firms such as AIG. (You may have noticed they are in need of a bail out too.) and the problem is just as you illustrated. They sold insurance to everyone, whether they owend the toxic paper or not. Their thought was that the premiums would cover the action, and it would have if the entire industry was not belly up.

In their case, I say let them die. We're better off without them. The problem is, if they are not around to insure this debt, suddenly the toxic paper is no longer AAA rated and the banks can't legaly hold "non investment grade securities". so they would be forced to sell them imediately into a market where there are no buyers. So the banks problem would get much worse instantly by AIG failing.

Another plan beng floated is to remove the Oxly-Sorbains "mark to market" rule for these securities. The big question in my mind is, "would this lead to a fairer valuation for these securities"? On the one hand, there is no market for them, so the mark to market rule, may have resulted in these banks haveing to mark the securities down to below their actual value. So the rule could have created an artificial problem. OTOH, these things may acutaly be worthless, so it's very hard to know. IF they are worthless, then removing the mark to market rule will only kick the problem further down the road.

Certainly the traunches that have access to the collateral are not worthless, but the traunches that are subordinated are somewhat likely to be worthless. And who knows which of these the treasury is thinking of buying. In a week of looking at this, I am feeling less like this is something the gov ought to be doing and more like this is all a strawman for something else.

One week later there is still no clarity.

In the Beginning -http://query.nytimes.com/gst/fullpag...gewanted=print
(Credit for the NYT link goes to http://hnn.us/blogs/entries/54991.html)


I concede whereisthetruth you were correct: a credit crisis was looming. And AMOG, again great insight from you. The FED should at least get credit for now intending to be flexible with homeowners.


Recap of recent events (correct me where needed):

The government bail out was approved to relieve the banks of bad assets, specifically subprime mortgages. The hope being to ultimately recapitalize the banks with the most liquid of assets: cash. In the meantime, US banks are hording what they have left due to a fear of another catastrophe (like Lehman) and their weak financial positions.

The result has been a credit freeze in the credit markets; meaning, big organizations are unable to refinance their debt that is coming due. (For example, it is like if I had a mortgage that is ending, and I can’t get anyone to renew the mortgage.) We have consequently seen a cascade of financial disasters. Countries (i.e., Iceland) whose banks rely heavily on loans from foreign banks have been made broke, forcing them to liquidate foreign equities at a great loss. States (i.e., California) that depend on loans to make up for budget deficits are in panic mode, as they seek means to pay for the next payroll. (And you can’t skimp on payroll, because employees expect a paycheck at the end of the week no matter!) Stock markets are crashing all around the world, because the capacity to fund economic activity has been greatly reduced: investors feeling uneasy about what pain the next big company that fails might bring along. Economic growth everywhere has been pushed back a few notches.

In a few words: money is being taken out of the system at a dramatic rate. A primary cause of this is the banks not lending to each other at reasonable rates. Japan is recommending the US do what it did to solve a similar financial sector crisis in the late 1990’s: inject capital (cash) directly into the banks. This should make the money start rolling again.

Major exchange owners are now planning new exchanges to accommodate trade in the financial instruments that caused this mess. The proponents of these exchanges claim they will introduce transparency in the trade of these instruments, which are currently “back-room” type of deals between the big financial companies. Hopefully, they will reveal what bank owns what, why and how much of these papers. Adding the above mentioned provision recommended by Dan Lufkin would also be nice.

That’s it for now in a snap.



Bloomberg did a good job analyzing and reporting on the developments:

Fuld Blames Lehman's Collapse on False Rumors, Old Rules, `Storm of Fear' (Good recap of the events that brought this meltdown.)

Bank Writeoffs May Triple, Mortgage-Bond Premiums Narrow as Bailout Begins

Rescue Legislation Contains Palliatives, No Cure: John F. Wasik (Lists some of the things of the bailout that will help ordinary Americans, including incentives for going to alternative energy.)


Some relevant BusinessWeek pages:

The Stunning Collapse of Iceland

California to Feds: Got a Spare $7 Billion?

Japanese Ire at U.S. Rises over Markets

Nations At Risk



Libor rate shows system distress (International Herald Tribune)

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I Am God Lord Jesus Christ

The above post pretty well sumarises things. The only thing I would add is that the problem stems from three main causes:

1. Lending at artificially low interest rates to keep the economy growing when it should have been allowed to slow down naturally to balance debt levels with GDP. Too much debt means that economic activity has to slow down so that the debt can be repaid, rather than new money going into more and more risky speculation.

2. Lending to parties that could not be expected to be able to pay off the debts.

3. Too little regulation of 'tiered' investment instruments backed by these poor loan contracts. The agencies that were supposed to oversee the 'prutentiality' of the loans on behalf of the second-tier investers failed to do so. Consequentially, trust in the value of these contracts has diminished, causing a freezing up of credit.

What has made things worse, is that the US and other governments have tried to stimulate the economy with fresh truckloads of money without dealing with the underlying causes. The US bailout has no transparent regulatory framework. The problem is not a 'liquidity' problem, it is a trust problem. Taking over bad debts doesn't make the new ones any better because there is no reason for the organisations to do anything different.

What needs to happen is that the market needs to be allowed to value these instruments on their true worth, and allow those businesses who are insolvent to go bankrupt or be taken over by better managed ones. That's what capitalism does best. Protecting the bad players only ends up hurting everyone. There is going to be pain anyway, so it's better to take it 'short and sharp' rather than letting it drag on because of fruitless attempts to artificially control the process to protect the chosen few.

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Mat 16:6

You bring up an interesting point whereisthetruth: Is the toxic waste (debt) still roaming around out there in attractive looking packages? If investors are not sure about this, financing might be being hurt from not just the banks, but the general investing world that does not dare play Russian roulette. In that case, the US government needs to step up, cleanse the system or whatever, and assure investors (through education) that it is safe to get back in.

However, even if it is a confidence issue that is impossible to resolve, the system will not be irreparably broken. As we know, a $100 deposit in a bank will bear many times that much for the streets. The potential for banks to resolve this credit freeze themselves easily exists.

To your claim that an artificially low interest rate is causing an unhealthy level of debt, I would say possibly. Two things on that: 1. Let us not underestimate the magnitude of the subprime mortgages (e.g., suppose $300K * 100K mortgages = BIG NUMBER) as a part of the overall debt; 2. Globalization and the fast growing economies all around the world = more debt to finance it all. But again, this is not the end of the world as we know it.

Make sure you read the Japanese link above.

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I Am God Lord Jesus Christ

Here are some interactive maps of the US “Subprime Tidal Wave” from the Wall Street Journal:

http://online.wsj.com/public/resourc...UBPRIME07.html

http://online.wsj.com/public/resources/documents/info_LAMB0809_Sort.html#


As you can see, $700B should be enough to back the bad mortgages, and then some.


Here is a cynic with some humor that I think whereisthetruth would like:
http://illusionofprosperity.blogspot.com/ (http://illusionofprosperity.blogspot...nding-map.html)

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I Am God Lord Jesus Christ