Sorry guys I was absent for a while you see my blog is mostly about economy and little about travel and photography and I want to keep it that way also because these 2 subjects are very independent. No matter which political party/country/religion you belong to economy affects everyone the same regardless of your background. Travel/vacations are always pleasure everybody enjoys them again regardless of their religion/country.
However once in a while these world level incidents take place and take focus. But anyway…I am back….and this time I will take you on an interesting economic journey going forward till the end of this year (except Friday’s that day is reserved for jokes/humor)…so in this post I would describe the basics. I will start with sub prime and will take you to the credit freeze most people talk about it this will only increase depth of their understanding on this subject ( I hope). So let us get started….
First of all do you even know when and where and how the foundation of sub prime was laid ? Someone had to come up with this idea…right ?…….do you know who ?……that is why you read my posts I try to answer unusual questions…..Today not only I will tell you how the foundation was laid but will also tell you the names of companies involved in laying the foundation of sub prime……read along… names are highlighted below….and don’t be surprised if you find out the sub prime concept was drawn by only 5 people over Chinese food……
Subprime Securities Market Began as `Group of 5′ Over Chinese
Dec. 17 (Bloomberg) — Representatives of five of Wall Street’s dominant investment banks gathered around a blonde wood conference table on a February night almost three years ago. Their talks over take-out Chinese food led to the perfect formula for a U.S. housing collapse.
The host was Greg Lippmann, then 36, a fast-talking Deutsche Bank AG trader who aspired to make mortgage securities as big a cash cow for Wall Street as the $12 trillion corporate credit market.
His allies included 34-year-old Rajiv Kamilla, a trader at Goldman Sachs Group Inc. with a background in nuclear physics, and 32-year-old Todd Kushman, who led a contingent from Bear Stearns Cos. Representatives from Citigroup Inc. and JPMorgan Chase & Co. were also invited. Almost 50 traders and lawyers showed up for the first meeting at Deutsche Bank’s Wall Street office to help set the trading rules and design the new product.
Those meetings of the “group of five,” as the traders called themselves, became a turning point in the history of Wall Street and the global economy.
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aA6YC1xKUoek
Do you still think America is NOT a land of opportunity ? Shame on you, where else in the world could you have a 36 & 34 & 32 year old come up with a scheme like sub prime ? Something that could lead this world to a financial mess. Get your facts right dude. In most countries people of these age groups would be pushing paper and cleaning desks for their bosses who have silver hair or some hair.
Now what is sub prime security or CDO ? Do you know ? Do you understand what it is ? Is there anyone who understands what it is ? Feel free to read the whole message if you want but I recommend read what is highlighted as that is the real answer. And then read who said it…so it’s clear that it is the correct answer.
Do you find it striking that banks keep looking into their investments and not knowing what they have?
………. Now if you’re going to understand that CDO, you’ve got 50-times-300 pages to read, it’s 15,000. If you take one of the lower tranches of the CDO and take 50 of those and create a CDO squared, you’re now up to 750,000 pages to read to understand one security. I mean, it can’t be done. ……………
I mean, it can’t be done – These are not my words my friend, these are Mr. Warren Buffet’s words….he answered this question for Fortune magazine in an interview. As always here is the link to his interview…..finish reading my post and then comeback to read it.
http://money.cnn.com/2008/04/11/news/newsmakers/varchaver_buffett.fortune/index.htm
How many of us have read all pages of our credit card contracts and then all those revisions that came by mail ? And how many of us do actually remember the first contract term and all alterations to it including the last one that just showed up in the mail recently ?
Chances are there is no one who remembers that many details! So the obvious question is when these CDOs were so complex that a simple CDO requires you to read minimum 300 pages worth of document why on earth someone will buy it ?
That’s a good question and let me answer that for you….(actual proof of it is in the video that you will play later ….towards the end of this article). I think there are 2 reasons for institutions across the world buying these sub prime or CDO investments.
First Reason – a.) Rating agencies (such as Moodys and S&P) rated these investments as AAA. AAA ratings are given to highest grade investments once they are rated at top level buyers of these tend to believe these are safest investments and details could be avoided. Mr. Warren Buffet said it himself contracts were so large they could not be read and understood so the only reason in my mind someone will buy them is if they were rated top grade and they were…at that point no matter what’s written in the contract…you’re under the assumption you’re buying gold and you just can’t go wrong. However rating agencies later said they didn’t understand the risks with these CDOs correctly either (who did ?) and so they rated them AAA.
Second Reason b.) To make it further more attractive same companies that were selling these sub prime securities/ CDOs, they also sold insurance on them.
Bear with for a minute and then you will know how the trap was laid. Follow this example and you will know what a Credit Default Swap is (CDS) which sounds like insurance but it’s not. This seems to be source of a bigger problem. Bigger than sub prime.
-CDS Explained.
Let us say your son/daughter/wife/girlfriend someone you know have bad credit history who wants to get a credit card with $5000 limit. But you know and they know banks won’t give it to them due to their bad credit history. But if you have a good history and willing to sign their application taking responsibility banks then will issue credit card with $5000 limit to anyone you want even to your dog. Why ? Because if the party DEFAULTED they will come after YOU. There is no risk to the bank !! Get it…in other words you have just entered a sort of Credit Default Swap (or CDS) agreement with the bank.
- Why bank does not see risk in this case ?
-Because…you are actually a type of insurer. How ever you did not sell insurance to the bank on the borrower, if you did then you must be a company or an insurance agent and you will be regulated and law will require you to set aside $5000 dollars. In that case REAL risk with the bank is 0 (zero). Because there already is that money (set aside). And this used to be case earlier if you’re as old as I am then you will know what I am talking about these were called ‘Secure Credit Cards’ where a bank will issue anyone a credit card for the amount of money one has set aside to be used for credit and that is how some of us built our credit history. Over a period when banks see that you’re responsible with secure credit only then they will issue you Un-secure credit card. But that’s old fashion now (I guess), today, parents would simply sign their names for kids’ credit cards as token of their love and banks will gladly accept it.
-Is the risk really gone ?
-Good question, the thing is - banks are under false assumption that their risk is gone because someone with better credit has co-signed the application. There is no way for a bank to determine that you (with better credit) will have the money $5000 + Interest +Finance Charges on the day when covered party with poor credit has actually defaulted.
And that’s the difference between Insurance and Credit Default Swap. If you read the example above sincerely you clearly understand the difference between insurance and credit default swap. In insurance you have to set aside $5000. But in credit default swap you don’t have to have $5000 but sufficient background is enough to indicate that you may have that sort of money to cover the credit risk when and if that time comes.
This is time to recap what you have read so far.
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Just 5 people over Chinese food invented the idea of sub prime.
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Once the plans are drawn contracts worth 100s of pages long were written to define the terms in these contracts which are impossible to read and understand. Further in the video below you will learn that actually great mathematicians and noble prize winners were hired to define the terms in these 100s of pages long contract.
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To sell these contracts 100s of pages long which on one can read and understand they (Wall St.) came with idea to make sure people will buy them. By first grading them to AAA category indicating don’t worry these are safe and then to make them even more attractive wrote CDS on them which again gave false impression to a buyer who thought he was covered by insurance if the paper defaulted.
….Please play the video now……….
Now that you have played the video you understand that CDS mess is 60 Trillion dollars way bigger than sub prime. Credit Default Swaps are un-regulated and since these are un-regulated and there is no way to verify if the party/bank does have the money to cover the risk they say they are covering.
Follow this hypothetical example. You see, how when someone like you with good credit singed an application banks issued credit to someone less worthy of credit. Now, let us say you open an office and keep signing these applications for anyone who came to you for a fee…believe me you would make a killing. At the same time a bank’s credit expansion will increase 10 folds. Specially if each time a bank ran check on your credit history and could not find how many applications you have signed and given assurance upon because the actual credit card is not on your name but it’s on someone else’s name.
In my understanding….writing CDS (sort of insurance) has been main source of credit expansion for last few years…that is why the market for CDS reached 60 Trillion dollars. Now that Bear, Lehman, AIG, Merrill have failed due to subprime and CDS exposure and everyone involved learned that these banks did not have they money (cash) to cover the insurance (CDS) they wrote. No one wants to believe in CDS anymore…..and no new credit is generated….not only that old credit that was written is now being reviewed but it’s being un-done………the only way to increase credit is the old fashion way…(remember secure credit card ?) show me the money….and you just learned from the video…it’s 60 Trillion dollar…5 times the size of US economy…do you think there is any country/bank out there that has that kind of money ? And since that kind of money can’t be produced over night….old fashion credit cannot be generated….hence the CREDIT FREEZE !!!
And that is why I think all attempts across the world by all central banks so far have failed to UNLOCK the credit markets. So much money cannot be produced over night, paper can be produced…and that is exactly what the governments are doing across the world…they are giving guarantee on the papers issued by these banks. In some cases they are also coming up with money for the paper that has gone under water to show that they are serious about backing up papers written by banks they some how want banks to start trading these papers again.
Did you get the point ? Let me make this more interesting…….When you cancel your phone contract premature of course you need to pay damages right ? What if you don’t have cash ? Then someone needs to extend you the credit, but wait a minute that’s not happening. That means you have to have cash and if you had some you will save it to break the contract. Seems logical enough.
Since most of these credit contracts (CDS) are/were written in USD and now being un-done to settle obligation (either actual default or the cost to break to contract) all these companies banks/insurance/mortgage companies need money cash. When there are so many companies need so much cash at the same time value of cash goes up. In this case since contracts were written in USD and are payable in USD that has pushed the value of cash (USD) UP. Now to further elaborate on this…you keep reading federal government makes these trillions of dollars available then how come economy does not go forward…well…think again…that cash is not coming to the economy (not yet) all that cash is used up in settling those worthless CDS contracts and losses there are 60 Trillion dollars worth of it actual number is not known even by the Feds you saw the video. So that money does not hit the economy as fast as one would imagine….however nothing lasts for ever this credit crisis will not last for ever either sooner or later it will be resolved and then money will start flowing again. In Between a lot of money would be created across the world to avert this crisis.
Now and this is pure speculation ( though logical) of mine once this credit crisis is resolved and after what his whole world has gone through. It’s only logical to conclude that Institutes from around the world will refuse to believe Wall Street and it’s paper as the once did. US/ Subprime/ CDO/CDS /USD relaxed regulations, no oversight are the problems to account for a few - as reasons.
Fingers are already being pointed toward US and people from all over the world are now concerned about their investments in US…heck with them we are sacred ourselves have you looked at your 401(k) lately or your retirement account ?
11/12/2008 JOSEPH E. STIGLITZ
Global Crisis — Made in America
http://www.spiegel.de/international/business/0,1518,590028,00.html
Importing a ‘Made-in-America’ crisis
http://www.indianexpress.com/news/importing-a-madeinamerica-crisis/375108/
Confidence is US is all time low…..you think these people will come back to issue more credit to America in future ? They ( biggest creditor China ) are worried about their investments now ?
China urges Washington to protect its investments
By JOE McDONALD
Associated Press
2008-12-04 01:14 PM
http://www.etaiwannews.com/etn/news_content.php?id=803467&lang=eng_news&cate_rss=news_Business&pg=7
–Story does not end here…………
Flip side of this is – value of USD COULD GO DOWN once this crisis is resolved. What happens when value of USD goes down ? Well I don’t need to tell you that…let these folks tell you that….and if they are right….then one thing is for sure…..USD value WILL GO DOWN.
Gold could hit $1,500, say Merrill analysts
By Moming Zhou
Last update: 8:26 a.m. EDT Oct. 14, 2008
NEW YORK (MarketWatch) –
http://www.marketwatch.com/news/story/gold-could-hit-1500-say/story.aspx?guid={A5996AE5-3242-4F5B-AFF6-1A46E86D44AD}
Let us look at something more recent.
Citigroup says gold could rise above $2,000 next year as world unravels
Gold is poised for a dramatic surge and could blast through $2,000 an ounce by the end of next year as central banks flood the world’s monetary system with liquidity, according to an internal client note from the US bank Citigroup.
By Ambrose Evans-Pritchard
Last Updated: 7:29AM GMT 27 Nov 2008
You see how 5 people over Chinese food could come up with an idea that could lead this wonderful country and the entire world to a financial mess………..who says America is NOT a land of opportunity where else in this world could 5 people do that ?
–And finally, like it or not…..now it’s time to put that disclaimer.
[views and opinions expressed here are mine and you need not agree with them. You should not make any financial decisions based upon material you read on this website. For that you must contact an expert in the relevant area of your need.]
