Fire Cloud...
An irregular marking on the exterior of Native American pottery: usually resulting from burning fuel coming in direct contact with the vessel during firing

Friday, 3 October 2008

Dark Rum and Wall Street Bail-0uts

San Juan, Puerto Rico

First off, I would like to wish my Little Brother in Wendover a happy birthday and a future life of happiness, equanimity and love....I don't have his telephone number with me. Happy Birthday, David!

I'm drinking more than my fair share of dark rum. I go down to the local liquor store and treat myself to a bottle of dark Bacardi select...I eyeball the Bacardi 151... but that way lies madness...

Flashback to 1964...I have a roommate, Ted, who is a blond good-looking fraternity guy from Palm Beach...He tells me about "pig parties". That is where you compete to find the least attractive possible date and then delight in their embarrassment when they realize that they have all been invited to a party for ugly women. He actually seems a little guilty relating this to me...maybe there was hope for him?

My deviant non-empathetic roommate produces a bottle of Bacardi 151. I end up with a traffic ticket for driving my Harley-Davidson Sportster at 110 MPH in a 30 MPH zone at 2 AM in front of the Tallahassee police station. Only a year earlier Jim Morrison, my former almost roommate, was charged for stealing an umbrella from a police car. The judge gives me a break after seeing my military ID, but he chews me out good...but at least I didn't get caught stealing a stupid umbrella...

Outside the hotel room tonight, they are blasting away with Puerto Rican of the songs is about "muchos saxophones"....I sit in an Audit Committee meeting with 12 staff and's embarrassing to be the only non-bilingual person in the room...they all speak English for my benefit...If I come back, I will be fluent in Spanish...

My pay grade is GS0...I'm a volunteer.

So what about that credit freeze? One problem is colateralized debt obligations (CDOs). These are bundles of securitized sub-prime mortgages. They were rated AAA by the rating organization when issued primarily because of "insurance" against defaults...more about that later.

The banks are using models to value these CDO assets which reflect home price declines in metropolitan areas. For example. the San Francisco Metropolitan Area (SFMA) has just experienced a 24% house price decline. The problem with that is that housing prices in some San Francisco areas are down 70% and in other area only 5%. The banks should be using zip code data to value mortgages and CDOs. This would result in valuing CDOs at near market value. For example, many banks are carrying CDOs worth 15% on the dollar at 75% or more.

I don't think $700 Billion is going to do much to correct the "exuberant excesses" of the last seven years. It's a ten trillion dollar issue...but wait...what about credit default swaps?...and what happened to the Investment Banks?

A Credit Default Swap is like an insurance policy against CDO defaults. Warren Buffet called these instruments of financial mass destruction five years ago. The Investment Banks collected big fees on these policies for years but never set aside payment reserves or anticipated any defaults on mortgages. So when the housing market went south two years ago, eventually "hedge fund" managers panicked and withdrew assets from the investment banks leading to the collapse of Bear Sterns, Merrill Lynch, AIG Insurance, Lehman Brothers and others...what's a "hedge fund"? Please...Don't even ask.

While "subprime" mortgages, borrower fraud, speculative greed and low interest rates created a huge housing and mortgage bubble, a bigger problem now looms...negative amortiztion or "pay option" mortgages. These have brought down Washington Mutual and Wachovia, two of the biggest US Commercial banks. How's this for a deal...sign an 8% mortgage but pay only 2% until your mortgsge balance reaches 125% of the original loan...then you get a letter that your payments have doubled or tripled. You owe maybe twice as much as your home is worth after a 30% decline in walk or not to walk...that is the question...

Meanwhile, inter-bank lending has virtually dried up because banks realize that mortgage assets of other banks are significantly overvalued or impossible to evaluate based on current valuation models. Depositors are making panicked (but somewhat justified) withdrawals from banks where they hsve more on deposit than the $100,000 FDIC insurance limit. The $44 billion in the FDIC fund won't go all that far in the current climate.

I've evaluated the finances of my own credit union. Here is some scary stuff on their provision for bad debts:
2005 $12,000,000
2006 $12,000,000
2007 $60,000,000
2008 $150,000,000

So what about suspension of the "mark to market" method of accounting for mortgage assets that just got signed into law as part of the bailout package? Now banks don't have to writedown assets to what they fetch in similar helpful..

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