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The pressure has been building
on both the US and global markets as the staggering realization that investors are holding billions in bad, and now unmarketable debt, finally sinks in. It was always bad and unmarketable business, from the very first, but the Wall street boys and financial gurus found clever ways to mask the odor, batching out their bogus sub-prime paper in one of the greatest games of cut and run the financial markets have seen in decades. But as one institution after another begins to buckle under the weight of all that red ink, reality is setting in. It was not just Bear Stearns announcement that they were carrying billions in CDOs that they could simply not value by any of the normal tricks of the trade. Other companies like Countrywide Financial, big in the sub-prime mortgage lending business, allowed their whispers to become public cries of pain. Shares of Countrywide Financial fell more than 17% in early August, when the largest U.S. home lender revealed the extent of the damage to their business. Earnings, to say the least, were going to be “severely impacted.” Other major “Hedge Funds” have been hit as well, including North American Equity Opportunities and Global Alpha, (which fell 26%), both under the roof of Goldman Sachs. The funds were being “kept open” in spite of mounting losses.
As Jim Cramer went into vitriolics, slamming his fist on the counter and raging that Bernanke had no idea how bad things were in the rank and file financial corporate trenches, the US stock market went into a predictable tailspin, losing 396 points on August 9, and opening down nearly another 200 points the following day. Asian markets sold off as well, prompting the world’s great central banks to begin pumping cash into the wheezing system, like Saudi oil men pumping seawater into Ghawar. Nearly $330 billion was infused into the financial wells over a two day period to try and stem fears that money and credit were drying up. The ECB poured on another $60 billion the following Monday.
The notion that all these shady real estate deals, trick mortgages, phony securities and clever investment packaging could pass through the gullet of the world economy without choking the goose was ludicrous from the start. Yet the game was to push out the paper, book the commissions and then dump the whole thing in the financial landfills of the world, the largely unregulated hedge funds and leveraged securities that don’t really get reviewed by the SEC at all. How clever crime can get when the perpetrators wear suits and ties. The trashy deals have been piling up for the last several years, and now the stench is finally reaching the trading pits on Wall Street. Look at these August 10 headlines:
* U.S. stock futures weaken further after Thursday's plunge
* Countrywide tumbles as mortgage market seizes
* Countrywide: secondary mortage market conditions 'unprecedented'
* Asian shares tumble on Wall Street sell-off
* European shares falter again as subprime worries weigh
* Fed fund futures point to emergency Fed rate cut
* Portfolio liquidation triggers turmoil among hedge funds
* Stocks sharply lower as credit-fears fed sell-off
* Central Banks Pour In Billions but Panic Continues
* Wall Street Journal: Complex Hedging Tactics Can't Trump Fear
* Markets Go Red as Contagion Spreads
* Subprime Mortgage Fallout Could Doom Pending Deals
By Wednsday the 15th the market lost a cool 1200 points off its dizzying high of 14,000, plunging to 12,861, and falling another 350 points the following morning to just over 12,500! Art Hogan, Jefferies & Co nabbed the quote of the day: “This market is going down like free beer. ... I would say if there had been a day when we're trying to price in a worst-case scenario, this might be it." The index shows a net gain under 5% YTD. You could have almost made that by buying a good CD at a place like ING. Why risk your money in the stormy volatility of the stock market? The damage I predicted over two years ago is starting to manifest. How will the financial wizards rig the system now to keep the game going? Will the big cash infusions by the central banks save the day, or are they simply going to act like a ship taking on water to balance a severe list, just more easy money flooding into a market that has been over saturated by quick and painless cash?
Meanwhile, the talking heads on the financial news shows came out wielding Chicken Little masks and crowing about the wonderful opportunities the sell-off was now creating. Who cared about the tide of foreclosures, delinquencies, bad debt? It was time to get in the pits and buy. What else can they say? A market crashes when too many sellers swamp the system, desperate to get out of unwise or failing investment positions of their own making. Of course the analysts are calling for buys, and Jim Cramer will likely lead the charge with his pithy, sound effects stock trade show.
Yet no amount of cagy optimism will cover the salient facts that are really driving this fear through the markets. Men accustomed to always bilking other men and making enormous profits, are now losing money. They don’t like losing money, so they’ll use this adversity to find a way to get richer. Mish Shedlock showed us a good example, when he wrote:
 “The chairman and chief executive of mortgage lender Countrywide Financial
Corp. exercised options for 92,000 shares of common stock under a ‘prearranged’ trading plan, according to a Securities and Exchange Commission filing Wednesday.” I’ll bet
the timing of the press release with all that bad news about Countrywide was also ‘prearranged.’ The following day the it helped force the market down 396 points. The sale netted Over $1.2 million. Meanwhile,
before you get all weepy eyed over Contrywide’s predicament, the NY Times reports on “business as
usual” there during the boom times: “Countrywide’s entire operation, from its computer system to its incentive pay structure and financing arrangements, is intended to wring maximum profits out of the
mortgage lending boom no matter what it costs borrowers, according to interviews with former employees and brokers who worked in different units of the company and internal documents they provided. One
document, for instance, shows that until last September the computer system in the company’s subprime unit excluded borrowers’ cash reserves, which had the effect of steering them away from lower-cost loans
to those that were more expensive to homeowners and more profitable to Countrywide.”
Mish continues to shine a little more light on the profits that some have made the last 5 years with their
shady banking and lending schemes: “Merrill Lynch, Lehman, Bear Stearns, etc all made fortunes passing the CDO trash to pension plans, life insurance companies, and foreign governments.” The Street.com
published an article on August 15 claiming: “...every Bear Stearns investor who has watched the stock collapse is probably kicking himself for not selling at least some back at the peak, before the crisis hit.
Four savvy investors did just that. Step forward, Alan Greenberg, Sam Molinaro, James Cayne and Warren Spector. Who are they? Top honchos at ... Bear Stearns.”
Does anyone really think that people inside these firms, knowing the gravity of what they have done, will
still not find a way to protect themselves and continue to profit? Of course they will. The financial wizards have simply perpetrated a grand fraud, knowingly, and with calculated forethought. They had the motive,
(profits), the means, (position as trusted financial insiders), the method, (overvalued CDOs), and the money. And no one was regulating the process. The SEC and ratings firms were either asleep or complicit in
their negligence. As one financial insider put it: “securities which are worth 10 cents on the dollar in the real marketplace are kept on the books as worth a dollar--a fiction which is allowed because regulators
have dozed at the wheel, happily enabling a global fraud of unimaginable proportions.”
In the process, tens of thousands of little investors will see their nest eggs evaporate, and the liability has
been deftly passed on to another institution. Meanwhile Accredited Home averted a disastrous margin call by managing to sell $1 billion in loans to an “unnamed investor.” Some fat cat out there has the means to
write that check, and thinks he’ll profit by it. The headlines roll on, “Foreclosures up...Builders Downgraded
...Capital One Shuts Down Mortgage Business...Sentinel Charged With Fraud....” Isn’t capitalism wonderful? The government is worried about terrorism???
Five years ago, when all this easy money to anyone with a pulse started, I wrote that your friendly banker was doing far more harm to America, to the heart and soul of middle class families, than Osama Bin Ladin
ever could. Now their trick loans are exploding all over this nation like well placed IEDs. The hedge fund implosions crash into the institutions that support our economy like truck bombs, but they do far more
damage. Osama? He’s managed to crank out a few badly edited videos the last five years, while the banks have cranked out so much bad paper, saddling millions of Americans with burdensome debt, that they have
plunged a knife into the heart of middle class America. So now we are finally seeing the measure of their handiwork, all these respectable men and women in gray tweed suits and starched white shirts. Stick the
bad paper on the backs of the blue collar guy, wrap the deal up in tinsel, and foist it off on the Chinese. Then file bankruptcy in the Cayman Islands and run for cover. When the Bank of China revealed that they
were now holding $10 billion in US sub-prime exposure on Aug 25th and the Hong Kong Stock market plummeted a whopping 6%.
James Kunstler put his finger on the action with his usual incisive pen: “What you're seeing now is a simple matter of financial sector players trying desperately to evade the consequences of their own actions
. The fake wealth generated by the synthetic securities they created is now being recognized for what it is: a swindle. The hallucination is over. The collective denial that supported that hallucination is dissolving. The
losses are become manifest. Even worse, the losses are growing exponentially because the synthetic securities were used as collateral to leverage far greater multiples of "positions," bets, and plays in a
casino-like global electronic trading arena.”
A look at how the Subprime Mortgage debt was dressed up to look like a much safer debt package is
instructive here. On July 30th J. Kyle Bass, Managing Partner of Hayman Capital Partners described how the sub-prime mortgage game is played by the suits in the finance houses:
“Subprime Mezzanine CDOs are 10-20X levered vehicles that contain only the BBB and BBB-tranches of
Subprime debt. (The bottom end of credit profiled customers)… The “real money” accounts (US insurance companies, pension funds, etc) stopped purchasing mezzanine tranches of US Subprime debt in late 2003
and they needed a mechanism that could enable them to “mark up” these loans, package them opaquely, and export the newly packaged risk to unwitting buyers in Asia and Central Europe!!!! …these CDOs were
the only way to get rid of the riskiest tranches of Subprime debt.
Interestingly enough, these buyers (mainland Chinese Banks, the Chinese Government, Taiwanese banks,
Korean banks, German banks, French banks, UK banks) possess the “excess” pools of liquidity around the globe. These pools are basically derived from two sources: 1) massive trade surpluses with the US in
US Dollars, 2) petrodollar recyclers. These two pools of excess capital are US dollar denominated and have had a virtually insatiable demand for US dollar denominated debt…until now. They have had orders on
the various desks of Wall St. to buy any US debt rated “AAA” by the rating agencies in the US.
How do BBB and BBB-tranches become AAA? Through the alchemy of Mezzanine-CDOs. With the help of
the ratings agencies the Mezzanine CDO managers collect a series of BBB and BBB- tranches and repackage them with a cascading cash waterfall so that the top tiers are paid out first on all the tranches –
thus allowing them to be rated AAA. Well, when you lever ONLY mezzanine tranches of Subprime debt… POOF…you magically have 80% of the structure rated “AAA” by the ratings agencies, despite the
underlying collateral being a collection of BBB and BBB-rated assets... This will go down as one of the biggest financial illusions the world has EVER seen.”
After the magic trick by “ratings firms” is exposed, the piles of bad debt are finally recognized to be what they are—fradulently rated securities. Now these foreign banks are starting to feel the pressure. On August
9th the Interbank money market system was shut down for a three hour period when the German Bundesbank was rumored to be holding an emergency meeting because of the impending collapse of a
major German bank, a failure that would have impacted the entire global financial system. On August 13, Deutsche Bank hired, (guess who), none other than Alan Greenspan, the old wizard of Oz himself, to help
them pull the levers and blow off the financial steam before the situation gets out of control. Pay no attention to that man behind the curtain, he’s only the guy that started the whole mess in the first place
with his interest rate slashing that opened the floodgates of easy money. Can you Imagine the conversation in that boardroom: “Dear Alan, what in the world do we do with all this crap you shoveled our way?”
And Cramer has the myopic hope that new Fed Chairman Bernanke could simply turn the interest level knobs and make all this go away? In 2005 I wrote: “the fundamental problems in the economy can no
more be regulated by the Fed’s interest level tweaks than the oil market can be controlled by Saudi production these days. The Saudis won’t be able to stop rising oil prices, and the Fed will be powerless to
prevent what is going to happen in the financial markets as well. The collapse will be continually fueled by unprecedented energy costs, combined with a crash in the credit markets. It will start with oil, then
gasoline and heating for our homes. In time it will be the electricity that wavers on and off, like it does each day in the newly liberated Baghdad, then water and food.” The beat goes on, but my message is the same.
No amount of tinkering with the system can cure the fundamental illness that underlies it, a sickly smell of fast cash action that has now become transparently fraudulent. You can’t get something for nothing, or as
Mustapha Mond of Huxley’s Brave New World put it: “Happiness has to be paid for.”
So who’s paying? Are the CEOs of all these hedge funds and sub-prime lenders going to step up and
write checks to cover these losses? An August report on their average annual salary showed they make over $400,000 per year, and many net more money in a single day than the average citizen makes in a
year. Nope. They want the Fed to print more money out of thin air (which is how the Fed gets it’s money), and simply buy up the bad paper. Sadly, the little guy on the street, literally on the street after his
foreclosure, will suffer far more than the financial suits ever could. And most Americans in the middle class look at the sub-prime debtor and say: “There but for the grace of God go I.” They are just one paycheck
from poverty, one bad decision or bad break away from losing all the things they struggle for each day. Yet all talk is about how to prop up these big, corrupt financial institutions, with nary a whisper about how
distressed borrowers can save their homes.
At the moment it is only numbers on paper to the folks on Wall Street, but those numbers are all real
people in the heart of America, hurting and suffering with real problems the CEOs could never fathom. Housing woes will get worse, and the tsunami of adversity will continue to erode our economy. The Fed
thought it was being clever by deftly removing things like food, fuel, health care, education and other necessities from their core inflation index. (They prefer to only measure costs to the typical corporation,
not the typical American family.) Today it will be willies in the stock market, with terms like “unprecedented
volatility” and “Liquidity crunch” being bandied about . A few years hence it will be food shortages and
power outages. The straining infrastructure of our aging power grid saw rolling brown-outs affecting many communities as temperatures rose to the 100 degree mark across much of the nation in early August.
In 2005 I wrote about the pressure on the little guy out there this way: “The average grocery bill for little ol’
me, a guy who really doesn’t buy all that much, is a little over $100 bucks per week. That works out to $450 or more a month. For those with more mouths to feed it can be much higher. Add in the rent or
mortgage inflated by all those equity loans, the rising utilities, the interest on those credit cards and guess what. Over 80% of Americans are just managing to squeak by these days on their average annual salary of
$32,000. Then there are kids to buy clothing for at the one day sales, tuition for school, and books and supplies. Now start cranking up that gasoline price and see what happens. If there was any money left over
, (and the record debt and all time low savings of most households says there isn’t) then that money will soon vanish as you try to keep the car on the road. When Americans don’t have lots of disposable cash
and credit, when they suddenly owe more on their house than the day they bought it, when they can barely manage to put fuel and groceries into the budget, how much do you think they will have left over to spend
at Robinson’s-May? (Now defunct and folded into Macy’s).
And the little secret that most people overlook is this: it’s what you have left over for Macy’s and Wal Mart,
K-Mart and all the rest that makes the wheels of our economy turn. It all runs on the assumption that there will always be a well off middle class in America that has plenty of disposable cash left after meeting
necessities—cash to spend on a dinner on the town, a weekend trip, a shopping spree at J.C. Penney—a
typical Big Box retail outlet where the entirety of the American Dream is “all inside.” That’s what the
housing bubble was created for—to prime the economy with easy, unearned cash, and to try and convert some of that massive unsecured debt out there to secured debt….
It was all just a finger in the dike, because the corruption at the heart of the system remains unchallenged by any reliable public institution. The Fed was merely throwing water on a gasoline fire with its injection of
funds and rate tweaks. And it will be a grave mistake to look at how the stock market rebounded and think it all worked and the crisis is over. We are seeing banks and other large financial institutions in Europe, the
UK and the US starting to hemorrhage under the pressure of all these bad investments. The fundamental rot in the system remains, and the stock market will not be the barometer of how our “economy” is really
doing. Watch the banks. Watch the people lining up outside them demanding their money. This hasn’t been seen since the Great depression, and it’s happening today.
In the meantime, our government turns the NSA loose in a massive data mining effort to profile American citizens, collect data on their phone calls, and do other manic things over the so call “threat” of terrorism
that has not harmed a single individual in this country for the last six years. They’re worried about terrorism? What about these fat cats in business suits generating all these phony CDOs and plastic securities,
corrupting investment funds that hold the life savings of millions of Americans?
Bear Stearns just filed bankruptcy on two multi-billion dollar investment funds that are now worthless,
riddled with bad mortgage paper, and they filed in the Cayman Islands to avoid law suits and claims against the funds through US courts. Note to the US government: Leave my telephone calling habits alone
and turn the resources of your spymasters on that action. America is being gut punched by wealthy, self-serving men in positions of great power. The Bear Stearns vanishing hedge fund act did more harm to this
nation than any single act a “terrorist” has dreamt up these last six years. So start listening in on the
phone calls of these wall street wizards, who have lined their pockets while harming hundreds of thousands of American citizens with their shady game of CDOs, LBOs, and the great mortgage merry-go round. The
cost of their actions will exceed the total cost of 9/11 many times over before this all is through. The woes of Countrywide and Bear Stearns are just the beginning. Financial guru Harry Schultz leaves us with this
cheery remark: “We're into the very early beginnings of the unwinding of the derivatives hurricane. Only the innocent will fall for the line that two failed funds from Bear Stearns and one European bank fund were the
only real problem, which caused the main central banks to massively push money into play, and repeat it and repeat it.”
As for the sub-prime mess, look at this chart published by CalculatedRisk.com. It shows the reset
schedule to higher payments on loans. The pain has only just begun. It doesn’t even peak until late Spring of ‘08. And you can bet that the foreclosure curve will ride this same wave, and that this issue will be
prominent in the Nov ‘08 election.
All those loans have been neatly sold off to hedge funds that nobody hears about until they fail. There are hundreds of other hedge funds out there treading water in very tenuous circumstances. The run on the bank
has only just begun. The run on Countrywide was just a warmup call, and if you think your money is safe, backed up by the federal government, think again. James Turk, founder of of Gold Money offers us this
sober assessment of the FDIC: “Its Deposit Insurance Fund only has $50 billion of assets, an amount that is less than half the size of Countrywide and that money is 'insuring' $4.2 trillion of deposits in 8,662 banks
.” There is a limit to just how much money the Fed can print, because every dollar they manufacture and put into the broken financial system pushed the risk if runaway inflation higher. Mr Turk has it right when he
concludes: “Banks don't worry about going bankrupt because they know central banks will always bail them out. Thus the banks can't lose. They make a bundle during good times and get bailed out in bad
times - but they are to blame for the bad times. Their imprudent lending creates the boom, which inevitably is followed by a bust.”
If you think things are bad now, just wait until April of ‘08 when all the sub-prime resets peak.
Article by:
John Schettler
Aug 2007
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