The reasons for the Global Financial PANIC 2007
explained in excruciating detail

From GREED to FEAR
and WHY
* * *
Deconstructing the coming Ecconomic Myth

A backgrounder to a love letter from me to pensioners
who are major victims of a vast Ponzi scheme

Below is long and cumbersome article by John Mauldin. It provides ample opportunity to illustrate what is wrong with perusing the American media for insight into the current global financial meltdown. As it proceeds, I get a right snarky attitude and begin sniping at John's ideas.

I am taking "the liberty" - as is my wont as a one of the new breed of grassrootz journalists- to *snip* at will otherwise you'll lose it - but that said I just couldn't do much to *snip* at all except to add my Pilgrim's Progress morality lessons after certain paragraphs. IF, I had a webcam perhaps I could illustrate this on youtube, but the linkz game is what I am good at.

Sadly, in 2007 there are no messiahs.

Explore the complex reasons why with me ...

As a form of noncomedic relief, I felt it instructive to get comment from those who had a Major Role in bringing it all about on the Greed Side. There is a Commercial Break and an Intermission.

Mauldin's article has been written for investors and is a bit a bit trippy, and my comments will make reading this all the trippier. I have insisted on some form of linguistic purity, and thus you are free to read links on the usage of certain words he uses and words that I use. It's my form of artistic license in the age of internet 'journalism". Specific care has been used to ensure few links are from "old" sources of information.

Most you will not have time to see and probably have not had or taken the time to find. Perhaps, and that's intent, you will use some of these sources of information I'm providing in the future, as this story has 'legs'.

For most of you wiseacres who drop by here for your daily dose of information. I, have faith that anyone who would stop by has a brain with working cells, unlike some bankers and politicos I have met, as well as a bit of time on your hands. I've left in the links, put in MANY other relevant ones, Mauldin's charts are instructive and my comments meant to be totally informative while held together by moral considerations. All bolds in his text are MINE, put in ORANGE and intensified when I so pleased. Comments by me are in PURPLE.

Links grow exponentially as you read on, for Good Reason. This is TRULY the modern day Pilgrim's Progress tale, morphed into an opera in multiple multiple Acts to follow the past two weeks' gory details. If you are bored, you can always go back to the Fear Channel at CNN and grab your bowl of popcorn, while you can still afford it.

Inflation, an unasked-for gift from the Federal Reserve Bank, will be eating up your food dollars, but hard to make the call just when it will take you several hours, a wheelbarrow and your new Amero coins to buy what was once thought to bea an affordable daily treat. Your Rich Uncle will be still be eating at a five-star hotel, however, enjoy whatever his itty-bitty desires.

And for editorial interest, I am not interested in seeing the PANIC bailed out. Time for people to wake up! and see HOW they got SET UP. As a person on a fixed income, my heart goes out to ALL PENSIONERS .. every single one WORLD WIDE; the evidence shows that the pension funds have been selected to be the next patsies. This the next grouping to be smashed by increasing globalization.

Will we soon, as the hedgers hope, maybe, just maybe, see some real leadership will rise to the top? Can the same old spinners and shills show us the way their the financial gloom? Can the New Man produce another Lech Wallesa Type when we need a person like that?

Well, no single MAN is going to bail this out, no matter how much we need a messiah. That man is definitely NOT Warren Buffet - the pension funds of our NEIGHBORS are the new target of a program to SAVE THE RICH and their very poor judgment. Or is it ...?

I've included links to show you why Buffet is a poor bet, but left Volker off the hook for the minute. Why? It's a day-to-day news story and he hasn't entered the stage yet in this financial opera ... but the Slough of Despond can become a reference point to you all. The last "bubble", in the high tech industry, borrowed this phrase widely ...

Here, then, is the whining whine of the Supremo hedge fund consultant, John Mauldin.

"Oh! Woe!" the Tenor sings as he marches off to vacation.

As our curtain goes up, the market is further collapsing and Tenor Mauldin awaits the Baritone who shall arrive, bearing the swords of revenge against a market that just doesn't understand what clever boys the yuppies have been ....

A copy of the Banker's Manifesto can be read by pushing the link.

Perhaps next week, I'll switch to our modern interpretation of the spiritual quest, Slaugherhouse Five, to explain our collective further woes.

Virginia

August 18, 2007 The Panic of 2007 by John Mauldin	.
End of the World or Muddle Through? This week I try to explain in simple terms the very complicated story of how we went from some bad mortgage loan practices in the US to the point of world credit markets freezing up. There is a connection between the retirement plans of Mr. and Mrs. Watanabe in Japan and the subprime problems of Mr. and Mrs. Smith in California. We find the relationship between European banks and problematic hedge funds. And finally, we try and see how we get out of this mess. Oddly, I think it is hedge funds (and maybe Warren Buffett) to the rescue, but not in the way you would think. It is a lot to cover, so let's jump right in. *snip* Since this letter is likely to be forwarded a lot, if you get this and would like your own free weekly subscription, you can go to www.2000wave.com and simply put in your email address. You can be one of my 1,000,000 closest friends who get this letter for free. We will send my Thoughts from the Frontline to you each Saturday morning, along with my Outside the Box, which features the writing of other analysts and comes out on Tuesday. [Don't say I didn't warn you not to listen to Hedge Fund Types. I am giving you some other options below.] To say the credit markets are frozen is an understatement. Talking to any number of people who have been in the markets for decades, this is the worst in their memory. Ironically, it is the 100-year anniversary of the Panic of 1907, when one banker (J. P. Morgan) stepped in and provided liquidity to the markets. The central banks of the world are providing liquidity; but as we will see, it is not mere liquidity that is needed. [I'll say! -V] You cannot explain the problems with just one or two items. A perfect storm of this sort takes a number of factors all coming together to work its mischief. Bad mortgage underwriting practices, bad rating agency practices, a destruction of confidence, excessive leverage and then the withdrawal of that leverage, the need for yield, greed, and complacency which then in a Minsky moment (explained below) becomes paralyzing fear - all play their part. An Alphabet Soup of Credit But let's start at the beginning. In the early '90s, investment banks created a new type of security called an Asset Backed Security (ABS). And it was a very good thing. Essentially, investment banks would take a thousand mortgages or car loans or commercial mortgages or bank loans and put them into a security. You could have a Residential Mortgage Backed Security (RMBS) or Commercial Mortgage Backed Security (CMBS) or a Collateralized Loan Obligation (CLO) and then a Collateralized Debt Obligation (CDO). I am going to grossly oversimplify the following description, but the principle is correct. Let's take a look at how a Commercial Mortgage Backed Security [and let's dig a bit deeper and ask who thought them up and ask WHY they were 'invented', shall we? There are links below to clarify some of this alphabet soup later.] is created. If you are a bank or institution, when you make a loan on a mall or office building, you incur a certain amount of risk. If you hold 100 such loans, you can almost be certain that some of those loans are going to be bad. Further, you are limited in the amount of loans you can make by the capital you have in your company. But what if you could package up those loans and sell them? You get your cash back, and then you can keep the servicing fees and make more loans. But who would want to take the risk of your loans? Through a form of financial alchemy, you can take your loans and increase the quality of them to potential investors. Let's say you have $100 million in commercial mortgage loans. You take this pool and divide it up into 5-7 (or maybe more!) groups called tranches. The first group gets the first (as an example) 60% of the principal which gets repaid. That means that 80% of the loans would have to default and lose 50% (80% of the loans times 50% loss is 40% total portfolio losses) of their value before your money would be at risk. If the bank originating the loan is not completely asleep at the wheel, your risk of an actual loss is quite small. So, an investment bank goes to a rating agency (Moody's, Standard and Poor's, or Fitch) [interesting links to follow, see below -V] and pays them a fee to rate that tranche in terms of risk. Since the level of risk is small, that first tranche gets an AAA rating. Then the agency goes to the next group. Maybe it is 10% of the pool. It would get all the principal repayments after the first group. In this case, 60% of the loans would have to default and lose 50% of their value before your group lost money. The ratings agency might give this group an AA rating. This process goes on until you get to the lowest-rated tranches. There is typically an "equity" tranche which is about 2-4%. That tranche is the last group to get its money repaid. In our example, if 8% of the loans went bad and lost 50% (8% times 50% is 4%) of their value, the equity tranche would lose all their money. Let's assume the average interest rate on the loans was 10%. Because of the lower risk, the investment bank putting the CMBS together might decide to pay the AAA-rated tranche only 7%. Each successive tranche would get a higher rate, as they were taking more risk. The equity tranche is priced to pay in the mid-teens (or more) if all the loans are paid off. Now, insurance companies, pension funds, and other institutions [Start think about insurance companies, folks; see below ...] can buy this security that pays an interest rate higher than they could get from a similar government bond. This difference is called the spread. And in the beginning, spreads were high, as not everyone was comfortable with these new-fangled investments. To see what I am talking about, you can look at the chart below, taken from the open education source at MIT. You can see the whole chapter here. [Some of MY links, I think, provide better info, as you shall see.] Let's also notice something. In order to get someone to buy the lower tranches you have to pay them more. So, the more of the loans you can get the ratings agency to classify as AAA, the more interest you can pay to the buyers of the lower tranches to entice them to buy. This is going to become an important point. (I should note that it also means you can charge higher fees for putting the deal together and selling it to your clients.) Now, this financial engineering is a very good thing. It is one of the reasons for the worldwide economic boom, as it allows capital to invest in all sorts of loans that would normally be considered too risky. And for the vast majority of all these various alphabet securities, the ratings are going to be just about right. AAA CMBS or CLO paper is where it should be. Even AAA-rated prime mortgage paper, which is now selling for a discount, will (in my opinion) turn out to be just fine. Investment banks put together all types of asset-backed paper. Car loans, mortgages, business loans, credit card debt, etc. are all fair game. And you can mix and match risk if you like. The combinations are endless. So it can be quite a complex task to analyze what you are buying. And to a very great extent, that analysis was delegated to the rating agencies. For all practical purposes, institutional buyers would look at the general classification of the security and then at the rating. It was on the screen, so they hit the bid. If you can't trust your friendly neighborhood rating agency, then who can you trust? And most of these securities had ratings from at least two if not three agencies. [Ah, ha!! Such neutral interests then, right? Find below who OWNS some of those. There is a problem which is hard to resolve, Captain CapitalISM.] But (and you know there is a but) there is a problem with subprime-rated paper. In the beginning, subprime loans were made the old-fashioned way. You had to have 80% loan to value and show you had a job and could actually pay back the money. And these loans were packaged up into a subprime Residential Mortgage Backed Security. Eventually, 80% of those loans would get an AAA rating. Now, this means that 40% of those subprime loans would have to go bad and the value of those homes drop 50% before the holders of that tranche of debt lost money. Even with today's loose lending practices, that is unlikely. I think any rating agency is going to be able to justify that initial AAA rating. [Here comes the set up .. BLAME THE VICTIM of RICO frauds .. This link will lead you to the book you were supposed to be reading in college when you decided spring had arrived and couldn't care less about final exams. The ruling elite may not like it, but said laws are still on the books. You, Dear Reader, will find some interesting links below about getting the Financial Criminals convicted listed below. -V] But then in 2004 loan practices began to change and had got completely out of hand by 2006. In 2005-6, about 80% of subprime mortgages were adjustable-rate mortgages, or ARMs, also called "exploding ARMs." These loans are so-named because they carry low teaser rates that often reset dramatically higher, increasing the borrower's monthly mortgage payments by 25% or more. [Teaser rates hit ZERO, as a nice enticement during the yuppie ascent to their trophy homes.] *snip* "According to reports from loan counseling agencies across the nation, the main reason homeowners give for falling behind on their mortgage payments is not a change in personal circumstances (such as a job loss), but instead, they are not able to make the increased payments on their ARMs. "The loan application and review process for 'no-doc' loans was so lax that such loans are referred to as 'liar loans.' In a recent report by Mortgage Asset Research Institute, of the 100 loans surveyed for which borrowers merely stated their incomes on loan documents, IRS documents obtained inadicated that 60% (!) of these borrowers overstated their incomes by more than half. [I did this myself in 2002, and the real estate broker moved my ppoved bank- approved mortage to HIS own ARM paper backer. Why did I do that? So that we could secure a home improvement loan of $10,000 at the same time as the 25% down payment as that had eaten all my LIQUIDITY. Inevitably going into default, and they forclosure me quickly, I lost the entire $46,000 in CASH I paid down - of which I saw not one penny back - and voile - I now live in public housing which took me five years to accomplish. In the intervening period of time I moved place to place, always paying top dollar for an apartment that was way substandard in some particular way. The figures given to the asset 'backer' were fiddled with not by me, but the mortgage lender who knew that with any kind of financial bump, he'd get my property, which was, truth be known, quite nice. It brought the price of every piece of real estate in my neighborhood up. Nice for the realtors, eh? In Canada, this practice was known as 'goesumping' as they got bidders warring with each other to get that one, decent property in a neighborhhod. For a rich, full investigation of how the housing bubble worked, or did not, in California and other places, have a visit to the dr.housingbubble website. You'll see that most people got involved in the housing finance scams for the same reasons I did. The properties needed major overhauls. Our efforts in doing the work ourselves propted up the retail renovations sector such as Home Depot and Walmart, too - V] "The newer mortgage products, such as 'piggyback,' 'liar loans' and 'no doc loans' accounted for 47% of total loans issued last year. At the start of the decade, they were estimated to be less than two percent of total mortgage loans. As a result, homeowners have never been more leveraged: the average amount of debt as a percentage of a property's value has increased to 86.5 percent in 2006 from 78 percent in 2000." Ok, let's run the math. Almost 50% of the loans made last year were made with little or no documentation check, and 60% of those people overstated their incomes by more than half!!! That means 30% of the loans made were to people who were stretching to buy a home and whose actual income would not qualify them for a home anywhere close to what they bought. [But then with inflation what is potential buyer to DO? Go without the home, which they think is a NECESSITY to keep moving up to keep up with the need for "security, or go without ..? Nice mess to be in. Buying home becomes a HEDGE against inflation in real terms. I warned you this is blame the victim rationale. Things are heating up in The Arugument -- some sort of morality card is being played that the BUYERS should be such straight shooters, when the GAMBLERS/Dealers have free drinks to come in Play Russian Roulette. He is merely showing me why his future plan, buying into the funds of CLO's is the WORST of ALL plans.] The following chart from RBS Greenwich shows the amount of mortgages hitting the reset button in the next two years. Research by RBS Greenwich (assuming I read it right) suggests that 20-23% of the subprime loans made in 2006 will go into default and foreclosure. *snip* The problem is that the lower-rated tranches comprise as much as 8% of the total pool. And that may be optimistic. The study done by RBS Greenwich reads: "Our cumulative default projection would translate to a cumulative loss of 10%-11.5%." As I showed last week, there are already some 2006-vintage subprime RMBS's that have over 50% of their loans at 60 days past due, with over 25% already in foreclosure or having been repossessed. That is in less than a year, and the interest-rate mortgage resets have not even really kicked in! (To see those charts, you can go here.) [His above reasoning show the need for "best case", "worst case" and "most probable" scenarios to be used. Iffen the WORST case scenario is the case, whoo hoo! PANIC sets in AND fear, not GREED drives The Big Market picture, and that is the case NOW. Things are WAY more complicated than just looking at rational solutions to the global financial meltdown than JUST solving the mortgage loan bubbles at this piont. Although this mortgage bubble appears to be "solved" - at least for a week! Hope you've read this far!!!! Bear with it, we are getting there. It's an opera afterall and we have yet to hear the Fat Lady sing ...] Turning Nuclear Waste Into Gold (and Back Again!) But that's not really where the problem is. Let's go to a great chart from good friend Gary Shilling (www.agaryshilling.com). In an effort to make it easier to sell the lower-rated tranches, the investment banks put together a Collateralized Debt Obligation (CDO) composed of just the BBB-rated paper. And then got the rating agencies to give 75% of that paper an AAA rating! So we have turned 75% of BBB waste into gold with the alchemy of ratings. That means that if those RMBS lose just 5% of their value, everything but the AAA portion of the CDO is wiped out. Any losses beyond that start eating into the value of what a rating agency said was AAA! If the Greenwich projections are right (and these are very serious analysts), then all 2006-vintage CDO's will lose their AAA rating when the rating agencies look at them again. The new rating becomes "toast." Who owns this stuff? According to Inside MBS, foreign investors own as much as 16% of the total mortgage securities. Mutual funds have about 16%. Oddly, for all the publicity, hedge funds probably have less than 5%. But they were leveraged, so the losses are magnified. [Cutting to the chase a bit here, but showing you how the Slough of Despond got SO big, take a look at THIS. That is from a Big Pension Fund consultant. You'll see easily all the Big Players relationship to this ... and begin to get the enormity of what's happened. Remember the moral of this Pilgrim's Progress tale is to see how things shifted from Greed to FEAR. To see where the market has been forced to go, read this Michael Panzer article, read by many investors.] Mrs. Watanabe and the Hedge Fund Connection If you live in Japan and are retired, investing in bonds is not all that exciting at rates that are barely 1%. But you can exchange your yen into all sorts of currencies that have investments that pay much higher rates. And of course, that makes the yen go lower, which increases your yield. You notice your neighbor is making very nice returns, and you open a retail currency account and start trading. 25% of Japanese currency trading is from small retail accounts. If you are a hedge fund, you borrow massive amounts of Japanese yen at 1% and invest in higher-yielding investments and make the spread. Life is good. The trade goes on and on. [Does the phrase "pyramid scheme" spring to mind ...? Oh, those US biz schools sure makes them intelligent these days, don't they . they minor in English Doublespeak, you know. I refer to it as creating money out of thin air. It was all on PAPER.] Hyman Minsky famously said that stability breeds instability. The longer things are stable, the more likely investors are to become complacent and risk premiums drop. Because of the lower yields, investors tend to over-leverage try and keep up their returns. The markets are then likely to have a "Minsky Moment" of instability, and then risk premiums rise and all sorts of assets are repriced. [The financial press is flocking to read the OpEd News article by Stephen Lindman, who had the nous to get people to look at the risk premiums issue at just the right hour. Check out the definition of nous; it's the stuff of which Great Arias are made.] And that is exactly what has happened. The markets are de-leveraging. The yen carry trade is going away, and hedge funds and Mrs. Watanabe are driving the yen back up in as violent a move as I can ever recall. Look at the chart below of the euro-yen cross. Notice the steady move up in recent months of the euro against the yen, and then a 12% correction in just two weeks! Ouch. Whether it was the Canadian or Aussie dollar, you were down big. And that is forcing a lot of funds to sell anything they can in order to meet margin calls. And since they can't sell their CDOs, they sell stocks, commodities, and anything that is high-quality. That means that assets that do not normally correlate with each now all move together. And the movement is down. [Take a look at that last link to understand why this has SUCH a grave effect on pension funds ... and then see if this guy can "think" his way out this mess. Not my "take", this is the WSJ's take. -V] . Groundhog Day For Hedge Funds One of my all-time favorite movies is Groundhog Day, featuring Bill Murray, where the main character keeps living the same day over and over. One hedge fund manager I know in the credit sector says this whole credit cycle has been like Groundhog Day for certain types of hedge funds. [Hope springs eternal in the human breast. Alexander Pope, long deceased.] In February some of the lenders began to notice that the credit quality of some of the CDOs they were lending on might not be as good as that rating they had. So they went to the hedge funds and banks and said, "We are not going to offer you as much leverage as before and are going to make you take an extra 5% haircut on those bonds." [In FEBRUARY? The handwriting was around long before that. Far better to ignore it as long as possible to pay for the August vacation. Like a bunch of immature Alfred E. Newmans, they simply said, "What ME, worry?"] So the funds sold collateral to make the margin calls. And guess what? They had to take less than face value. And that lowered the value of those bonds on everyone's books. Which means the banks went to anyone holding those bonds and demanded more margin money and gave less credit, which created more selling and fewer buyers. The cost of hedging became expensive. It started a vicious cycle. In May, the Bear Stearns fund blew up, and the rout began in full earnest. The chart below is from www.markit.com. You can look at any of the scores of indices they track, and see that the problems began in February. [Read this fantastic comment about Bear Stearns and the problems it has caused I thank Dan Gross of MSNBC for a fabulous link above, one the apologists clearly dislike ... When foreclosures are concentrated in a particular area, it hurts the whole neighborhood. In a fantastic Wall Street Journal article (subscription required) about the impact of subprime lending on a single block in a lower-middle-class section of Detroit, a real estate broker noted that banks would have a tough time selling homes on which they had just foreclosed. "Nobody's going to want to buy into a neighborhood with 20 percent foreclosures," he said. "You end up with no neighborhood." Now think about THAT as you continue to read and you'll see why I say that certain CONgre$$people should get the h*ll out of DC and out from the sway of lobbyi$ts, as this situation has been ALLOWED to develop since FEBRUARY, minimum. NICE. - As for MOTIVE read THIS as to the WHY nothing was done: (2) doing so would have imposed financial hardships on themselves, on their friends, customers, and neighbors. The residents of neighborhoods targeted by subprime lenders typically receive no such consideration. V] The above chart is of a BBB RMBS CDO (enough alphabet soup for you?) issued early this year! It is now down to $.33 on the dollar, and it may well go lower. Pools of senior bank loans are selling by as much as a 10% discount. All manner of debt is selling at significant discounts to what it was just 7 months ago. The problem is, quite bluntly, that no one knows what the values of some of the mortgage-backed securities are. And if you don't know, you don't buy. And today, even very well-designed CDOs with no subprime exposure are selling at discounts, if they are selling at all. Senior bank loans are selling at an apparent discount to subordinated debt (which is not selling, so no one knows the value, so the "price" is the last trade). [Are you getting the addictive nature of the gambling going on yet? A later link to Bob Chapman will reveal how these knuckleheads on The Streets don't really have a clue yet. We call it denial in everyday parlance.] And what about the banks that bought those CDOs? What exposure do they have? Are they in a fund or part of the bank capital? Do you want to lend them money on the overnight markets, for a few basis points more than government securities? The commercial paper market for many banks has simply evaporated. These banks depend on this market for their financing. Last week, the Germans had to completely rescue an older, venerable bank which had a great deal of commercial paper and some off-balance-sheet funds which essentially made the bank's balance sheet negative. If you can't trust a German bank, who can you trust? This has consequences. As of today, the largest mortgage lender in the US, Countrywide, is now only doing "agency" loans (Fannie Mae and Freddie Mac). Even the best of firms, like Thornburg, are having problems. If you want a nonconforming loan this week to buy a home, either subprime or over $417,000, you may have a very hard time. [For the Canadian equivalent see Coventree. That link on Countrywide is current as of its bailout and reflects Friday market closing ... They were taking on the paper from the unstable US housing market. This is my MOST favorite quote ... "It took an emergency meeting Wednesday of Quebec's provincial pension plan and some of the world's largest banks to defuse the crisis." Oh! Oh! Looks like some CANADIAN pensioners are going to have a very rough ride SOON-ish, as the market continues its meltdown and investor confidence continues to erode. Defuse, diffuse, the pensioners are going to eat it this latest installment of the PONZ game in as our opera progresses. ] The Rating Agency Blame Game The ratings agencies have put 101 different CDOs on "watch," which is market speak for "we are probably going to change our rating." [important concept to grasp here is risk aversion ... anyone still reading, may tell me if I am wrong, but doesn't this tell you WHY the Federal Reserve was FORCED by global presure to make its move on Friday?] But that's a little too late. In 2006, nearly $850 million or 44% (up from 37% in 2002) of Moody's Investors Service total revenue came from the rarefied business known as structured finance. [Please note the change in The Game as of this week on that which is set forth at the link above.] In 1995, its revenue from such transactions was a paltry $50 million. Moody's took in around $3 billion from 2002 through 2006 for rating securities built from loans and other debt pools. The same pattern holds for Standard and Poor's and Fitch. [The link on S&P is as of TODAY . Becuz FITCH is a Big Player, to see vaguely what's happened with them as of market close yesterday click HERE. I think more commentary will be coming out on them over the weekend. They are a KEY player to watch carefully, if yer interested in this whacky GLOBAL financial charade ... Time now to bring you, during Intermission, a MUST read YOu must need a 'beverage' by now -- this definition of PONZI SCHEME should do the trick ..... Here is what Frank Scott of Dissent Voice has to say about the global impact of this current global Ponzi scheme. Take yer seat, intermission over.] In short, the ratings agencies were making huge amounts of money from the investment banks for rating these structured products. And let's make no mistake about it, they were selling their name and credibility. Everyone knew what a AAA rating meant when it came to a corporation or a country. [Who pray tell, was everybody ..? This is were John's assumptions are showing. People's financing of a place to live is a "product" - that is the illogic of an insane system of finance solely dependent on so-called free trade.] And even though there were disclaimers in the 500-page documents accompanying the CDO sales material, the investment banks were clearly pointing to the ratings as they sold that paper. The entire process hinged on the credibility of the rating agencies. Somehow, no one seemed to think that the default rates from "no-documentation" and "liar" loans would possibly be different. I am sure you can find a paragraph in the offering documents which will make that contention, at least obliquely. Lawyers are good at that stuff. But that is entirely beside the point. [No, it's NOT. As the above link amply illustrates, THE GAME goes on. Try this word, boiler plate. Key phrase; to protect the PROVIDER. Wall Street and the banks routinely use them; they are pumped out each and everyday by a PC specialists and numerour printers under the direction of lawyers. Caveat emptor, and all that. I am positive that plenty of people were highly aware that rates of liar and no doc loans would be SIGNIFICANTLY higher. A home buyer taking them would be the most likely defaulter around. As for other credit "instruments' the boiler plates were design to obscure the risk. But people simply don't read them; that's what their extensive length is designed to do; play down the speculative nature of what's proposed. Looks being everything. John, you are getting too obviously self protective ...] Credit markets function because there is the belief that if you lend money you will get it back. Ratings are the grease for those markets. Now they have become sand in the gears. If you are a bond buyer on an institutional desk, do you want to risk a career-ending move and buy a bond that you are not ABSOLUTELY sure it is what you think it is? Do you want to buy 3-month commercial paper for a few points of spread from a bank or corporation about which you are not 100% sure? Just how solvent is that bank? So, you wait and go to US government bonds in the meantime. If you are in Europe, you worry about your money market fund. In the US, you think about your CD at Countrywide if it is over $100,000. Everyone gets nervous, and central banks everywhere have to step in and offer massive amounts of liquidity, as they should. [Again, we turn to Daniel Gross - another good read - to understand WHY people continue to buy US bonds ... "many foreigners view the United States as a sort of global bargain basement. And the fact that the big hitters in the game are Chinese, Indian or Saudi reminds us that while the United States is clearly the richest and most powerful nation on Earth, we Americans no longer have the field to ourselves." And here is the raw truth from Bob Chapman at International Forecaster, whose advice is for those who are going to be able to hang on to some money.] Where Do We Go From Here? Hedge Funds to the Rescue! This is not the end of the world. I actually think things should sort themselves out by October or so, given no new major surprises. But how do we get back to normal markets? [Commercial Break!! The Daily Reckoning PRESENTS: A 'normal market' is a lot like a 'normal tornado' - both can whip things up and tip over the outhouse. Our only hope is that we're not in it when it does. Bill Bonner explains… The latest is here. The widely esteeemed Mogambo Guru, Richard Daughty, writes this on 20 July in The Daily Reckoning.... Note: I get the Daily Reckoning each and every day, free. For more information, subscribe to George Ure's Peoplenomics.com for a measly $40 for some great PEOPLEnomics and an extensive roundup on the news each day. Your real Financial Opera guide option. Also of note is The Privateer .. and this may take some about 3 hours per week to digest. Don't get blindsided in to the US media financial 'take' anymore. Now back to the young hedge fund manager consultant. Thank you for listening.] It might be helpful to look at how we got out of the savings and loan crisis in the late '80s. As everyone now knows, Congress changed the rules and allowed local savings and loan thrifts to finance all types of debt. They jumped in with both feet. Many were very bad at assessing risk and went bankrupt. The government [??!!] had to step in and bail out the depositors. The assets of the collapsed savings and loans went into the Resolution Trust Corporation (RTC). [And for THAT, we owe a huge, huge tip o the hat to George Hubert Walker Bush.] I had friends who made a great deal of money in that market. They would walk into the RTC offices. There would be two-foot stacks of manila folders, each folder representing a loan. You could go through the files and then make a bid for the whole stack. Quite often, in the file there would be checks from good borrowers who kept sending in their check for the car or boat. Since the S&L was gone, there was no one to cash them. People were paying $.15 cents on the dollar for good loans, and working out the rest. Now, some of the loans were indeed 100% write-offs. But a lot were not. But there were so many that the RTC simply took high bid and went on to the next pile. I also had a friend (whom I have lost touch with) that bought half a dozen older apartment complexes that needed work. He got them for very little cash, put his own work into fixing them up, got them certified as lower-income housing and then got government-guaranteed rent. He was able to retire in a few years. [And thus we find urban itty-bitty sitting rooms, for people to hovel in during the last few years, while virtually no funding goes into constructing real housing for the poor. Again, nice.] The same process needs to happen in the credit markets. First, we need someone to step in and actually make a market for the downgraded credits. Who is that going to be? Mutual funds? Investment banks? The Fed? No, no, and no. The answer is that it will largely be distressed-debt hedge funds, both those that exist today and the scores that are being formed as I write. There are bonds and loans, various CDO securities, CLO funds, etc. that are seriously mispriced because of the lack of liquidity and transparency. When you can buy a loan today for $.94 that has a 99.9% chance of being good, you simply take the interest and get the extra return for allowing the loan to go back to par. Even modest leverage produces very nice returns. [And this adds to the vicious cycle. This was released in the last hour shows how this is DESTROYING banks. This is a global problem, don't forget.] Savvy distressed-debt managers will go in, look at the paper, and buy it. This time, instead of manila folders it will be electronic files. But with a lot of work, someone will be able to assess the value. Of course, the bad paper needs to be written down and off the books. There will be little appetite for a lot of the riskier paper. [They could NOT do it before? There is no reason to asume that suddenly the manpower is gong to be availble in the gambling haze to do so now, or ever. However I am sure that some will attempt to do that. I see a real future for optical companies and opticians as attempts are made to do that] Also, the structure of many CLOs will help. Most CLOs are formed and have a finite life. But for the first 5-7 years, they take the principal repayments and reinvest those dollars in other loans. CLOs that are getting cash today are finding good values. [What they are doing is holding auctions with printouts of electronic files. It's like those $2 boxes outside the main auction event where nobody knows what is of value and what is NOT, but ta buyer will purchase any box striking their fancy in raw HOPE. A no brainer activity for true gamblers. Treats for eeeeeeeeeeeeeveryone galore!! One simply advertises to find someone to collect these debts LATER.] Warren Buffett Needs to Take Over Moody's [!!!!!] [?????] Ah .. imagination ... neverending. Let's look in my comments at some of the suggested Messiahs, remembering that the POINT of the Ponzi game is to net the Big Boys an even bigger part of the pie.] Second, the rating agencies need to restore their credibility. Warren Buffett's Berkshire Hathaway owns about 19% of Moody's. I would suggest that Mr. Buffett step in take over the company (much as he did with Salomon years ago) and put his not inconsiderable credibility on the line for all future ratings and the inevitable re-ratings that are going to be done. [Man, o man. This is RICH. And just why is to be missing what Warren Buffet IS doing. This game is made for HIM and the other ritzos, not for YOU.] The Panic of 1907 was solved by the credibility of one man, J. P. Morgan, who stepped in to provide liquidity. The Panic of 2007 is not a problem caused by lack of liquidity. It is a problem caused by lack of credibility. Morgan could (and did) provide liquidity. Buffett can (and should) provide credibility. [Let's get into THIS contention, before a new messiah is born. The PANIC of 1907, was EVENTUALLY resolved with the formation of the Federal Reserve SYSTEM, a full six years later, is not a US government agency, despite popular misconception(s). I often wonder what those "for other purposes" actually ARE . Don't you ..? Pundits have pointed out during the year and before that the circumstances are VASTLY different as indeed the financial system is GLOBAL and high tech trading vastly alters the circumstances. PANIC spreads FAST and confidence and credibility are shot ALREADY. Not only THAT, but the Fed Reserve is now issuing the banks credit. They are deciding who stays in The Game and Who Does Not, as Friday's announcement made very clear. This Guardian article makes it clear; CASH IS KING in the pain trade and the writer goes deeply into the Buffet bailout idea.] Can Volker be summoned into the trenches yet one more time?) [Ah ! Clever idea! Big FAT clever idea . let's bring an ONE WORLDER! FAR OUT! He's just beeen a true financial leader of late as this thing came DOWN! BAM! WHOP! Ta DAH! "THEY" will have Bigger Fish coming down the pike for him to fry, soon. Iran, Venezuela, Pakistan, North Korea .. maybe a nice audit prior to the imposition of the North American Union? ] This is not about whether some person or group at the ratings agencies necessarily did anything wrong, although more than a few lawyers will suggest just that. [Ever hear of the RICO Act .....? PRICE FIXING IS ILLEGAL. But to expect our pal Alberto Gonzales, busy protecting all the Bushistas to provide legal direction on the behalf of the American people is a right laff. - V] This is about restoring credibility to the ratings and markets as soon as possible. Without someone new at the head, future ratings are likely to be viewed with the skeptical (and correct) question, "Is this from the same group of people who rated that bond that I bought just a few months ago that is down 50%? Why are they right now? Where is the adult supervision? Who has made sure the process is now working?" [Watch carefully now as The Dude, our young Christian, tries to hold onto his Holy Grail, a nice fat portfolio to wave at his friends in perpetuity; damn those who come along needing homes, or incomes, or social services or who will fall prey to TAXOBABBLE AGAIN!!! You, of course, John, are free as a US friggin citizen, to keep your entitlements to endless profitability, relying on someone else to keep handing it to you, some endless PARENT in the form of the US Treasury/taxpayer to bail YOU out. Your friends can just keep on drinking that bubbly and Remy, and let DADDY figure it all out . . only this time Daddy ain't gonna do that -- they'll take YOU out, too, as they lean on the average middle class person who just cannot afford one more dollar in TAXES to pay down this incredible debt. Thinking about driving a cab. They're busy, busy, busy setting up the new NASDAQ. Nasdaq Gives High Rollers A Market Free Of Regulation Nasdaq is set to launch tomorrow what its executives are calling one of the most significant developments on Wall Street in decades -- a private stock market for super-wealthy investors Stock market brushfire; will there be a run on the banks? By some estimates, $326.3 billion has now been added to the G-7 Nations’ intra-banking system to prevent a breakdown. That amount will steadily rise in the weeks ahead as the situation continues to deteriorate Yet, dig this, it's these remaining middle class working stiffs PATRIOTIC duty to give up their life, liberty and pursuit of happiness as the corporate state imposes ever more ceding of civil liberties. And don't forget to vote for the incumbents come 2008!!!! To complain of the upcoming doom will be anti-American. The death of sovereignty in globalISM is going to make for lots of victims and strange ideology. Our rights trampled for GOOD.] The SEC has announced that they will allow mortgage lenders to work out resetting mortgages with borrowers in cases where there is an obvious default about to happen. [Note there are probably as many as a dozen cases under investigation for sub-prime related mortgages offenses as of today, it's right there,on that link ...] In many cases, that will mean extending the lower coupon rate another year. Yes, John, I know you think it may buy you another 3 years; you've been brain washed into thinking that. But here is the recent news out of Japan on THAT. See there simply must be some trading partners left in a GLOBAL market. Unless of course, we want to see a complete realignment of geoeconomic alliances. In which case, Russia will have a whole lot of resources fall right into their lap. No wonder the price of uranium continues to rise.] That may just put off the problem, but it will keep a home off the market and allow for a more orderly solution. [No! all this will do allow time for another class of investor to step forward to take the rap. Have a look at Buffet's ploy just now ... after the pension funds get NAILS IN THEIR COFFINS, the insurance companies are NEXT. And Buffet will come in and scalp THEM later for profit$ as he has the "time" to wait this out, iffen the SEC don't get "with" it . Do they have the legal labor power to do this? .. stay tuned. My guess is forget THAT; however, increasingly, many small and institutional investors see their involvment as the best possible solution.] Will a Fed Rate Cut Make a Difference? A rate cut will not make a difference as to the credibility of the ratings, nor will it transform bad debts into good ones. But my view has been for a year that the economy is heading for a recession due to the housing market problems. Given the turmoil in the markets, a rate cut may be in the offing later this year. And given that lower rates will make mortgages cost less, that will help. [The market and the economy is heading into a recession because that is where it was heading, hedge fund crisis or NO. Most of the "profitablity" was just hidden inflation; the reserve currencies were merely hiding it very nicely. The Thang, the Ultimate Cycle going on is so very very complex, isn't it . are you beginning to get that? Remind me not to trust you with the economic policy of the future. Dear Reader, I warned you this was gonna get TRIPPY. And a quiet reminder: don't forget that meanwhile, the Big BoyZ are still agambling away.] The significance of today's cut of the discount rate, and the willingness to look at up to 30 days of loans and high-quality asset-backed paper, is not the actual cut but more the boost to confidence. It is the Fed saying to the market, "Daddy's home. Everything is going to be all right." [Boyz and girlz, I called the date as of 28 June that the market was SHOT. Gone, kaputo. Have a nice look at that chart on that confidence link and it's worse TODAY... AND Nero fiddled while Rome burned.] Beyond that, let's look at what Nouriel Roubini says today in his blog about the Fed move to cut the discount rate: [Here is a nice long *snip* as I am going to spare you all this *rare and fruitless* GARBAGE and suggest that you read HERE instead!! as it will make you see how muddied are the waters in the river our dear Christian must cross have become.] *snip* While I am not so sure that the Fed will cut in September, they have signaled that they are aware of the problems, as noted above. [Problems for WHOM? Surely not the Little Man, they've abrogated responsibility for him long, long ago ... It's SOCIALISM for the rich, You are On Your OWN -- For the newly initiated the meme is known as YOYO, as in Katrina and all other catastrophes in this age of neoconISM -- for the rest of us folks and God help those on fixed incomes!!! I've been reading the Fed Reserve minutes all year waiting for them to pay attention to the problems being created, as the chairs got shuffled on the Titanic, plowing along looking splendid with the bolts all loose. This upcoming period will be called FREE TRADE and the taxobabble will get in full swing. You owe it to America's Security and Prosperity to lose your home and STARVE. First you were supposed to be a loyal consumer and lie to get your home loan to feed the profit$ bottom line, sold to you by bottom feeders .. now you are to WAVE THE FLAG with a much tightened belt; you'll just have to make do with stone soup, stone cold soup, as the oil prices continue to sky rocket .. This article is staring in the right soup pot, but barely begins to scratch all the implications of the current situation.] As an answer to my opening question, I think we are in for a return of the Muddle Through Economy rather than the End of the World. Credit markets will get back to normal, as there is a lot of money that needs to find a home. It is just looking for a credible home and one that will feature higher risk premiums and spreads. Please explain "It", what the 'money' ..? No you are just looking to maintain your cozy little billet and your adoring fans which you may or may not continue to do, as the powers that be determine you shall, just as they dusted off the dotcom people, the S&L boys, and all the other Tools. You've been commodified, too. That's how the Big Fish feed. And for those new to this there is no insurance for ANYONE or anything save what the ritzos want saved. I pick on John's particular article becuz I know over the weekend it is getting HUGE HUGE internet reading .. I can see the google links to it gathering, and know it will leave people thinking there is some way to save our fundamentalist Capitalist Believers from Hell's Gate. But John, to get with it, time to pick up a new book - Slaugherhouse Five. The old metaphor for the True Believers is outta date! It just might hold some Answers about what to do to quit thinking up IDEAS to rationalize what is basically a corrupted, horrifying way to run our world. "there is nothing intelligent to say about a massacre." ~ Kurt Vonnegut, d. 2006 *snip* Have a nice vacation!! Your enjoying the ride analyst, John