Thursday, September 25, 2008

All bundled up

So far, unlike The Wife, I've managed to maintain at least a shred of the post-vacation Zen with which we returned from France.

This is partly because I have consciously been avoiding news that might disturb my equilibrium. I have managed, for example, to escape reading anything lengthy about Sarah Palin in, oh, about three weeks now. Furthermore, the headlines about the election that I have tentatively perused have lately been signalling that things just might actually be going pretty well on that score.

And I've been listening to a lot of death metal recently, which, curiously enough, always seems to leave me with a deep sense of inner tranquilty.

These factors all might play a role. But I suspect my relative well-being is also partly down to the fact that the main political issue I've spent any time reading about in the last few days has led to more befuddlement than -- at least so far -- blind rage.

I'm referring to the financial...crash...bailout...collapse...thingy.

Don't get me wrong: I'm quite clear that there are plenty of reasons for anger here and lots of people who I will decide, I am sure, need a good kicking.

All in good time.

But it's occurred to me that I'm still a bit...confused about just what, exactly, it is that's in the process of collapsing and, precisely, what that proposed $700 billion is going to be used for in the interests of preventing the Utter and Complete Meltdown of the American Economy.

I mean, it helps if you can attach an image to a economic crisis. Tulipmania was about, well, tulips, and even if the value of a tulip is a pretty abstract thing, you still know something about the rational core of the madness that resulted. The Great Depression? Yep, have plenty of visuals on that, dustbowls and all the rest. The oil crisis of the 70s? I have personal memories of 'no gas' signs and waiting in long lines to tank up the car. The villains were clear: bearded men with sunglasses and funny headgear. The dotcom bubble? No problem. I knew what a browser was and the villains were smirking 23-year-olds who burned through billions of semi-imaginary dollars based on semi-imaginary business plans.

But I'm trying to visualise a 'collateralized debt obligation' or a 'credit-default swap' (more on these below) and I just...can't get there.

And I don't like admitting that kind of confusion, since, you know, I like to think that I have a reasonably well-informed understanding of how the world works.

But, on this issue, I have to say that my grasp of things is only a bit sketchy.

On that score, though, it's becoming clear to me that I'm not the only one.

At the New York Times today, Vikas Bajaj has an interesting little article with the intriguing title 'What's all this stuff worth?'

And, you know, it turns out that answering that question is a bit more difficult than you might think.

Vikas, over to you:
Consider the Bear Stearns Alt-A Trust 2006-7, a $1.3 billion drop in the sea of risky loans. Here’s how it worked:

As the credit bubble grew in 2006, Bear Stearns, then one of the leading mortgage traders on Wall Street, bought 2,871 mortgages from lenders like the Countrywide Financial Corporation.

The mortgages, with an average size of about $450,000, were Alt-A loans — the kind often referred to as liar loans, because lenders made them without the usual documentation to verify borrowers’ incomes or savings.

Let's just pause here for a brief moment. Just for a measly few seconds.

Please just consider that last sentence, the one in which it is pointed out that lenders gave people mortgages worth an average of nearly a half-million dollars without even checking how much they earned or how much money they had?

Is this for real?

Because if it is, I can only say: What--please pardon my French (you know, I've been spending some time there)--the fuck?!

A few years ago (when things were still going generally well in the banking world, mind) our mortgage application (for, ahem, a lot less than the above-mentioned average) to buy our house in Germany required that we submit ourselves to bank scrutiny that felt like the financial equivalent of a colonoscopy.

You mean in America, we could've gotten more than twice as much without even having to prove we could pay it back?


Ok, let's continue...

Bear Stearns bundled the loans into 37 different kinds of bonds, ranked by varying levels of risk, for sale to investment banks, hedge funds and insurance companies.

If any of the mortgages went bad — and, it turned out, many did — the bonds at the bottom of the pecking order would suffer losses first, followed by the next lowest, and so on up the chain. By one measure, the Bear Stearns Alt-A Trust 2006-7 has performed well: It has suffered losses of about 1.6 percent. Of those loans, 778 have been paid off or moved through the foreclosure process.

But by many other measures, it’s a toxic portfolio. Of the 2,093 loans that remain, 23 percent are delinquent or in foreclosure, according to Bloomberg News data. Initially rated triple-A, the most senior of the securities were downgraded to near junk bond status last week. Valuing mortgage bonds, even the safest variety, requires guesstimates: How many homeowners will fall behind on their mortgages? If the bank forecloses, what will the homes sell for? Investments like the Bear Stearns securities are almost certain to lose value as long as home prices keep falling.

Ah, 'bundled' is such a nice cosy word, isn't it? It doesn't seem quite the right word for what's been described here, which seems--if I have this right, and there's no guarantee that I do--to involve something like this:

You have a bunch of dodgy loans, which have been repackaged as a shiny new financial product mixed up with a bunch of other products conjured up via a similar kind of investment bank voodoo. This tasty cocktail has thereafter been blessed by a rating agency with the label 'triple A' based on 'guesstimates' and sold to people who think they are making a solid 'investment'.

Ah. Yes.

I am, as I've said, a Fucking Moron when it comes to complicated finances: but I can't for the life of me see how this was a good idea.

But it gets better:

The Bear Stearns bonds are just one example of the kind of assets the government could buy, and they are by no means the most complicated of the lot. Wall Street took bonds like those of Bear Stearns and bundled and rebundled them into even trickier investments known as collateralized debt obligations, or C.D.O.’s

“No two pieces of paper are the same,” said Mr. Feltus of Pioneer Investments.

'Bundled and rebundled'. Excellent!

Now, I suppose it's obvious that while this might all seem terribly complex to your average person who doesn't know all that much about economics, like yours truly (or, say, by his own admission, John 'I have to skip the debate so I can go off and singlehandedly solve the crisis I had a role in creating' McCain), clearly the people who were, you know, running the system knew what was going on.

Didn't they?

Yes, you would think that wouldn't you?

However, in a flabbergasting article that I read in the International Herald Tribune while still on vacation, it seems that many of them did not know what it was they were selling.

In Nelson D. Schwartz's 'A crisis too complex for easy fixes' (the title in the print version I bought on the Normandy coast was the far more direct 'Complexity of trading overwhelmed the traders', but it might be that that the more critical title was intended only for foreign distribution in communist countries like France) we find suggestions that a lot of the people -- even the senior people -- casting their kooky financial magic spells didn't really know what kind of dark forces they were meddling with:

In some ways, Wall Street suffers from a generation gap. At 62, Richard Fuld, the head of Lehman Brothers, had ridden out everything from the oil shocks of the 1970s to the Russian debt default and Asian economic flu in 1998. But in recent years, his firm and other Wall Street giants derived an ever-increasing share of profits from products that barely existed a decade ago, like credit-default swaps. Essentially insurance on debt, the market for credit-default swaps has ballooned from $900 billion in 2001 to a nearly unimaginable $45.5 trillion now.

Um, yes, nearly unimaginable. Anyway...

Jamie Cawley, a veteran player in the credit-default swaps market, says he doubts whether the older chiefs of the firms who profited from these products, or the young traders who specialized in them, fully understood the implications of what they were doing.

"Had they understood the implications, we wouldn't be where we are today," said Cawley, founder and chief executive of IDX Capital. The overriding feeling on Wall Street, he said, was: "Let's make money while the sun shines and worry about the details later."

Aw shucks, that's a great feeling, ain't it? What a bunch of fun!

Tell me: is cocaine still as popular as it once was on Wall Street? Because this sounds like the kind of killer Good Times that would only sound convincing and sensible to a bunch of coked up Harvard Business School grads.

Yes, these are the people to whom we were told we should trust the privatisation of Social Security not all that long ago. I shudder to think what they might have 'rebundled' that into.

And they were being paid so much money for their fine stewardship of the nation's key financial giants...

The compensation of Fuld and other Wall Street chief executives followed a similar trajectory higher during the earlier boom years.

"If you're approving things you don't understand, that's not doing your job," said Jonathan Koppell, director of the Millstein Center for Corporate Governance and Performance at the Yale School of Management. "What are these guys compensated for, if they're checking off things they don't understand?"

"A huge number of directors probably didn't understand what their companies were up to, and it's quite likely at least some of the leaders of these companies didn't fully understand what their employees were doing," he added.

Some of these are, remember, quite possibly those companies that we've been told are 'too big to fail', that have to be rescued by a pretty massive infusion of public money or Economic Life as We Know It will come to a halt.

Two final thoughts on this issue for the moment, as it's nearing bed-time and I'm beginning to feel angry and, you know, I don't want to go to bed angry.

One comes from Bernie Sanders (via Dale):

We must end the danger posed by companies that are "too big too fail," that is, companies whose failure would cause systemic harm to the U.S. economy. If a company is too big to fail, it is too big to exist. We need to determine which companies fall in this category and then break them up. Right now, for example, the Bank of America, the nation's largest depository institution, has absorbed Countrywide, the nation's largest mortgage lender, and Merrill Lynch, the nation's largest brokerage house. We should not be trying to solve the current financial crisis by creating even larger, more powerful institutions. Their failure could cause even more harm to the entire economy.

To which I can only add, as Sarah Palin might put it, yup.

The second is an interesting look at exactly what $700 billion actually means, at Slate:

If the federal government siphoned off Florida's gross domestic product, we could cover the bailout. Invading the Netherlands might be advisable—that nation's GDP was $768.7 billion last year. Of course, invasions cost a lot of money. Back in 2003, the Bush administration told Congress that the Iraq war would cost between $60 billion and $100 billion, but it's estimated that, so far, we've spent about $600 billion. Should the Treasury receive authority from Congress to borrow $700 billion, the national debt will rise by only about 7 percent. Right now, it's sitting at $9.6 trillion.

A variety of other measures are in the article. Whether it's a lot of money or a nearly unimaginable amount of money, I leave to your own discretion, dear reader.

So, maybe, considering the scale of this thing and the apparent fact that a lot of people who were supposed to understand it (and who were paid substantial sums of money on that assumption) were asleep at the wheel, I don't feel so bad.

I mean, I have to reveal my ignorance only to that select circle of readers of this humble blog.

Sarah Palin has to do it on national television.

(Via Dale and Andrew: great minds thinking alike tonight)

Finally, in the course of writing what has turned out to be a much longer post than I intended at the start (if you're still here, well, thanks for sticking around for the ride), it has occurred to me that the word 'bundling' -- long before it was adopted by Wall Street banks as a means of recycling toxic waste -- was a term used by Robert A. Heinlein in The Moon is a Harsh Mistress (one of my favourite science fiction novels) as a futuristic slang term for, ahem, sexual intercourse.

Seeing that the financial system appears thoroughly fucked, this somehow seemed appropriate.

At least enough to inspire the title of a blog post.

Good night, folks.

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