"A Single death is a tragedy; a million is just a statistic”
Joseph Stalin
In these times of crises, only the dark side would appear in our minds.
The demise of Lehman Brothers last week was projected as a great tragedy and rang alarm bells all across so much so that that AIG was bailed out by an 85 Billion package. However what may be less known is that since late 2006 more than 286 Mortgage companies have gone bust while since mid 2007 about 81 hedge funds have been liquidated.
Now the US government is in with a 700 Billion bailout package which will essentially convert private debt into public debt, or about 2,200 dollars for every person in the US. This would have been probably allright and considered a necessary evil, if the maths added up and we actually knew what the debt was. The problem is we really do not know with all types of fancy financial instruments being used to show profits in boardrooms.
I have been provided some very insightful information by Mr. Louis F Hill, Chairman of Rockwood Capital Management, Inc. He has shared the following:
In October 2007, Bill Gross, of Pimco, estimated $ 250 Billion losses in US sub-prime mortgages. Then in January 2008, the G-7 Finance Ministers estimated there would be $ 400 Billion Losses in US mortgages. This increase was caused by the realization that the mortgage mess had spread beyond just the sub-prime class. By April 8th 2008, The IMF estimated there would be $ 564 Billion losses in US residential mortgages. Please note, that the headlines for the IMF numbers were reported higher ($ 945 Billion) because of their inclusion of $ 380 Billion in commercial real estate losses. So what is the scale of the SIV’s (Structured Investment Vehicle) involved with residential mortgages? If mortgages were the only holding in these vehicles, we could estimate that the SIV’s debt exposure would be 10 times the latest estimate or $ 5.64 Trillion.
The Bank of International Settlements reports there are more than $ 500 Trillion dollars of derivatives in 2007 and $ 600 Trillion in 2008. Credit default swaps were estimated at $ 58 Trillion in 2007 and $ 64 Trillion in 2008. So the mortgages in the SIV’s, at the $ 5.64 Trillion level, are a small part of the total numbers derivative instruments in existence.
In the past six years, Stephanie Pomboy of Macromavens estimates 500% more credit has been created outside of the banking system than within it. This means that those financial products are essentially unregulated.
To understand one of the issues one needs to get an idea of what a CDS or Credit Default Swap is.
“A credit default swap is like an insurance policy. It can be used by a debt holder to insure against a default under the debt instrument. There is no requirement to actually hold any asset and is not generally considered insurance for regulatory purposes”
Now if we have created enormous amounts of credit outside the banking system, which are unregulated then, I guess all the numbers will become just that; Statistics, which would cause enormous hardships to people who will also become statistics in government records.
Back to the housing fiasco, some idea of statistics is below:
Bank seizures in the first half of the year increased by 154 percent to 370,179 from the same period in 2007. while a record 1.2 million homes were in foreclosure during the second quarter of 2008. That represents 2.8% of all outstanding loans, up from 1.4% of all loans during the same period a year ago, according to a report released Friday by the Mortgage Bankers Association (MBA).
During the three months ended June 30, 2.9 million homeowners, or 6.4%, were behind on their payments, up more than 25% from last year.
Joseph Stalin
In these times of crises, only the dark side would appear in our minds.
The demise of Lehman Brothers last week was projected as a great tragedy and rang alarm bells all across so much so that that AIG was bailed out by an 85 Billion package. However what may be less known is that since late 2006 more than 286 Mortgage companies have gone bust while since mid 2007 about 81 hedge funds have been liquidated.
Now the US government is in with a 700 Billion bailout package which will essentially convert private debt into public debt, or about 2,200 dollars for every person in the US. This would have been probably allright and considered a necessary evil, if the maths added up and we actually knew what the debt was. The problem is we really do not know with all types of fancy financial instruments being used to show profits in boardrooms.
I have been provided some very insightful information by Mr. Louis F Hill, Chairman of Rockwood Capital Management, Inc. He has shared the following:
In October 2007, Bill Gross, of Pimco, estimated $ 250 Billion losses in US sub-prime mortgages. Then in January 2008, the G-7 Finance Ministers estimated there would be $ 400 Billion Losses in US mortgages. This increase was caused by the realization that the mortgage mess had spread beyond just the sub-prime class. By April 8th 2008, The IMF estimated there would be $ 564 Billion losses in US residential mortgages. Please note, that the headlines for the IMF numbers were reported higher ($ 945 Billion) because of their inclusion of $ 380 Billion in commercial real estate losses. So what is the scale of the SIV’s (Structured Investment Vehicle) involved with residential mortgages? If mortgages were the only holding in these vehicles, we could estimate that the SIV’s debt exposure would be 10 times the latest estimate or $ 5.64 Trillion.
The Bank of International Settlements reports there are more than $ 500 Trillion dollars of derivatives in 2007 and $ 600 Trillion in 2008. Credit default swaps were estimated at $ 58 Trillion in 2007 and $ 64 Trillion in 2008. So the mortgages in the SIV’s, at the $ 5.64 Trillion level, are a small part of the total numbers derivative instruments in existence.
In the past six years, Stephanie Pomboy of Macromavens estimates 500% more credit has been created outside of the banking system than within it. This means that those financial products are essentially unregulated.
To understand one of the issues one needs to get an idea of what a CDS or Credit Default Swap is.
“A credit default swap is like an insurance policy. It can be used by a debt holder to insure against a default under the debt instrument. There is no requirement to actually hold any asset and is not generally considered insurance for regulatory purposes”
Now if we have created enormous amounts of credit outside the banking system, which are unregulated then, I guess all the numbers will become just that; Statistics, which would cause enormous hardships to people who will also become statistics in government records.
Back to the housing fiasco, some idea of statistics is below:
Bank seizures in the first half of the year increased by 154 percent to 370,179 from the same period in 2007. while a record 1.2 million homes were in foreclosure during the second quarter of 2008. That represents 2.8% of all outstanding loans, up from 1.4% of all loans during the same period a year ago, according to a report released Friday by the Mortgage Bankers Association (MBA).
During the three months ended June 30, 2.9 million homeowners, or 6.4%, were behind on their payments, up more than 25% from last year.
This brings us to the question:
Is the 700 billion bailout like putting a band-aid on a bullet wound, would it be enough?
Linkedin Debate:
http://www.linkedin.com/answers/financial-markets/equity-markets/MKT_EQU/329558-564729
5 comments:
A band-aid is probably a very good analogy. The ‘red flag’ here, is that the US Government is undertaking this bailout under the guise of ‘saving its citizens additional economic hardships’. I don’t know about you, but I’m more than willing to take my chances without their intervention. Borrowing & lending money is mostly what’s responsible for the current crisis. The very idea that borrowing & lending more money is going to solve anything longterm is absolutely ludicrous. We would be so much better off if they would just stop spending money that they don’t have.
RT
Yes a better analogy is sending a box of band aides to hiroshima or nagasaki
I wish people would use any small semblance to logic when thinking about this bailout. In most instances, the core issues can be identified by "dumbing down" your thought process. So here it goes...
Take your personal financial situation. If your income is $2000 per month but your monthly bills are $3000 per month, you have a monthly deficit of $3000. In a rush to "stay alive" you borrow the monthly difference using a credit card, which in turn raises your monthly bills. You do this in a hope that at sometime in the future, you will balance your budget and hopefully have a surplus (savings) Once you "max out" your credit card, you need to apply for more, you eventually tap out every source of credit available to you and end up with a new monthly bills of $5000. The problem is, no one will lend to you anymore because your income doesn't match your bills. You can go "off the market" and hit up friends and family, but unless you hit the lottery or get a massive pay increase the end is near and you become bankrupt and insolvent.
Take the above and multiply it by a hundred fifty two billion (us work force population is aprox. 152MM) and you see that the bailout is a hope and a prayer, since the US doesn't produce or export anything but debt and inflation.
Dumbing down your thought process to something you can relate to shows that adding more debt to a debt created problem only compounds an issue and does not solve it.
The proponents of the bail out hope to un-freeze the credit markets in order to start lending again, the equivalent of your credit card companies increasing your limit. So I ask you, is that the long term solution ?? Sure it may buy you a few more months (perhaps you personally may hit the lottery), but at the end of those months (if you didnt hit the lottery), when your cards are maxed out again, is your debt higher or lower ?? Is your problem better or worse ??
Jack Gaffney
Executive Vice President
Providence, Rhode Island
I think the answer is maybe. You're absolutely right that the problem is much larger than the $700. However that's largely do to complex leveraging of assets around the world that has been occurring. So, yes, the house of cards can fall.
My hope would be, if the policy makers get this right (and I don't think they're quite on the right track yet) they can shore up the foundation of this house of cards and either prevent it from collapsing or at least delay or slow the collapse enough to allow for an orderly unwinding of all of these exotic contracts. So maybe $700 billion is enough to do that.
We also have to be vigilent about the problem that we're creating in coming up with a solution (the seeds of the next destruction are always sewn in the solution of the current one).
My opinion is that we're going to see significant inflation and/or currency devaluation occur. With all of the money that the central banks have pushed into the system it's difficult to see how the global economy is going to absorb that. Economic growth is highly unlikely to be sufficiently high to absorb it. The good news in that is that we may inflate our way out of a debt problem (we'll just have other problems as a result).
There's lot's of ugliness yet to come. And nobody's talking much about the impending credit card debt problem yet. That's still to come.
Larry
For me it is like being lost in the forest and knowing that the way out is in one direction,and regardless of what you run into you keep walking in that direction, walking into trees, walking through lakes, etc.
Not taking the lay of the land into account and being single minded is not necessarily the answer.
Ray Miller
This article is excellent and it provides very good insight about the current financial melttdown..
For me it took almost 7 days to understand what CDS is all about.. a very good compilation..
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