March, 2010 archive

Bloomberg investigates the fall of AIG: amongst the factors, traders selling Credit Debt Obligations (CDOs), then changing the collateral supporting the CDOs:

Replacing good collateral with bad helped erode Davis Square III’s (a CDO fund–ed.) value. Declines in quality added to the cash AIG had to pay to holders of its insurance because its Financial Products division, headed by Cassano, made agreements with banks that included what are called collateral triggers. That was a feature other bond insurers didn’t offer, (former non-AIG trader Thomas–ed.) Adams said.

The possibility of downgrading the collateral was mentioned in the prospectus, so that made It All Okay.

Just like you know the pea is going to get switched in the old shell game.

Bringing competition to a Galt.

Royal Bank of Scotland Group Plc, the recipient of the world’s biggest bank bailout, was fined 28.6 million pounds ($43 million) by U.K. antitrust authorities for giving confidential future pricing data to Barclays Plc.

The fine was reduced from 33.6 million pounds because RBS admitted the breaches and cooperated, the Office of Fair Trading said today in statement. Barclays isn’t likely to be fined because it brought the matter to the OFT’s attention.

“Securitization” is taking debts, slicing and dicing them, then bundling them up and selling the sliced dices as assets.

In accounting, an asset (something you have, like a building or a client list or money in the bank) is the opposite of a debit (something you don’t have).

In some cases, debts, which you don’t have, can be accounted as assets, because they are expected to become assets, though they aren’t yet. In other words, you can proceed as if you have them, even though you don’t.

If the debts are good solid debts likely to be repaid, there is nothing wrong with this. The lender can take that expectation of future income and spend it to make something new, even though he doesn’t actually have it yet. That’s how markets “create money.” As long as everyone in the chain keeps repaying, the chain stays strong.

That’s why, back in the olden days when I was a young ‘un, getting a mortgage was an ordeal. The lender wanted to make sure the borrower was almost certain to repay. Back then, the lender made the money from the mortgage payments–more mortgages, more mortgage payments.

Lately, the lender has made money by “securitizing” mortgages: slices full of dices were sold almost as soon as the mortgage was signed. Consequently, the lender came not to care whether the loan was likely to be repaid. The big money was in sales commissions. They forgot that, to keep the chain strong, everyone had to keep repaying.

Persons were tricked into buying dicey adjustable rate mortgages by sales persons who told them that “real estate always goes up” so “you can always refinance when the note comes due” and “think of all the neat stuff you can buy by refinancing and taking the cash out.” (About the only bright side I’ve seen in the housing crash is the almost-disappearance of spam calls and letters urging me to remortgage so I could take the cash out.)

In the credit card biz, securitization has not been much of a problem, because each dice in a slice is so small and the slices so large that the odds of individual defaults (your or my not paying up) do not threaten the whole slice.

The housing thing was different. With “securitized” mortgages the dices in the slices were larger.

Then, when real estate did go down because prices had gone absurdly high, the buyers could not refinance because they could not sell or mortgage the houses for more than they paid for them so as refinance for more money in order to pay off the notes and keep the houses and have even bigger mortgages. No more dices for the slices.

Because the dices in the slices were larger and because the crash was, like Savoir Faire, everywere, suddenly the defaults mattered. And the securitized “securities” turned out to be, well, not secure.

It sounds complicated when you hear it explained in Wall Street-ese. The banksters like it to sound complicated, because complicated sounds serious and important and is also incomprehensible to outsiders; they like to feel serious and important while remaining incomprehensible.

But it amounts to “leave all the money on 21 because 21 is going to keep coming up.” You gotta win!

Then not 21 came up. Whoops! I just sold you the system. You placed the bets, sucka.

So statements like this give me the willies:

Brian Sack, head of the markets group at the New York Fed, said the financial system can’t operate well without leverage and signaled that he supports the return of a “properly” structured securitization market.

“Securitization is a powerful vehicle that should play an important role in the intermediation of credit in the economy,” Sack said in a speech delivered by video conference from New York to an audience in Sydney. “We should also understand that a reduction in leverage to near zero in the financial system is not desirable.”

(Aside: Catch that “intermediation” in there. So serious, so complicated, so incomprehensible. Looks like a fancy word for “middleman.”)

“Leverage” (a fancy word Wall Streeters use for “debt” because it doesn’t rhyme with “bet”) is indeed a powerful and a necessary thing. Being able to borrow money on expectations has helped persons and companies to wonderful accomplishments, from buying cars and houses to building railroads and selling computers cheap.

Historically, that debt has been called “stocks.” In London in 1606, the Virginia Company raised money to support the expedition that eventually founded the first permanent English-speaking colony in the New World by selling–wait for it–stock. It was far from a sure thing. They were borrowing money in hopes of making more money and the investors knew the risks.*

Securitization, not so much, for it is an attempt to turn a minus (someone else’s debt, not a debt owed to me) into a plus (my asset that I can therefore sell because I already have it even though I don’t have it yet but I will someday promise cross my heart hope to die) through semantic tricks. Instead of selling expectations out in the open, as the Virginia Company did, the company that sells “securitized” securities is selling risks as certainties (remember, all this junk had AAA ratings–that bankster for sure things.)

That’s why they want to call them “securities.” They are telling us they are “secure,” for Pete’s sake.

The investors (pension funds, individual persons, mutual funds, other banks) did not know the risks, because the risks were buried twice ten fathoms deep.**

And they were not secure.

They were bags of air.

Under securitization as currently practiced, I can sell you a bag of air. When you open the bag and say, “There’s nothing here!” I can say, “Ahhhhh. Oh well, nobody could have predicted . . . . You’re on your own, sucka,” then ask the guvmint to cover my asset because my asset is too big to flail.

And this bozo from the New York Fed is buying into this whole hocus-pocus-slicus-dicus thing. Too damn Wall Streety for me.

I seriously doubt that there can be such a thing as “properly structured” securitization. Just as I am sure that fire is not caused by phlogiston.

And, if such a thing as “properly structured” securitization exists, it is probably already traded on the–wait for it–blankety-blank stock market.

Bring back Glass-Steagel.

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*You can be damned sure that, had the Godspeed, the Susan Constant, and the Discovery not returned, King James I wouldn’t have bailed anyone out. Beheaded, maybe, but not bailed.

**Many persons saw the danger because they saw through the double-talk to recognize that the underlying premise–that real estate always goes up–was invalid. But few persons listened. There was no quick money in prudence.