Global Financial Crisis (Was: Subprime Meltdown)

[markr]

http://news.bbc.co.uk/2/hi/health/7342923.stm

Hormone surges among City traders could be partly responsible for driving "boom and bust" economics, say researchers.

More possible explanations for irrational behaviour in a free market!

[R.D. Silverman]

Originally Posted by ewmayer

The "only" solution? Just a bit pompous there, dontcha think, Eddie, my man? Heck, just add or subtract a few $ from your "only" solution and you get ... another alleged solution. Proof by contradiction, as the math geeks like to say.

The solution should be obvious. Let the market correct itself. This will
take time. It will also mean allowing companies to fail. There is no
quick fix.


We also need some laws prohibiting these kinds of things in the
future. We should not allow:

(1) A mortgage without at least some downpayment.
(2) Variable rate mortgages.
(3) Making the fixed interest rate depend on the amount of downpayment.

Fewer people will be able to buy homes, but so what? One shouldn't
buy things one can't afford.

I'd like to see some/most of the financial execs that caused this mess held
criminally responsible. There don't seem to be any relevant laws, and we
don't allow ex-post-facto laws.

BTW, whatever happened to PMI? At least here in Massachusetts noone
can get a loan without also requiring PMI unless they put at least 10%
down. (or maybe it is 20%???). The insurer is supposed to pay the loan
off if the borrower defaults.

Did most of these foreclosures involve mortages that did NOT have PMI?
Why isn't the insurance industry that issues PMI also taking it on the
chin?

And for the record.... I have a fixed, low interest 30-yr mortagage
on my condo that I am paying off much faster than 30 years. And I
put a good chunk down. (no PMI) At today's rates for fixed-income
investments (typically about 3% for a CD and 1.5% for U.S. govt.
bonds/T-bills) it is much better to pay off my mortgage quickly than
to invest the extra cash.

[R.D. Silverman]

Originally Posted by R.D. Silverman

The solution should be obvious. Let the market correct itself. This will
take time. It will also mean allowing companies to fail. There is no
quick fix.


<snip>

.

Allow me to also add something that I said before.

We need laws limiting executive compensation. ESPECIALLY "bonuses".
One simple (and democratic) way of doing this would simply to require
any company that gives out bonuses to give them uniformly to ALL
employees. If the CEO gets a 50% bonus (in any form), then everyone
gets a 50% bonus in the same form.

[ewmayer]

Foreclosures jump 57% in March: But CNBC Shills Assure Public: "The Bottom is In!"

Lehman's Fuld Says "Worst Is Behind Us" in Credit-Markdet Crisis - Note that this is on the very same day that LEH goes back to Papa Fed and his magical discount borrowing window in order to exchange another big basket of toxic CrapSecurities for taxpayer-financed US Treasuries, despite "not needing the extra liquidity", and that Fitch - the only big ratings agency not completely in bed with the companies whose debt it rates - cut its rating on another $3B bundle of Lehman-oewned subprime loans. But hell, the folks running Lehman would have to be idiots - and even more implausibly, not the greedy bastards they are - not to take advantage of the Fed-brokered good-money-for-bad giveaway scam.

And on a more-positive note [well, not really, but at least it`s couched in nice-sounding sentiment], the folks at the HousingPanic blog wish everyone a Happy Real April Fool's Day.

[Xyzzy]

We have a neighbor who is an investigator for a mortgage insurance company and they look for shady practices on the part of the people originating the mortgage. If they find anything questionable, they do not pay out.

According to her, they find a lot of weird things.

[cheesehead]

Originally Posted by R.D. Silverman

We should not allow:

(1) A mortgage without at least some downpayment.
(2) Variable rate mortgages.
(3) Making the fixed interest rate depend on the amount of downpayment.

I don't see why any of these is inherently bad enough to ban. We've had them for decades, and they weren't causing noticeable trouble. Of course there need to be responsible limits on each, but there were, until recently anyway.

Why not just ban subprime mortgages, which are what caused the recent mess?

BTW, whatever happened to PMI? At least here in Massachusetts noone can get a loan without also requiring PMI unless they put at least 10% down. (or maybe it is 20%???). The insurer is supposed to pay the loan off if the borrower defaults.

It's not that they pay the loan off (which would protect the borrower), it's that PMI protects the lender by reimbursing part of the loss when sale of a foreclosed property fails to cover the mortgage.

A little over halfway down in this Washington Post article http://www.washingtonpost.com/wp-dyn...200572_pf.html is, "For example, if your house has a loan of $250,000, but at foreclosure sells for only $200,000, PMI will pay the lender part of the difference."

Why isn't the insurance industry that issues PMI also taking it on the chin?

AFAIK, PMI is operating just fine because (a) they pay out only if the property sale doesn't cover the mortgage (many foreclosed houses haven't yet sold at all), (b) they pay only part of the lender's loss (I don't know the typical fraction), and (c) as Xyzzy points out, they pay only if the lender has done everything properly (and many lenders are in trouble precisely because they didn't do everything properly).

[ewmayer]

Spiegel.de: The Madness of Ben Bernanke: The dollar is in a tailspin, the trade deficit is growing and a recession is on the horizon. The American way of life is in serious danger. But the head of the Federal Reserve keeps on pumping easy credit into the system -- a crazy policy that will worsen the crisis.

In the case of the real estate crisis which reached the banks and is now unsettling the stock markets, the markets are now showing what G7 finance ministers and central bank governors meeting last weekend in Washington for their annual spring get-together declined yet again to admit publicly: Americans must change their lives -- or it will be changed for them by force.

...

Bernanke is doing nothing to dampen this hunger for credit. The former advisor to President George W. Bush is even trying to whip up credit-financed consumption by lowering interest rates. This is helping to fuel inflation because the monetary growth isn't being matched by growth in real economic output. Inflation in the US currently stands at 4 percent.

It's a paradox. The private commercial banks which have just had to make billions of dollars in write downs have become more cautious. They're scared of further risks. The management resignations at Citigroup and Bear Stearns have had a sobering impact.

Patriotic Madness

Meanwhile the Federal Reserve is urging the banks to go on taking risks. It has been injecting cash into the banking system for the past half-year while urging bank CEOs in confidential chats to offer more credit. The aim is to keep on financing consumer spending and even to stimulate it further -- for reasons of patriotism.

There's a word for this policy -- madness.

Nakedcapitalism.com: Merrill's Reckless Mortgage Bond Binge: A page one story in the Wall Street Journal, "Merrill Upped Ante as Boom In Mortgage Bonds Fizzled," tells the sorry tale of how the brokerage giant did so much damage to itself via a pathological disregard for risk at the very time when the mortgage markets were about to sour. The firm is still taking losses from this misadventure; it's expected to announce an additional $6 to $8 billion in writedowns for the first quarter.

Highly recommend the WSJ article mentioned above - it's an appalling yet oddly fascinating chronicle of the type of irresponsible, borderline insane corporate risk-taking behavior which the Bush/Greenspan laissez-faire credit, [no-]regulatory and market policies have fostered and in fact rewarded during the past near-decade. Of course Bush and Greenie weren't the first to do so - a lot of this sort of thing was also going on under Reagan and to a slightly lesser degree, Clinton - but during W. Bush's time in office it's just gotten completely out of hand, like so many other insane excesses. Example snippet:

The first tremor that rattled Merrill's profitable business of underwriting mortgage securities came at the end of 2005. As it repackaged mortgage bonds into securities called collateralized debt obligations, or CDOs..... [a]n AIG unit bore the default risk of the CDOs' largest and highest-rated chunk, known as the "super-senior" tranche....AIG at the end of 2005 stopped insuring mortgage securities.....

Instead of scaling back its underwriting of CDOs, however, Merrill put the business in overdrive. It began holding on its own books large chunks of the highest-rated parts of CDOs whose risk it couldn't offload.... It generated $44 billion in CDOs in 2006 -- triple its 2004 output. Although not able to sell the bulk of the CDOs, it collected about $700 million for underwriting and trading these and other structured products. And its top ranking was considered in the calculation of executives' bonuses.

Risk controls at the firm, then run by CEO Stan O'Neal, were beginning to loosen. A senior risk manager, John Breit, was ignored when he objected to certain risks taken in underwriting Canadian deals, according to people familiar with the matter....Mr. Breit sent a letter of resignation to Merrill's chief financial officer...

Some managers seen as impediments to the mortgage-securities strategy were pushed out....Jeffrey Kronthal, who had imposed informal limits on the amount of CDO exposure the firm could keep on its books ($3 billion to $4 billion) and on its risk of possible CDO losses (about $75 million a day). Merrill dismissed him and two other bond managers in mid-2006....

To oversee the job of taking CDOs onto Merrill's own books, the firm tapped Ranodeb Roy, a senior trader but one without much experience in mortgage securitie.... This led to an inside joke at Merrill. Mr. Roy is known as Ronnie. Some employees took to saying that if they couldn't find a specialized bond insurer, known as a "monoline," to take Merrill's risk on the deal, they could resort to a "Ronoline."....

In August 2006, one Merrill trader fought back when managers pushed to have the firm retain $975 million of a new $1.5 billion CDO named Octans....

The result was a heated phone conversation with Merrill's CDO co-chief, Harin De Silva, who was out of the office. Mr. De Silva urged the trader to accept the securities....The alternative was to let the deal fall apart, which would leave Merrill holding the risk of all the securities that would have backed the CDO.

In the end, Mr. Roy's group took the $975 million of securities on the firm's books....a step that helped the firm hold its top rank in CDO underwriting and led to an estimated $15 million in fee revenue...

Pressures rose in early 2007 as the housing bubble lost air. Merrill set out to reduce its exposure, in an effort referred to innocuously as "de-risking."

It could have sold off billions of dollars' worth of mortgage-backed bonds that it had stockpiled with the intention of packaging them into more CDOs. But with the market for such bonds slipping, Merrill would have had to record losses of $1.5 billion to $3 billion on the bonds, says a person familiar with the matter.

Instead, Merrill tried a different strategy: quickly turn the bonds into more CDOs.

And of course companies like MER bask in their Government-virtually-guaranteed "to big to fail" status. As with Bear Stearns, the message from the Fed is clear: no matter how badly you screw up, no matter how recklessly you run your finances, if worst comes to worst we'll arrange a bailout that allows all of your top execs to keep their outrageous bonuses. Yep, no moral hazard there ... after all, as former Fed governor and Greenspan palsie-walsie Alice Rivlin tells us a few posts up, the whole concept of moral hazard is patently "preposterous." Must be a regrettable failure of "regulatory oversight" or "unprecedented market pressures" at work here, then. This calls for a taxpayer-funded federal bailout ... or at least it will, once companies like Merrill have been given sufficient time and government incentives to dig themselves an even deeper hole.

[ewmayer]

Bloomberg.com: Merrill Has Third Straight Loss on $6.5 Billion Writedown, Cuts 3,000 Jobs

"We are planning for a slower and more difficult next couple of months...and probably next couple of quarters," Merrill Chairman and Chief Executive John Thain said during a brief conference call Thursday after shaving $6.6 billion off the value of the bank's deteriorating assets and reporting its third consecutive quarterly loss. He called it "the most difficult quarter as I've seen in my 30 years on Wall Street." He also had to deal with Moody's Investors Services warning that Merrill's overhang of souring mortgage assets may lead it to downgrade the bank's credit rating and with Standard & Poor's declaration that Merrill's write-downs highlighted "the extent of further market deterioration this year" and underscored "the outsize nature of the risk" the bank has taken in mortgages and leveraged buyout loans.

Now since we live in the Bizarro Economy, where bad news is good news and even-worse news is great news, MER stock up smartly - up nearly 10% from today's open - on this dismal news and grim forecast. The madness of crowds...


Funny Wall Street Math, Part 1: In shocking news of dishonesty in the financial sector, it seems certain banks-who-shall-not-be-named have been taking advantage of the "we assume y'all are gonna be honest" self-reporting aspect of the LIBOR [London Interbank Offered Rate] spread, considered a key measure of banks' assessments of their own and their peers' creditworthiness:

NakedCapitalism.com: Stressed Banks Fudging on LIBOR Reporting


Funny Wall Street Math, Part 2: Nice article in Business Week about the USGov's funny numbers regarding "personal spending":

Business Week: The Consumer Spending Mirage

Stocks riding high on illusions of consumers continuing to spend may be in for a nasty surprise. Forecasting the stock market is a fool's game—but there are grounds to believe there's another drop in the market yet to come. The reason: a broad decline in consumer spending, which so far has been masked by a quirk in the government's statistics. Combine that with a rapidly unraveling job market, high energy prices, and the continuing credit crunch, and you have the recipe for a drop in consumer stocks. A big decline there could take the rest of the market down with it.

Personal Consumption: Quirky Stats

But a closer look at the numbers shows that the consumer spending boom may already have come to an end, without investors noticing. The problem is this: What the government calls "personal consumption" is actually a grab bag of items, some of which don't really fit the usual notion of consumer spending. For example, the nation's current annual personal consumption of $10 trillion includes about $1.8 trillion in outlays by Medicare, Medicaid, and private health insurance providers. This is real money, but consumers don't control or even see most of it, since it usually goes right to the health-care provider.

The government's count of personal consumption also includes "imputed" categories, that is, entries that don't involve any money changing hands. Two of the biggest examples: $1.1 trillion for "rent" that homeowners theoretically pay to themselves to live in their own homes, and $240 billion for "services furnished without payment by financial intermediaries"—in other words, the value of services like no-fee checking accounts.

In fact, once medical outlays and those two imputed categories are set aside, it turns out that the rest of personal spending has actually fallen since November, adjusted for inflation. The decline is pretty much across the board: inflation-adjusted purchases of food, clothing, furniture, and motor vehicles are all down. The part of health-care spending that individuals control most directly—prescription drugs—is down as well.

Amazing how "quirky" so many key economic barometers used by the government are these days: here's just a few more:

- Consumer Price Index, a.k.a. "When you strip out all the things whose prices are shooting through the roof, you get a number which is not shooting through the roof, then you loudly proclaim that 'inflation is tame' based on that."

- Weekly Jobless Claims: Of course you don't look at the millions of folks who have given up on looking or who are only working part-time when they'd rather be fully employed: instead you only focus on extremely narrow things like "first-time jobless claims." If employers aren't hiring, there's less "new blood" entering the system, hence a lower potential for first-time jobless claims. You can't lay 'em off if you don't hire 'em in the first place. People who have merely lost their *latest* job, they don't count - because after all a 17-year-old burger-flipper who loses their first minimum-wage CrapJob is a much more meaningful barometer of national economic health than a financial-industry veteran who loses his high-paying job of 20 years.


Mish Shedlock has this take on the government's funny math:

Like personal consumption expenditures, GDP also includes the government imputed value of "free" checking accounts and the value homeowners receive from renting their own house. Calculation of the latter is based on a survey of homeowners asking them what they would pay to rent their own house if they did not own it. This is as preposterous as counting the value of free sex one gets from one's lover as opposed to what one might have to pay visiting the local red light district. Heck, why not count the value added for mowing one's own grass vs. hiring someone to do it? What about free backrubs?

And pretending those "free" checking accounts have unrecorded value that consumers should be paying for is equally absurd. Banks sweep money out of checking accounts nightly, lend it out, and collect interest on it. Banks make plenty of money lending out money that is supposed to be available on demand but really isn't.

Hedonics are yet another mirage that never occurs. Computers are the best example of hedonics. Prices go down every year while processing power, disk space, and other features increase. Let's say you buy a computer for $500. The government tries to figure out what that computer would have cost last year. For the sake of argument let's say that number is $1,000. So the government records the sale at $1,000. Multiply this by every computer sold and you have a massive fictional number. Hedonics also come into play with autos. For example, if the government decides there are new features or safety improvements on this year's models vs. last year's model, sales numbers are upwardly adjusted.

Subtract out all of this nonsense and the US was likely in recession quite some time ago.

BusinessWeek has this correct: Consumer spending minus hedonics and imputations is lower than reported. One thing BusinessWeek did not mention is the massive increases in gasoline expenditures. The three month running total of gasoline purchases is 22% higher than a year ago.

Wages are falling, unemployment is rising, and rising oil prices are cutting spending elsewhere. Consumer spending, especially discretionary spending, has only one way to go and that is down.

Funny Wall Street Math, Part 3: Asia Times Online has a nice piece about the kind of bogus accounting being done especially by the Wall Street big finance firms like Lehman, Goldman, Citi, Merrill et al to artificially inflate their assets and hide their true status, which is that nearly all of them are in fact insolvent:

Asia Times: The degradation of accounting

[ewmayer]

Google defies the skeptics: Internet search leader reports sales and earnings that top Wall Street estimates; stock soars as fears of a slowdown may be put to rest.

The fine print here is interesting - this is the same effect that helped "lift" IBM and Intel earnings in dollar terms:

Google's large global footprint has produced a strong source of revenue for the company. In the first quarter, international revenue accounted for 51% of the company's total sales, marking the first time in which revenue abroad surpassed sales at home. Google said one contributing factor to large global revenue was that it got a big boost from the plummeting dollar.

So we see hear the emergence of the third bubble in the Greenspan/Bernanke series of speculative asset bubbles:

1. The DotCom Bubble: Easy credit and unrealistic expectations of Internet and Tech-driven profit growth drive the Nasdaq up 3x in the span of a few years, before the bottom falls out;

2. The Housing Bubble: Easy credit and unrealistic expectations of eternal double-digit housing-price appreciation drive home prices and consumer spending up 2x [and consumer debt at least as much] in the span of a few years, before the bottom falls out;

3. The Global-company dollar-profit bubble: Easy credit and the Fed's dollar deflation policy drive up dollar-based profits of US companies with a large global sales component in their earnings, despite the fact that the companies aren't really selling more goods and services than before. This continues until the U.S. recession and the inflation caused by the Fed's continued easy-money policy spreads sufficiently that a significant proportion of the world's economies begin to suffer, the dollar stops falling, and the flock of circling crows, having grown wise to Bernanke and pals standing in the cornfield, clanging with wooden spoons on pots and pans and waving shiny pieces of tinfoil to try to distract the ravenous birds, finally come home to roost.

[ewmayer]

Citigroup Has $5.1 Billion Loss, Cuts 9,000 More Jobs: Loss is 'less than analysts' most pessimistic estimates'; S&P 'reviewing Citigroup's rating for a possible downgrade'

Another $16B in writedowns and bad loans, mass layoffs, no prospects for improvement in the business for at least another 2 years ... great news! Entire financial sector up big on Wall street today.

Friday Cartoons! Thanks to Master gerbil Xyzzy for the Mike Luckovich piece:

[ewmayer]

This one is of Il Maestro Verdi-span getting his fiscal ingenuity recognized by a person who knows ingenuity when he sees it, even if he can neither spell or pronounce it correctly. Happy weekend to all our readers, and may all your fiscal malfeasance be blessed by a personal Bernanke-Panky-style liquidity injection from Uncle Ben himself.

http://hogranch.com/mayer/images/fun...span_medal.png

[Edit: For some reason the image refused to display in the post when I used the usual "manage attachments" procedure, even though that indicated that the image had uploaded successfully. After trying 3 sepearte times, gave up and instead provided a link to an ftp-server upload of the file.]