Lehman is being allowed to fail instead of bailed out, score one for moral hazard, and that won't affect individual Americans as much as if it were FRE/FNM, which actually are too big to fail.
Yet, the concerning part, I can't find any press or research on the actual market value of CDO's.
When Lehman's CDO's are sold at market, suddenly other financial companies have a way to value their own hand-wavy balance sheets and that's what scares me. Day of reckoning. Sunlight-as-disinfectant is a great idea and is what we need for the long term, but I do fear actually living through that process, and am glad the industry I work in is education, a bit removed from the greater turmoil.Also, there are still big lending institutions that have yet to go under but appear to be teetering: Wachovia and WaMu.
And, AIG, the insurance company, is pretty much insolvent and now has permission to borrow from itself to continue operating. That's insanity. I bet one of those 3 companies is in the news next Sunday as being forced under or into acquisition. And another the week after that."They can make a bridge loan to themselves" - Gov Patterson, about AIG. Sign of times during the Bank-apocalypse?
If it turns out the Bank of America was allowed to fund their purchase of Merrill with treasury funds secured against CDO's, I really will have lost all faith in the market personally.
The over all derivatives market is something like $100 trillion dollars in the US
, and granted most of that is never going to see the light of day or be made actual, but can any person honestly understand the effects of four levels of chopped and diced risk? Institutions clearly can't. Our elected representatives surely don't. I don't! Maybe we need some restraints on how imaginary investments can get before they're plain old fraud. 2nd order derivation is about where I lose my ability to follow along, and I'm a fairly smart guy.So, what it means, as I see it: no more living on credit for Americans as individuals or as a nation. It's going to hurt. I have a feeling that I won't be able to buy a home until I save 20% of the purchase price, like back in the good old days.
Why? Not letting 2001 become a real get-rid-of-the-deadwood recession, but instead injecting insane cash into the system, and letting real estate values build up to soak up the liquidity and prop up the economy, because it had nowhere else to go but overseas. Financial markets were deregulated, allowing investment banks to merge with regular banks, removing firewalls and independence and creating bizarre shadow world markets that are magnitudes larger in notional dollar value then the stock market. For the last 30 years, our economic measuring tools have been made worthless by presidents of both parties, making the situation seem less dire then it actually is, inflating or hiding information to make themselves look good. Also, a half trillion dollar war in Iraq didn't help.
I do not see a soft landing in store for us, and am glad I have another 35 years to be able to save up money to retire at some point.
It's because the people that lived through crap like the depression are either A.) Dead B.) in Dementia Land or C.) Run into younger "know it alls" who listen politely and laugh off whatever they say. So when an MBA our age thinks they know how to maximize risk synergy to extract full profit potential, stuff like this eventually happens. Perfect example, Bashar Issa.
(e:jim) - those days were the real wild, wild west of capitalism. Insider trading? Not illegal! Ultimately the SEC was created as a result.
That is absolutely incredible - 25%?!?! They must really, really want to make sure the debt is backed up by something tangible if they are going to be THAT stingy with money.
(e:vincent) - excellent analogy. You are right to mention irresponsible buyers as part of the problem. Really though, the guys on the street should never have backed CDOs with risky debt. They chose to out of greed and nothing more. They thought sub-prime mortgages would never default as they have, which was a gamble that they lost badly. It is incredible who are culpable for the situation we are in - it is such an ugly picture that really you could name any number of parties who had a hand in the collapse.
That is an interesting perspective, to suggest that perhaps the rundown on oil might have been greater if the margin requirement was at its previous rate. That very well may be true, although we'll never know. Personally I'm comfortable with only the well capitalized players in the game. I think mitigation of speculatory increases on futures contracts is the more important issue in the end. If these guys want to make a bet on a commodity integral to the world economy, it damn well should be expensive.
Thanks Vincent, I never made the mental analogy between mortgages and margin accounts in my head, but that is an awesome way to understand the problem. Margin trading of stocks was the big cause of the '29 crash, right? So it's kinda silly we fall into this same financial trap over and over.
Yea, the leverage for Oil was pretty powerful a year ago with the Margin requirement being $5000 for 1 contract to control 1,000 barrels of oil. Now it's $15,000 to control the same amount. So the margin was raised and as powerful the move up was, IMHO with the margin requirements being raise it may have slowed down the drop we have seen to $90 a barrel a bit by having only the well capitalized players still in the game.
It's kind of what happened to Real Estate. The boom had a lot to do with the margin requirement for a house being places @ Zero. The principle of a down payment or documents to prove you were capable of receiving a margin account [mortgage] went away in the early 00's. So you can say that the average American could have "screwed" us by taking out loans that they could never pay back to the companies that sold their paper and are behind this bloodbath on Wall St today. IMHO if we would have kept the margin requirements on a house say @ a 25% down payment like they had in the 60's we would have never seen the run up in prices and never would have been in this mess today.
Yeah, I have a few thousand in debt that I wanted to get a personal loan to pay off. Two years ago when I needed a personal loan for something I got it at 13% interest. This year they were going to charge me 25% interest. And I have good credit! That didn't change between then and now, what did is that money is not circulating like it used to be.
The Fed may be cutting interest rates to prop the system up some more, but I'm against that. We should feel pain and get it over with now, not keep pumping up from a dry well subsidized by the future.
Ooh. I was typing fast and I'm glad I just proofread what I wrote. It is Jon Corzine, not Jim Corzine. I subbed your name in for a guy who made $400m on the street... hard to complain!
Well said (e:jim). The value of a CDO, as you have said, can be a bit nebulous to calculate. The thing about CDOs is that they have been around for nearly 10 years; it is only relatively recently that they decided it was a good idea for SPVs to issue debt obligations backed by extraordinarily shaky collateral. The reason? Market value CDOs allow asset managers to build up asset under management quicker than with other instruments. Any guesses on how these asset managers get paid? =D With this method active trading is essential. CDOs backed by bonds, etc. are more stable debt obligations and are sounder in nature, but the fees don't quite stack up as high.
The derivatives market is a headache. It isn't all bad, but losses can be as exaggerated as the gains and by far the riskiest asset class is derivatives. I don't think the average person really needs to understand the complexities of the derivatives market. What is obvious is that these derivative markets need more regulation. If it isn't CDOs, then it is oil futures, which is traded at a cheaper premium than other commodities. Why? Speculators took advantage of the rules, had a field day and screwed us.
About borrowing - Lehman tanked while having a AAA bond rating, which is astonishing. I'm sure no execs on Wall St. could have imagined a day where that would happen. What it means for the everyday person who wants to borrow is simple - for the time being it is going to be more difficult to qualify for home loans, even for people with great credit. I've heard whispers of going back to the days of 20% down on home loans - it is certainly possible although I hope it isn't quite that severe. I think the Fed itself isn't entirely sure how this will shake out, particularly with inflationary pressure on the economy added on for extra measure.
They keep using terms like "flushing the system," etc. I suppose that is true, although we aren't just flushing the system of bad debt. We're also flushing the structure of Wall St. and the structure of global investment banking.
I don't think our politicians are suitable enough to come up with a good solution to the problem. The banking system is so integral - if you ask me they should put together a bi-partisan commission stacked with former St. execs and SEC officials to come up with proper regulatory solutions that will solve the problems without killing the capitalist system entirely. I worry that our politicians aren't sophisticated enough to understand what is good or bad for Wall St., and the problem is such a tangled web that we need the best and the brightest, who know what they are doing and understand capital markets. I can think of two guys that would be very good in this case - Former Gov. Mitt Romney of Mass. (formerly head of Bain Capital) and current Gov. Jim Corzine of New Jersey (formerly head of Goldman Sachs).
What an awesome post, (e:Jim). Well done to you. More later.