So, who's payin' who around here?

Originally posted by shavixmir
I'll have to delve into your answers tomorrow.
But here's something else some radio presenter was telling me (I don't know if I picked it up correctly):

Banks lend out 9x the amount of money that actually exists. This is no problem until they start asking rent. Rent is a non-existent amount of money on top of a heap of money that doesn't exist.

What the hell does that mean?
And, again, am I screwed because of it?

I will try to explain what that radio program was saying.

Yes, you and I and all of us may indeed be looking at very hard times for a long time to come. Then again, perhaps not.

A lot of this turns on the collapse of the insurance giant A.I.G., which seems imminent, but may not happen. That collapse would be as close to an extinction-level event as the financial markets have seen since the Great Depression.

Now, here's what I think that radio program was talking about. A.I.G. does business with virtually every financial institution in the world. Most important, it is a central player in the unregulated, Brobdingnagian credit default swap market that is reported to be at least $60 trillion in size.

Nobody knows this market’s real size, or who owes what to whom, because there is no central clearinghouse or regulator for it. Credit default swaps are a type of credit insurance contract in which one party pays another party to protect it from the risk of default on a particular debt instrument. If that debt instrument (a bond, a bank loan, a mortgage) defaults, the insurer compensates the insured for his loss. The insurer (which could be a bank, an investment bank or a hedge fund) is required to post collateral to support its payment obligation, but in the insane credit environment that preceded the credit crisis, this collateral deposit was generally too small.

As a result, the credit default market is best described as an insurance market where many of the individual trades are undercapitalized. But even worse, many of the insurers are grossly undercapitalized. In one case in the New York courts, the Swiss banking giant UBS is suing a hedge fund that said it would insure nearly $1.5 billion in bonds but was unable to do so. No wonder — the hedge fund had only $200 million in assets.

If A.I.G. collapsed, its hundreds of billions of dollars of mortgage-related assets would be added to those being sold by other financial institutions. This would just depress values further. The counterparties around the world to A.I.G.’s credit default swaps may be unable to collect on their trades. As a large hedge-fund investor, A.I.G. would suddenly become a large redeemer from hedge funds, forcing fund managers to sell positions and probably driving down prices in the world’s financial markets. More failures, particularly of hedge funds, could follow.

Regulators knew that if Lehman went down, the world wouldn’t end. But Wall Street isn’t remotely prepared for the inestimable damage the financial system would suffer if A.I.G. collapsed.

While Gov. David A. Paterson of New York on Monday allowed A.I.G. to borrow $20 billion from its subsidiaries, that move will only postpone the day of reckoning. The Federal Reserve was also trying to arrange at least $70 billion in loans from investment banks, but it’s hard to see how Wall Street could come up with that much money.

More promisingly, A.I.G. asked the Federal Reserve for a bridge loan. True, there is no precedent for the central bank to extend assistance to an insurance company. But these are unprecedented times, and the Federal Reserve should provide A.I.G. with some form of financial support while the company liquidates its mortgage-related assets in an orderly manner.

The Fed cannot afford to stand on principle. The myth of free markets ended with the takeover of Fannie Mae and Freddie Mac. Actually, it ended with their creation.

Originally posted by kmax87
Although what you say is generally true, the rates of default have not been that far above what has traditionally been usual for sub prime loans.

This is wrong, both default rates and foreclosures are very high.

Edit: http://graphics8.nytimes.com/images/2008/08/04/business/0804-biz-LEND-web.jpg

This are delinquent moretgages, not defaults, but it's the best I've found in a quick google search. Still, you can see how banks are struggling. Foreclosures have also gone up significantly and with the house prices going down like they have, you can see how refinancing might be a better option for banks than outright default.

Originally posted by no1marauder
The idea that foreign central banks are naive victims gets a : LMFAO!

A smarter person than you might recognize that foreign central banks are NOT naive and understand that the central banks knew that even if freddie/fannie et al got into trouble, US taxpayer would HAVE TO bail it out since the central banks would just threaten to stop buying your US BONDS. This would force the US govt, to do the bail out.

Either way, the Central Banks were ultimately protected and they knew it. How's it feel to know your country is run by foreigners to a large degree?

Originally posted by Palynka
This is wrong, both default rates and foreclosures are very high.

I'm no expert in this but there has been suggested that the sub prime borrowers were not as much to blame as the lenders who were having difficulties servicing their leveraged positions. From a news perspective it was easier to blame the home buyer it seemed than to explain the labyrinth of credit wrapping that makes up a modern financial services institution.

I may be wrong but the default rates and foreclosures may only have increased once credit in the market first started to dry up, so that the origins of the sub prime issue stem from the lack of liquidity in the market to start with and not the other way around. Rates of default were not the primary cause of liquidity disappearing out of the market, but rather a consequence of it.

Originally posted by kmax87
I'm no expert in this but there has been suggested that the sub prime borrowers were not as much to blame as the lenders who were having difficulties servicing their leveraged positions. From a news perspective it was easier to blame the home buyer it seemed than to explain the labyrinth of credit wrapping that makes up a modern financial services institution ...[text shortened]... the primary cause of liquidity disappearing out of the market, but rather a consequence of it.

Hey, shav just asked for an EASY explanation
🙂

Originally posted by Scriabin
I will try to explain what that radio program was saying.

Yes, you and I and all of us may indeed be looking at very hard times for a long time to come. Then again, perhaps not.

A lot of this turns on the collapse of the insurance giant A.I.G., which seems imminent, but may not happen. That collapse would be as close to an extinction-level event as th ...[text shortened]... ended with the takeover of Fannie Mae and Freddie Mac. Actually, it ended with their creation.

you forgot to give the NYTimes link that you copied this article from.

Originally posted by uzless
A smarter person than you might recognize that foreign central banks are NOT naive and understand that the central banks knew that even if freddie/fannie et al got into trouble, US taxpayer would HAVE TO bail it out since the central banks would just threaten to stop buying your US BONDS. This would force the US govt, to do the bail out.

Either way, the C ...[text shortened]... and they knew it. How's it feel to know your country is run by foreigners to a large degree?

A smarter person than you (i.e. virtually anybody) wouldn't have written this:

The real problem here is that the investors didn't really understand what TYPE of mortgage the US banks were giving to homebuyers .........................

The problem is that the "investors" who bought these bad investments weren't just individuals. They were foreign central banks, private banks, investment banks, insurance companies etc.


Your initial, unsupportable claim is what I laughed at.

Originally posted by no1marauder
A smarter person than you (i.e. virtually anybody) wouldn't have written this:

The real problem here is that the investors didn't really understand what TYPE of mortgage the US banks were giving to homebuyers .........................

The problem is that the[b] "investors" who bought these bad investments were e companies etc.


Your initial, unsupportable claim is what I laughed at.

I'm certainly no expert on this stuff, but it seemed to me that uzless was just describing how CDOs work (collateralized debt obligations). What he said seemed reasonable to me.

Originally posted by Mad Rook
I'm certainly no expert on this stuff, but it seemed to me that uzless was just describing how CDOs work (collateralized debt obligations). What he said seemed reasonable to me.

It "seems reasonable to you" that foreign central banks didn't understand the nature of the mortgage backed securities they brought and/or the realities of mortgage practices in the US?

🙄

Originally posted by no1marauder
It "seems reasonable to you" that foreign central banks didn't understand the nature of the mortgage backed securities they brought and/or the realities of mortgage practices in the US?

🙄

That's the way I understand the process, as ridiculous as it seems in hindsight. Some financial firm would take a bunch of sub-prime mortgages and slice up the loans into CDOs (and take a fee for doing this). Then some rating agency would declare the CDO to be investment grade paper, which was then sold to anyone willing to buy them.

Originally posted by Mad Rook
That's the way I understand the process, as ridiculous as it seems in hindsight. Some financial firm would take a bunch of sub-prime mortgages and slice up the loans into CDOs (and take a fee for doing this). Then some rating agency would declare the CDO to be investment grade paper, which was then sold to anyone willing to buy them.

I repeat my: 🙄

The idea that central banks don't throughly investigate the securities that they buy (in this case they brought hundreds of billions of dollars worth of them) is ridiculous.

It is far more likely that they knew exactly what they were buying, but considered them no-risk because they believed that the US government would make taxpayers pay them if the corporations they brought them from couldn't. This is what came to pass even though the law regarding these two entities specifically stated that their securities were NOT backed by the US government. So the American public was hoodwinked and now has an approximate $5 trillion dollar bill to pay.

Originally posted by no1marauder
I repeat my: 🙄

The idea that central banks don't throughly investigate the securities that they buy (in this case they brought hundreds of billions of dollars worth of them) is ridiculous.

It is far more likely that they knew exactly what they were buying, but considered them no-risk because they believed that the ...[text shortened]... the American public was hoodwinked and now has an approximate $5 trillion dollar bill to pay.

Well, all I can say is that Warren Buffett couldn't figure it out.

http://money.cnn.com/2008/04/11/news/newsmakers/varchaver_buffett.fortune/index.htm

"Do you find it striking that banks keep looking into their investments and not knowing what they have?

I read a few prospectuses for residential-mortgage-backed securities - mortgages, thousands of mortgages backing them, and then those all tranched into maybe 30 slices. You create a CDO by taking one of the lower tranches of that one and 50 others like it. 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. When you start buying tranches of other instruments, nobody knows what the hell they're doing. It's ridiculous. And of course, you took a lower tranche of a mortgage-backed security and did 100 of those and thought you were diversifying risk. Hell, they're all subject to the same thing. I mean, it may be a little different whether they're in California or Nebraska, but the idea that this is uncorrelated risk and therefore you can take the CDO and call the top 50% of it super-senior - it isn't super-senior or anything. It's a bunch of juniors all put together. And the juniors all correlate."

Originally posted by Mad Rook
Well, all I can say is that Warren Buffett couldn't figure it out.

http://money.cnn.com/2008/04/11/news/newsmakers/varchaver_buffett.fortune/index.htm

"Do you find it striking that banks keep looking into their investments and not knowing what they have?

I read a few prospectuses for residential-mortgage-backed securities - mortgages, thousands of nything. It's a bunch of juniors all put together. And the juniors all correlate."

Yes, you're right; there's no way the experts employed by a central bank could possibly figure out such a complicated financial instrument or the realities behind it. They would just buy a few hundred billions dollars worth of such instruments on a lark.

My bad.

Originally posted by no1marauder
Yes, you're right; there's no way the experts employed by a central bank could possibly figure out such a complicated financial instrument or the realities behind it. They would just buy a few hundred billions dollars worth of such instruments on a lark.

My bad.

Well, we simply don't know what the banks were thinking when they bought the CDOs. Maybe they really understood the instruments, but the fact that one of the best investors in the world can't figure them out makes me doubt this possibility. Maybe they thought they understood the instruments but didn't. Maybe they knew they didn't understand them, but they bought them anyway for the reasons you mentioned. But I find it interesting that just because you apparently don't like uzless, you automatically poo-poo his statements without giving them much serious thought.

Originally posted by Mad Rook
Well, we simply don't know what the banks were thinking when they bought the CDOs. Maybe they really understood the instruments, but the fact that one of the best investors in the world can't figure them out makes me doubt this possibility. Maybe they thought they understood the instruments but didn't. Maybe they knew they didn't understand them, but they b uzless, you automatically poo-poo his statements without giving them much serious thought.

Some people on these forums try to personalize everything. Grow up.

I don't agree with the assertions made by some people in this thread (including you). What that has to do with "liking" someone I have no idea.

Any analysis that holds as one of its main tenets that central banks brought hundreds of billions of dollars of a certain type of financial instrument without making a reasoned assessment of the instrument can be rejected without a "serious thought". Of course, uzless abandoned that argument after his first post on the subject here; I suggest you do the same.