The Oil Drum | DrumBeat: July 18, 2007

163 comments on DrumBeat: July 18, 2007

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Durandal on July 18, 2007 - 9:23am

Yeah, I'm hoping I can suck another year out of the market before it crashes. I'm enjoying those 17% returns. My returns are greater than the APR on my credit card. I would like to think that moving my money to stocks in renewable energy companies such as SunPower and Evergreen Solar would be beneficial, but I'm sure the market will take those down right with the rest of the stocks due to general panic.
~Durandal (http://www.wtdwtshtf.com/)

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The Chimp Who Can Drive on July 18, 2007 - 9:25am

Yeah, I'm hoping I can suck another year out of the market before it crashes.

Famous last words.

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HeIsSoFly on July 18, 2007 - 9:43am

Yeah, and don't count on it, looks like the market will do the sucking:

Bear Stearns Warns Hedge Fund Investors of Total Loss

Bear Stearns Cos. told investors in one of its hedge funds that they won't get any money back after creditors forced it to sell assets at depressed prices, according to a letter sent by the firm.

While a second fund still contains ``sufficient assets'' to cover the $1.4 billion it owes the New York-based firm, there's ``very little value left for the investors,'' Bear Stearns said in the two-page letter, a copy of which was obtained by Bloomberg News from a person involved in the matter. Bear Stearns bailed out that fund last month with $1.6 billion in emergency funding.

The situation underscores the severity of the shakeout in collateralized debt obligations, securities that the funds used to bet on subprime mortgage loans. Bear Stearns said in the letter that the funds faced ``unprecedented declines'' in bonds that were rated AAA or AA, the two top investment grades.

NB: One Bear [sic] fund was valued at $5 billion, the other at about $15 billion. No word on that one yet, but they're not even trying to save it.

NB2: An isolated incident?! Sure, and isn't it hilariously great that the Dow is breaking records? Try this one from the TOD:Canada Round-Up:

Options market expects a drop in U.S. stocks

..... the Leuthold Group, whose flagship fund has beaten 99 percent of similar funds during the past five years, expects the S&P 500 to slide as much as 19 percent by the end of the year.

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The Chimp Who Can Drive on July 18, 2007 - 9:51am

sent to me by a latoc reader 10 days ago. I didn't post as I didn't want to create a panic. but he turned out to be correct. Oh well.

http://www.lifeaftertheoilcrash.com/Archives2007/blogcatastrophe.html

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HeIsSoFly on July 18, 2007 - 9:54am

Matt, that links leads me here: http://internetnewz.info/?rid=705831.
Not what you intended, I'm thinking. Been hacked?

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The Chimp Who Can Drive on July 18, 2007 - 9:56am

Try this:

http://www.lifeaftertheoilcrash.net/Archives2007/blogcatastrophe.html

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BrianT on July 18, 2007 - 10:10am

Matt: The Fitts book looks like a good read. Thanks.

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eric blair on July 18, 2007 - 8:49pm

Did someone say Fitts!

http://www.solari.com

http://www.solariactionnetwork.com/phpBB2/

Start up a good Peak Oil discussion. I'd like to see someone other than Daybrown post!

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MicroHydro on July 18, 2007 - 10:13pm

Fitts had the correct reply. The stock markets, interest rates, dollar index, and gold prices are all actively managed. The Fed (~JPMorgan) and Treasury (~GoldmanSachs) have all the tools required to prevent abrupt market discontinuities. The BOJ, BOE, and ECB are all partners in this process. There will only be a financial "crash" when and if the PTB want one.

In addition, for people who have significant investments, "crashes" can be immensely profitable. Selling some stock (even in Evergreen Solar) and buying some put options can put one in position to profit from a "crash".

As for real estate, the "crash" can't come soon enough for this renter. IMO, someone who bought their house or farmlet in 1977 should be very happy to sell it to me for a 1997 price and make a huge profit. But, they still are greedy enough to want a 2007 wishing price, which is at least twice a reasonable multiple of local income and no buyer will pay it. Bring on the "crash", please!

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paulah on July 19, 2007 - 12:43am

What is the BOJ, BOE, and ECB and the PTB?

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HeIsSoFly on July 19, 2007 - 12:59am

Bank of Japan
Bank of England
European Central Bank
Powers That Be

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The Chimp Who Can Drive on July 19, 2007 - 1:44am

MH,

I intend to poach you from TOD over to the LATOC forum. I can offer you lots of turnips.

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710 on July 19, 2007 - 9:15am

Everything MH said about the PTB and a crash are pretty much dead-on, however, if the PTB really had all the power they think they do, and all that we attribute to them, we wouldn't be in quite the level of sh!t we are in right now.

The best laid plans, and all that.

And a crash can also be profitable a little later on when large amounts of material resources can be had for fire sale prices, but one again needs significant resources to begin with.

The rich get richer, etc.

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BrianT on July 19, 2007 - 10:46am

710: TPTB are rich-they are getting richer-they are presently too busy to worry about everybody else's problems.

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robert2734 on July 18, 2007 - 10:26am

If I have a 5% fixed 30 year mortgage, and the bank has a call provision that allows them to call the loan at any time, and they can get 7% on their money somewhere else, why don't they?

If S&Ls made 3% fixed 30 year mortgages in the 50s and 60s, and the prime interest rate went to 20% in 1980, and the S&Ls can call in the loan, why did they choose to go bankrupt instead?

If a BANK is actually solvent but having a liquidity crisis, can't they borrow money from the federal reserve? Bears Stern investment fund I dunno, but if it was solvent, and Bears wanted to, I presume they could borrow money from somebody.

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HeIsSoFly on July 18, 2007 - 11:21am

If I have a 5% fixed 30 year mortgage, and the bank has a call provision that allows them to call the loan at any time, and they can get 7% on their money somewhere else, why don't they?

They would bite the golden goose that feeds them. As long as that mortgage is in their books, they can use it as collateral to go out and "fractionally invest" 10 times what the mortgage is worth. That pays far more than the 2% extra you mention. In fact, if they use your loan to raise 10 times what it's worth, and get 10% interest on that, their return is 100% of the loan, not some lousy 5-7%.

They'd be real dumb calling it in, it would kill the collateral, and hence the chance to invest.

What's more: it's not their money you borrowed for your home, they created it out of nowhere, it's not like they had it waiting in the safe when you walked in. They need just a few percent of it in their books, if that.

If a BANK is actually solvent but having a liquidity crisis, can't they borrow money from the federal reserve? Bears Stern investment fund I dunno, but if it was solvent, and Bears wanted to, I presume they could borrow money from somebody.

These funds consist of 95% borrowed money to begin with. They'd have to borrow money to save the money they borrowed to buy into vehicles that are now worthless. One of Bear's funds' big lenders is Merrill Lynch, and they got the ball rolling recently, by making a call on Bear. When they tried to auction off part of the funds' "assets", no-one offered more than pennies on the dollar, and the auction was halted.

So where could Bear borrow? Not at Merrill's. Other big banks? Not today, honey, I have a headache...

Goldman, JPMorgan Stuck With Debt They Can't Sell to Investors

Goldman Sachs Group Inc., JPMorgan Chase & Co. and the rest of Wall Street are stuck with at least $11 billion of loans and bonds they can't readily sell.

The banks have had to dig into their own pockets to finance parts of at least five leveraged buyouts over the past month because of the worst bear market in high-yield debt in more than two years, data compiled by Bloomberg show.

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ET on July 18, 2007 - 12:03pm

Goldman, JPMorgan Stuck With Debt They Can't Sell to Investors

Goldman Sachs Group Inc., JPMorgan Chase & Co. and the rest of Wall Street are stuck with at least $11 billion of loans and bonds they can't readily sell.

It strikes me that these big financial institutions have tons of money. So much money that they can hold $11BN of worthless bonds on their books pretending that it is still worth something. The tipping point will come when, in aggregate, the excess money sloshing around at these institutions dries up and they can't pretend any more. The only things we can be sure of are:
1. the real picture is highly likely to be worse, maybe much worse, than the publicly reported picture.
2. They will keep pretending as long as they aren't totally forced into some kind of liquidation
Hmmmm, sounds like other pictures, such as oil and energy and Global Warming.

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Dragonfly41 on July 18, 2007 - 12:30pm

Another finance company getting hit...

CIT Group Posts Unexpected Loss on Home-Lending Exit

http://www.bloomberg.com/apps/news?pid=20601087&sid=aal8W.hF.QpM&refer=home

CIT Group Inc., the largest independent commercial finance company in the U.S., reported an unexpected second-quarter loss and said it's getting out of home lending.

--snip--

``They're essentially taking about a 7 percent haircut on the value of those assets, meaning they think they're worth 93 cents on the dollar,'' said David Chiaverini, an analyst at Bank of Montreal's BMO Capital Markets division in New York. ``The way the housing market has deteriorated, it certainly wouldn't surprise me if they have to take an additional charge.''

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OuttaControl on July 18, 2007 - 12:38pm

Hooray! That makes it 100!

http://ml-implode.com/

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Darwinian on July 18, 2007 - 12:25pm

They would bite the golden goose that feeds them. As long as that mortgage is in their books, they can use it as collateral to go out and "fractionally invest" 10 times what the mortgage is worth.

Damn, and just when I thought I understood banking! I always heard, from my economics teachers and other such no-nothings, that banks were allowed to loan out a given percentage of monies held on deposit. I believe it was 90% at the time but I would not swear to that.

But now I hear that this is not the case at all. That instead banks are allowed to loan out 10 times the money they already have out on loan. Well no, that's not really what you said is it? You say they can "fractionally invest" ten times the money they have out on loan.

Exactly what does "fractionally invest" mean anyway. Where would they get this money to "fractionally invest"?

I did a Google search on "Fractional Investment" and find it means to invest in a fraction of a property. For one million dollars you can buy a ten percent fraction of a ten million dollar property.
http://www.rees1031.com/pdf/fractionals.pdf

Uhhhh....now I am really confused.

What am I missing here HeIsSoFly, somehow that just doesn't make any sense at all. I need you to explain what you mean and do banking laws really allow this sort of thing.

Ron Patterson

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HeIsSoFly on July 18, 2007 - 12:51pm

Ron,

I am genuinely sorry that it's hard to understand, and humbly suggest Money as Debt to clarify matters.

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Darwinian on July 18, 2007 - 2:57pm

HeIsSoFly, thanks for the link. I watched all 47 minutes and 7 seconds of it. It was excellent and I would advise anyone to watch it. Although I do not see money as the bogeyman the creators of the film obviously did, it was nevertheless very good.

I found the explination of how the economy must grow exponentially as we use, then throw away, our natural resources very interesting.

That being said, the film cleared up for me where you got the idea that banks were allowed to loan out or "fractionally invest" ten times the amount of existing loans. You simply misunderstood what the film was saying.

Banks were allowed to loan out ten times the amount of moneys that were invested, by the bankers, in the original bank charter. After that, as the film clearly stated, banks were then allowed to loan out 9 dollars for every 10 dollars on deposit in the bank. And that is the way banks create money.

A bank will loan out 10,000 dollars. The borrower then deposits the 10,000 back into the bank. New deposits! Then the bank can loan out another 9,000 on these new deposits. The borrower then deposits the 9,000 back into the bank. The bank then lends out 8,100 on these new deposits and so on down the line.

That is exactly how I learned it in economics classes and that is exactly how it is explained in this film.

Thanks again for the link.

Ron Patterson

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HeIsSoFly on July 18, 2007 - 4:23pm

Ron,

I'm glad you liked it, and yes, i agree, everyone should watch Money as Debt.

Your description of the process is exactly how I tried to describe it; the term "fractional investing" was half-jokingly used.

I was responding to the question why banks wouldn't call in loans if they could make more with "their money" elsewhere. As the film says: If there's no debt, there's no money. So that loan of yours is a prerequisite, and it's not so important how much the interest is. You are the vehicle that allows the bank to make money.

I like the following piece by Prof. Succo at Minyanville for describing the next phase in money for nothing and your chicks for free: derivatives.

FT's financial editor Gillian Tett wrote well on that topic too, see The Dream Machine, and estimated the trade at $470 trillion.

The Land of Credit

A $1 billion REPO by the Fed doesn’t seem like much until you check your premise. The Fed just did a $1.3 billion dollar coupon pass, which is like a permanent REPO. The Fed calls up JP Morgan (JPM) and purchases its bonds with credit, credit created from nothing. They just tell JP Morgan, "we owe you money."

JP Morgan now has funds (credit) it can lend out. But because of margin requirements it can lend out much more than $1.3 billion. In fact it lends out about twenty times that amount. So let’s say they call up 20 regional banks and let them borrow $1 billion each. In turn, each regional bank then lends out $5 billion to various mortgage borrowers. These borrowers refinance their house and spend the extra cash while the equity in their home drops.

The original $1.3 billion of credit the Fed created yesterday will in a few days turn into $100 billion of money borrowed by consumers. In fact these numbers are born out by the Fed’s activity over the last year. The Fed’s balance sheet has grown by about $30 billion over that time, while total credit market instruments outstanding grew by $3.5 trillion.

But that is just traditional pyramiding. Today we have the derivatives markets where JP Morgan can take some of that credit and lever it 100 to one by underwriting derivatives (I don’t mean to pick on JP Morgan, although it is by far the largest derivatives dealer in the world; others like AIG or other large Broker Dealers are doing the same). So of the $1.3 billion, let’s say JP Morgan keeps $300 million and then sells options to customers. It uses that credit as capital to support the trade; the trade itself is $150 billion in notional contingent liabilities. The notional amount of derivatives over the same period of time has grown by a scary $88 trillion. Derivatives are lending on steroids.

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Leanan on July 18, 2007 - 4:12pm

"Rich Dad" Kiyosaki put it this way:

Besides, banks really do not need your savings. They don't need much in deposits because they can magnify money at least 10 times. If you put a single $1 note in the bank, by law, the bank can lend out $10 and, depending upon the reserve limits imposed by the central bank, possibly as much as $20. That means your single $1 suddenly becomes $10 or more. It's magic! When my 'rich dad' showed me that, I fell in love with the idea. At that point I knew I wanted to own a bank, and not go to school to become a banker.

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Darwinian on July 18, 2007 - 4:32pm

Leanan, sorry dear but that is not the way it works.

Watch the film:
http://www.rees1031.com/pdf/fractionals.pdf

Or just skip to the point where this point is explained. It begains at about 13:28 into the film.

The 9 to 1 reserve ratio applies only to the banks investors in a newely chartered bank! That is to the banks original investors, not deposits. After that the law kicks in that governs loans verses moneys on deposit. And that is 10 to 9, or 9 dollars can be loaned out for every 10 dollars on deposit.

It is al explained very well on the film. Just watch the part beginning at about 13:28 on the film and runs for three or four minutes. Just take the short time to do that and all this muddy water will be cleared up.

Ron Patterson

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mr f on July 19, 2007 - 1:43am

And may I rudely add that Kiyosaki is a louse.

You want proof? The Google Corporation happily obliges:

http://video.google.com/videoplay?docid=-7039974980410674247&q=Kiyosaki&...

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Bakedplanet on July 18, 2007 - 1:49pm

I think the term that you want to look up is Fractional Reserve Banking. See link for an explanation of Fractional reserve banking.
http://en.wikipedia.org/wiki/Fractional-reserve_banking

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TechGuy on July 18, 2007 - 9:06pm

Banks rarely invest their own deposits in Mortgages these days. Banks usually off load Mortgage debt to the GSE or sell Mortgage backed bonds on the market (Syndication). They make money collecting service fees. This is why during the mortgage boom years banks were more than eager to loan money. They didn't own the debt, so if the borrower defaulted, they cared less. The more loans they made the more loan service fees they collected, but they don't make any direct money off the loan interest. Since the Banks don't own the debt the can issue as many billions or trillions they wish without violating federal (or state) banking laws. I believe HeIsSoFly doesn't quite understand how mortgage lending works.

Another common misunderstanding is how long term fixed rate mortages work. When a borrow gets a 30 yr fixed mortgage, the lender doesn't issue a 30 yr fixed bond to finance it. Generally a long term mortgage is financed with much shorter term bonds (2 yr, 5 yr and 10 yr). When the bond comes do, they re-issue a new set of bonds. They'll continue to do this until the mortgage is paid off. However, there is a risk factor. For instance lets say that a lender offers home owners 30 yr fixed at 6.00%. They calculate that the during the entire life of the loan, that they'll be able to issue bonds below 6.25%. Usually its a significantly lower since they make money off the difference. Now lets suppose that with in the next few years, the rates rise substantially, so that the Fed overnight rate is at 6.50% and the lender must sell a new set of bonds to finance a group of 30yr mortgages sold @ 6.00%. Can you see the lender's problem?

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capslock on July 18, 2007 - 1:55pm

Seems as though the whole bond market is tanking. Check out the price of AAAs:

Image Hosted by ImageShack.us

And some comments:

"World wealth isn't growing, world DEBTS are growing and the place they are growing the fastest is the US which is the sole terminus of world trade at this point. The biggest growth industry today is selling debt instruments. The entire existence of hedge funds, for example, is to funnel profits from uneven trade with the US back into the US via dumping debts onto the backs of any corporations that can run up more debts!"

Get it? It's all just recycled dollars — debt piled on debt piled on debt piled on debt — repeat ad infinitum. America's equities portfolio = 1% assets, 99% pure helium.

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westexas on July 18, 2007 - 7:53pm

Some interesting numbers from the Housing Bubble Blog:

“Each month about 5,500 homes come on the market in Las Vegas and only 1,500 are sold.”

An interesting photo essay on the number of businesses that have shut down along a three mile long commercial area in Boston:

http://www.financialsense.com/fsu/editorials/nystrom/2007/0718.html

I've begun to notice a similar pattern in the Dallas area--businesses closing and no one taking over the empty space.

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westexas on July 18, 2007 - 10:46am

I thought that the news release from Southwest Airlines--probably the best, or at least one of the best, managed airlines in the world--was pretty interesting.

Southwest is offering buyout packages to about 9,000 of their highest paid employees--basically offering to pay them to go away.

The fundamental restructuring of the US economy from an economy focused on meeting wants into one focused on meeting needs has begun.

One of the many reasons that I recommended trying to live on half of your current income, as part of ELP, was that it would allow you to offer to take voluntary pay cuts in order to keep your job and benefits, at least for a little longer. You need to be thinking about how to become, or work for, a provider of essential goods and/or services.

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BrianT on July 18, 2007 - 10:53am

WT: Another option, if one has a modest nest egg, is to relocate. There are gringos living quite well in Costa Rica on $20000 per annum.

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westexas on July 18, 2007 - 11:14am

Or live cheaply in the US: http://www.katu.com/news/local/8499817.html

This is an article from the EB, about a woman living in a 84 square foot space.

Recall our discussions about 100 square foot living spaces last year? I mentioned it in my August, 2006 net oil exports article:
http://www.energybulletin.net/19420.html

"Cheap is the new chic"

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BrianT on July 18, 2007 - 11:32am

WT: If you wanted to live that lifestyle, my estimate would be $7000 per annum in CR. Talking to expats in CR, it seems like the main obstacles to a really cheap existence in the USA are 1. health insurance (one woman alleges her bill for a family of 4 was $10000 per annum) 2.property taxes and 3. house insurance (for expats from Florida). The minimum charge to breathe the air in the USA seems to be increasing at a good clip.

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jjhman on July 19, 2007 - 12:44am

"alleges"???
Health insurance for my wife and I cost us over $14,000 per year.

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BrianT on July 19, 2007 - 8:57am

JJ: Wow. I wasn't questioning her number, I just wasn't sure as I am in Canada and health care is almost free here. I think yours is the biggest bill I've heard.

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wizofaus on July 19, 2007 - 6:37pm

Is it also true that the deductible for a single treatment can be as high as $10,000? I won't admit where I got that figure from...

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HeIsSoFly on July 18, 2007 - 11:34am

WT, this absolute gem of an article has a different take:

Everything I Want to Do Is Illegal

You would think that if I cut the trees, mill the logs into lumber, and build the house on my own farm, I could make it however I wanted to. Think again. It's illegal to build a house less than 900 square feet. Period. Doesn't matter if I'm a hermit or the father of 20. The government agents have decreed, in their egocentric wisdom, that no human can live in anything less than 900 square feet.

Our son got married last year and wanted to build a small cottage on the farm, which he now oversees for the most part. Our new saying is, "He runs the farm, and I just run around." The plan was to do what Mom and Dad did for Teresa and I: trade houses when children come. That way our empty nest downsizes, and the young people can upsize in the main family farmhouse. Sounds reasonable and environmentally sensitive to me. But no, his little honeymoon cottage or our retirement shack had to be a 900-square-foot Taj Mahal.

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CEOJr1963 on July 18, 2007 - 12:04pm

Then build it 900 square feet. You just got to out think the Feds. Make all but 200 square feet Open to the outside via porches which are considered living spaces in most house plans. Move your kitchen to one of these porches and you have the ability to have a no heated area for cooking in the summer time and a heated kitchen in the winter time for added heat to your living areas.

I could with a few hours prep time draw up several ideas for a 900 square foot house. I have plans for a 450 square foot house that seconds as a 600 square foot house with all the covered decks and open roof design for star watching.

Just because a gov't agency tells you to live beyond your desires does not mean you have to cowtow to them, it just means you have to work around their petty rules and get better at design work.

Me and my dad discussed the fact that if we had cisterns in our yard we could have gotten over 2,000 gallon of fresh rain water over the past 2 weeks of rains. And if we had other systems in place we could rebuild the kitchen to house several renewable energy items while we rebuild it sometime this next year. He is working 48 hrs a week for a company that is in the closeout mode. They were only supposed to work 13 weeks, as it stands they have about 6 more weeks than that worth of merchandise to sell. But he is for once getting paid time and a half for his overtime. and he is working it just to catch up. But at 71, he is afraid that when he does stop work he will go down hill fast if he does not have something to do after this mess goes away.

We could get into the design and building of small cottage homes in the 900 square feet or less range.

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jokuhl on July 18, 2007 - 8:32pm

Aww, just build it as small as you want, then put wallpaper on two of the outside walls and leave up a tape perimeter for the 'rest' of the mansion.. put up a nice, courteous sign saying 'pardon our appearance while we build'..

Sometimes its better to ask forgiveness than permission.

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BKhere on July 18, 2007 - 8:01pm

Building codes are why people are putting these little habitations on wheels. That way they become trailers, not "houses." A friend of mine in New Hampshire has done the same thing, because housing on wheels is not subject to property taxes. She has hauled her "Gypsy Cabin" up to a 340 acre hunk of land she owns in the northern part of the state.

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rainsong on July 18, 2007 - 6:12pm

Replica of Thoreau's Walden one room cabin c. 1850. Thoreau wrote of the virtues of a simple life on the land.

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ggg71 on July 18, 2007 - 6:50pm

I grew up in and around Central and Boston, MA, and have walked around Walden Pond many times, but that is the first picture I have ever seen of what Thoreau's cabin looked like on the inside.

Thank you, it's quite inspirational.

Garth

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bruce from chicago on July 18, 2007 - 8:04pm

Where do I fit the big screen plasma Monitor????

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Cornucopia on July 19, 2007 - 1:55am

On the wall?

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WNC Observer on July 19, 2007 - 9:34am

How about the landfill?

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ET on July 18, 2007 - 12:09pm

Southwest is offering buyout packages to about 9,000 of their highest paid employees--basically offering to pay them to go away.

I have a nephew who got a job flying for Southwest a few months ago. I thought when I saw this, that his job might be at risk, but then it might not be. They will likely try and shed the pilots with more seniority and higher pay, hanging on to the newer ones with entry level salaries. Thus contributing to the general lowering of median income that is going on, and probably accelerating.

At any rate, my nephew is very cognizant of the hazards.

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JetA on July 18, 2007 - 9:54pm

ET,

Your nephew must also be cognizant that he is in a union shop. The junior guys will be the first ones to go. Seniority in king. Trust me, I have the same hazards as him.

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geewiz on July 18, 2007 - 11:04pm

this buyout package has a fine print. must have been employeed for 10 years minimum. not all labor groups in the company are allowed to take up this offer. Then the package offers 25k cash lump sum severence, plus free flying privilages, and medical coverage for one complete yr after leaving the co.
By the way: these highest paid employees is a misnomer. yes they are highest paid (by virtue of seniority) for their work group. but for some of them, the highest paid employees are only making 40K a year, maybe up to 60 (rare case). these particular work groups are over staffed. and the company is simplying thinning out the dead weight in these work groups who are over staffed. unlike maintenance (which is staffed lean and mean) or pilots.
ET, email me sometime. I may have already met your nephew on a gate call!

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SonicTheHedgeFund on July 18, 2007 - 11:28am

Given all the people I've met from Bear over the years and what I know of their culture, I'm not shedding any tears, but don't get all hyped over the losses at BS causing a major meltdown. 5-year CDS on Bear only widened from 31-ish to 67/70 and this occurred at a time when credit markets have been "repricing" risk across the board i.e., CDS spreads have widened out significantly over the last few weeks. 5-yr CDS on other financials: Goldman 48/51, Mother Merrill 49/51, MWD 54/58, LEH 59/62.

The entire subprime mess is, what, 10 times smaller than the S&L mess back during Bush 41? The world didn't end then. Why should anyone expect markets to meltdown now? Maybe disaster will strike, but let's keep the current mess in perspective.

The HEDGE FUNDS to watch that could sink us all are Freddie Mac & Fannie Mae not some internal fund at Bear. (If you use the famous "duck" test, Fannie & Freddie are hedge funds, and funds of enormous size.)

They are a great scam: use an implicit govt guarantee to issue debt lower than you could otherwise and take the funds and speculate in the mortgage securities market. It gets better: don't be required to mark the multi-hundred billion in assets you hold to market (just focus on annual cash flow), and then channel any profits to shareholders and employees. If you blow up, the taxpayer gets stuck cleaning up the mess.

The move to hedge-fund-in-disguise status started way back in the 90's. Freddie moved first, Fannie followed. So far, we've all been lucky that they haven't messed up too badly.

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HeIsSoFly on July 18, 2007 - 12:13pm

Wait, there's more. Heeeeeere comes Ginnie....

US Turns To China To Save Mortgages

The Bush Administration is urging China's central bank to buy more government-backed mortgage bonds, Bloomberg reports, in an effort to sustain financing for US home loans in the midst of the subprime mortgage crisis.

The Secretary of the US Department of Housing and Urban Development is in Beijing to persuade the PBoC to buy more securities from Ginnie Mae - a seller of US mortgage products which, unlike Fannie Mae and Freddie Mac, are government guaranteed. China has delved into Ginnie Mae securities previously, but not in any significant fashion.

China has, however, increased its foray into mortgage products in general over the past three years. Investments totalled US$107.5 billion at June 2006, up from US$3 billion three years earlier. The HUD hopes to direct China's recycling of US$1.33 trillion of foreign reserves into its Ginnie Mae products ahead of others, as they offer the government guarantee for the same credit rating.

China has bought $104.5 billion in US "mortgage products" in just three years, and now the White House sends a US Secretary to plead with them to speed up the buying. But that stuff is about to crash, right?

Well, not really. What is real then? Look, this is how Wall Street unloads its gambling debts on the American taxpayer. Why would the Chinese be worried that the paper is worthless? You have personally guaranteed that you will pay taxes to pay them whatever they might lose.

PS article stolen, again, from The Round-Up: July 17th

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HeIsSoFly on July 18, 2007 - 12:36pm

Sonic, one more thing:

It's hard to figure how big it all is, but 10 times smaller than S&L sounds a long way off. If I were to follow Jim Willie's reasoning:

COMPOUND DAMAGE ORGY (CDO)

The Greenspan reaction to the 2000 tech/telecom stock bust was to create a housing/mortgage bubble perhaps 20x larger.

And then I'd combine that with you saying S&L was 10 times bigger than the subprime tsunami, I'd have to conclude that S&L was 200 times bigger than the tech/telecom bubble. And that I find hard to believe.

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SonicTheHedgeFund on July 18, 2007 - 3:42pm

The most recent figure I saw on the subprime was that it would take 120 billion to clean up. (It was plastered all over cnn.com and elsewhere no that long ago.)

The Resolution Trust Corp spent something on the order of 400-500 billion (or more) S&L mess back some 15 years ago.

Adjust for inflation and round and we get one order of magnitude i.e., the S&L mess was roughly 10x bigger. (500 bn at 6% for 15 years is almost exactly a factor of 10. The 10x figure is meant to be approximate to facilitate discussion. If one uses a lower compound rate and only gets a factor of, say, 7x, does it really matter?)

Regarding the Chinese owning $107 bn of US mortgage securities. What percentage is subprime? Maybe 15%? Of that, it's not all worth zero. (Recovery rates on unsecured corporate bond average on the order of 40 cents on the dollar; it averages well over 60 on unsecured bank loans.)

Again, the basic question is, since the much larger S&L mess/fraud didn't sink us (though it did cause a recession & extensive credit rationing), why should the subprime mess/fraud sink us? Is something truly different this time (a far, far more leverage economy perhaps?), or should we just expect a replay of 1990-1991 (mild recession, credit rationing, etc.)?

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musashi on July 18, 2007 - 5:57pm

(a far, far more leverage economy perhaps?)

You bet.

Watch what happens when they tighten credit.

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GreyZone on July 18, 2007 - 6:33pm

I've seen figures ranging from $900 billion to $2 trillion.

You seem to forget that the LTCM debacle was cleaned up with a few billion dollars but the overextended nature of LTCM had them over $120 billion into trouble. It's the leverage that is the real problem here.

Ghawar Is Dying as we slide Into the Grey Zone
"The greatest shortcoming of the human race is our inability to understand the exponential function.

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SonicTheHedgeFund on July 19, 2007 - 11:49am

I haven't forgotten LTCM: I helped take several of their trades off their books (and made several million in trading profit in the process). LTCM may have had $100+ bn in positions, but that was not their net exposure.

I finally found an "official" FDIC figure for the S&L mess: $153 billion. Initial estimates were far lower. Estimates at the height of the mess were far, far higher ($500+ bn). So, take $153 bn, gross it up for the time value of money, and compare it to the current subprime mess. Using 6% for 15 years gives $367 bn in 2007 dollars -- an order of 3X (not 10X as I guessed above -- me bad).

Fed governor Susan Bies estimates that the subprime market is about 7-8% of the $10 trillion mortgage market. That is consistent with your $900 bn figure. However, that does not imply $900 bn in losses. Not all loans go bad, losses on bad loans are not 100%, etc. The $120 bn estimated loss figure estimate I cited seems an appropriate figure to use to compare with the S&L mess from the late 80's/early 90's.

While the subprime mess will hurt, I see no reason to expect disaster given how the significantly larger S&L mess played out unless the massive increase in leverage throughout our economy over the last 15 years amplifies these losses. Our near-term economic future is highly uncertain, caution from the subprime mess seems warranted, but not fear or panic (IMO).

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GreyZone on July 19, 2007 - 6:11pm

Not all loans go bad, agreed. But this is not about individual loans! This is about a derived financial instrument that is dependent on the sum of the parts performing at a certain expected level and if some subset of the parts performs below that level then the entire financial instrument is worth less (or even worthless, as Bear Stearns discovered).

Your error is in focusing on individual mortgages. Every single CDO created has defaulting mortgages. That was written into the CDO but if the number of defaults exceeds a certain limit, the paper drops in value. And since that paper was then used as collateral for other loans, those loans might be called in because the collateral no longer matches the requirements for the loan.

"The greatest shortcoming of the human race is our inability to understand the exponential function." -- Dr. Albert Bartlett
Into the Grey Zone

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TechGuy on July 18, 2007 - 8:43pm

For Alan from the "Big Easy":

http://www.lifeaftertheoilcrash.net/Archives2007/blogcatastrophe.html

"What no one seems to be paying attention to is a simple clause that exists within nearly all conventional, and non-conventional commercial mortgate agreements that enable banks, or other financial institutions, to 'call' a loan. That is, they can demand that homeowners pay the remaining unpaid balance of their mortgage within 30 days, EVEN IF THEY ARE NOT LATE ON THEIR PAYMENTS, NOR HAVE EVER BEEN LATE ON ANY OF THEM."

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Leanan on July 18, 2007 - 10:01am

Either it's a mistake, and he meant .net instead of .com, or he lost his .com domain to a domain name vampire.

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PigglyWiggly on July 18, 2007 - 1:33pm

Interesting stuff and to the point. It was pretty well disclosed (although peripherally and not fully marked to market, which it has been now ... as 0$) during Cantor's auction on June 22. I made a little post about this here:

http://pigglypress.blogspot.com/2007/06/to-market-to-market-to-buy-fat-p...

Many folks saw this as the big bad sign.

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Durandal on July 18, 2007 - 10:28am

Hoping, but I'm not realisticly expecting to be in it that long. The fact is that I can't pull all of my money out for at least another month, and personally I would love to wait until Jan 08 to pull out my money due to tax reasons. The thing is, most investors aren't PO aware, and they don't know the writing is already on the wall and they're just riding the momentum. Yup, it's risky, but I'm not sure that having my money in the bank would be any safer.

~Durandal (http://www.wtdwtshtf.com/)

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WNC Observer on July 18, 2007 - 11:41am

My signal to liquidate my US equity positions in 1999 was that idiot "Dow 36,000" article. Be on the lookout for something similar this time around, then bail out immediately.

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BrianT on July 18, 2007 - 11:46am

WNC: I wouldn't write off Dow 36000 just yet. The way the greenback is going (down 12% against the Cdn dollar since Jan)you never know.

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PigglyWiggly on July 18, 2007 - 1:44pm

This is true. I have often advised coworkers, friends, and family to invest their assets in a basket of stocks on the Zimbabwe stock exchange. At about 12000% return it's done very well. At least until recently:

http://www.voanews.com/english/Africa/Zimbabwe/2007-07-09-voa47.cfm

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CEOJr1963 on July 18, 2007 - 12:14pm

Try under your bed. I don't trust banks either, but then again I did keep a lot of pennies till i found that the new ones are getting an electro-plating over junk metals. I don't trust hard currencies much either unless it is silver or gold, or stones.

going to start storing coal soon, LOL

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AlanfromBigEasy on July 18, 2007 - 12:47pm

Nickels and pre-1982 pennies are still worth saving. 1982 was the change-over year with some of both.

But even new pennies have almost 1 cent worth of zinc in them.

Alan

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sgage on July 18, 2007 - 1:34pm

You can easily separate copper pennies from the post-82 zincies (as I call them, since they're basically zinc with a thin copper finish) by simply dropping them on a hard surface. The zincies go "click", but copper pennies have a noticable ringing sound. I save my copper pennies, just for the helluvit.

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CEOJr1963 on July 18, 2007 - 6:50pm

Thanks Alan.

I'll make sure my pennies that I save are of the later models.

Not that I will need them much, I have skills in finding food in the wilds where most citie dwellers do not.

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hummingbird on July 18, 2007 - 11:38am

Durandal, you must have a strong stomach. I think the meltdown could begin any time now.

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jeffvail on July 18, 2007 - 12:10pm

Why not hedge?

If you really want to wait until January 1st to take your money out of the market for tax reasons, then pick up a couple of March '08 put options well out of the money on the Dow (and possibly also the Dollar). Assessing how many you'll need, and how far off the money, requires that you consider how much you currently have in the market and where the threshold for an unacceptable loss is. Just a guess (haven't checked the option quotes), but you should be able to hedge loss from a million dollar portfolio through January 1st for somewhere in the neighborhood of $10k-$20k. And, given your tax concerns, if the options expire worthless because the markets didn't crash, you can write off the loss.

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Durandal on July 18, 2007 - 1:57pm

Well, the majority of it is in my 401k. I was dumping 21% of my income into the thing for a few years. I'm young so it's a relatively small nest-egg compared to some people on the board, but it's still enough $ that I would cry if it were to all disappear.

The rest are in balanced mutual funds and money market accounts that I can yank at a moment's notice. Instead of saving it in a bank, I'll spend it on something worthwhile. (I would prefer to buy land with it, but that takes time.)

~Durandal (http://www.wtdwtshtf.com/)

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oilmanbob on July 18, 2007 - 3:43pm

Durandal,

Diversification is a myth in this kind of economy. Why don't you take a look at oil and gas royalty trusts? They're paying 8%-9% right now, and since they are a physical asset can only get better. Look at Permian Basin Royalty Trust and Sabine Royalty Trust.

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PigglyWiggly on July 18, 2007 - 2:11pm

You don't have to play the option market directly. You can short the Dow or S&P with mutual funds. They even pay you a dividend!

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dbarberic on July 18, 2007 - 1:57pm

It is not going to play out that way. The market is not going to “wake up” one day and accept Peak Oil as fact, close up shop, shut everything down, and everyone goes home.

Global central banks are inflating their currencies, many in double digits.

As of 07/09/07, Country YOY % increase in money supply:
Russian Fed. M2 50.94
India M3 19.70
China M2 16.74
Australia M3 14.05
United Kingdom M4 13.84
Mexico M4 12.21
Brazil M2 11.92
Denmark M3 10.62
Korea M3 10.07
Canada M3 8.08
OECD Total M3/ EUROZONE 7.86/10.9
United States M3 reconstructed 13.7
Germany M3 6.16

Excessive money printing will beget new bubbles, which will require more excessive money printing to offset the bubble when it pops, to create another new bubble to offset the popped bubble. Rinse and repeat.

The terminal phase will be inflation, followed by a brief period of dis-inflation, followed by massive inflation, followed by a brief period of dis-inflation, followed by hyperinflation. The markets will be an outlet for the massive liquidity being pumped on a global scale and it will be irrelevant if the price of oil continues to rise (irrelevant in the sense that certain industry sectors may be hit, but other sectors will experience bubbles pumped by liquidity and rising oil prices: Alt Energy, infrastructure, traditional energy companies with long life reserves, energy service).

Those that are waiting for deflation and a market crash are correct, it will eventually happen. But they are way to early, we must go through terminal hyperinflation first.

References:
No Deflation! Disinflation then Lots of Inflation
The "Ka" phase of "Ka-Poom" has officially begun
by Eric Janszen
http://www.itulip.com/forums/showthread.php?t=417

CRACK-UP BOOM, PART IV: Gold, Oil and the Dollar
by Ty Andros
http://www.financialsense.com/fsu/editorials/andros/2007/0628.html

Ka-Poom is a Rhyme not a Repeat of History
In a World of Floating Exchange Rates and Fiat Money, What Goes Down, Must Come Up
by Eric Janszen
http://www.itulip.com/forums/showthread.php?t=428

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