Wednesday, October 24, 2007

More sub - prime talk

Previously, we had talked a bit about a fall out from the sub-prime world and in particular, how it is evident that the people who helped foment the mess seem to be on their way to procuring a get-out-of-jail-free card in the form of a super fund developed to bail out illiquid mortgage backed financial instruments. A recent article by Paul Krugman over at the NYT explains in relatively simpler terms the details behind the mess and uses a simpler analogy.

Today, when a bank makes a home loan, it doesn't hold on to it. Instead, it quickly sells the mortgage off to financial engineers, who chop up, repackage and resell home loans pretty much the way supermarkets chop up, repackage and resell meat.

Brings to my mind the recent debacle over at Topps.

It's a business model that depends on trust. You don't know anything about the cows that contributed body parts to your package of ground beef, so you have to trust the supermarket when it assures you that the beef is U.S.D.A. prime. You don't know anything about the sub-prime mortgage loans that were sliced, diced and pureed to produce that mortgage-backed security, so you have to trust the seller — and the rating agency — when it assures you that it's a AAA investment.

So, why isn’t anybody punishing the rating agencies who rate junk investments as triple AAA misleading everybody? Apparently there is a plan afoot to deliver legislation that will curb the irrationality inherent with rating agencies (the rating agencies are hired and paid by the issuers of the very securities they rate - something like students paying the professor for grading their work) and give aggrieved consumers the right to seek legal retribution from mortgage companies that deceived them – but – a huge BUT here, I am sure that K street will not allow that legislation to go anywhere...

Supposedly safe investments suddenly turned into junk bonds when the housing bubble burst. High profits reported by hedge funds — profits that were reflected in huge payments to the fund managers — turn out to have been based on wishful thinking.
Right now the bleeding edge of the crisis in confidence involves worries that there may be large losses hidden inside so-called "structured investment vehicles" — basically hedge funds that borrow from the public and invest the proceeds in mortgage-backed securities.

An article by Alan Blinder, an economics professor at Princeton titled ‘Six Fingers of Blame in the Mortgage Mess’ is a useful read that might help us avoid such debacles in the future – but then who listens amidst irrational exuberance

Of course, even the superfund being developed to safeguard the high flyers who bilked homeowners seem to be running into a bit of flak. It is being compared to using more smoke and mirrors to cover up existing skullduggery - according to the former Federal Reserve sage Alan Greenspan (read full report here)

He also had the following chilling words: “There will be a crash in China, I just don’t know when”...

Xiong Lijun, 'Don't educate me', oil on canvas, 78" X 62", 2004

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