Village Voice: What Cooked the World's Economy

[AsburySkinsFan]

Strange, then, that this happened despite the number of federal regulations increasing over the course of every administration since Bush I.

The deregulation story behind this crisis is a myth.

Well considering the fact that it was under Clinton that some of the strongest regulations fell, I would say you're wrong.

[AsburySkinsFan]

I'd love to see a substantial piece on this, but this one isn't it.

You'll never find what you are looking for unless there is an open Federal Investigation, FBI the works to investigate this, because these guys were working in secret and refuse to open their books, heck even Bloomberg failed to get them open.

[HOF44]

I just wonder if a single entity bought multiple insurance policies on the same mortgage security.

The real dunces in this are the banks selling the insurance. They just trusted the rating companies and didn't do due diligence.

Which brings up another point, what were the rating companies doing?????

[AsburySkinsFan]

I just wonder if a single entity bought multiple insurance policies on the same mortgage security.

Not sure why that wouldn't be possible, I mean they were selling the derivatives to people who didn't own the securities why not sell multiple policies to the same investors; after all these securities were highly rated so its like betting that a Ferrari will be cool right...until someone who is in charge of rating coolness says, "Nope these are no longer cool."

The real dunces in this are the banks selling the insurance. They just trusted the rating companies and didn't do due diligence.

True dat, but every step was covered in greed; from the guy wanting a bigger house, to the agent selling him a subprime to the bank buying that subprime loan in a security to the hedge funds who bought insurance on those securities. The only problem now is that only one group of those 4 got rich.

Which brings up another point, what were the rating companies doing?????

I guess we would have to ask who they are...and where they were invested? At this point would it really shock anyone to find out that some at the top were heavily invested in these hedge funds?

[DjTj]

What information (from your link):

"Shamefully, neither Washington nor AIG will explain where the billions went. But the answer is increasingly clear: It went to counterparties who bought derivatives from Cassano's shop in London."

How is the answer becoming increasingly clear? What information is making it increasingly clear?

They also aren't even saying that it went to people that didn't own the security in the first (which is your claim).

I'd love to see a substantial piece on this, but this one isn't it.

I think it's reasonable to believe that a good chunk of the bailout money must have been paid to counterparties to CDS's whose claims matured, but I doubt that most of those counterparties are evil hedge funds who were plotting to destroy the US economy.

Most people holding CDS's were likely big banks trying to protect against their risk in the mortgage market (and even if they are held by hedge funds, it is likely that the big banks invested in those hedge funds). Part of the reason for bailing out AIG was to prevent those other banks from going under if the CDS's didn't pay out (or if they had to take the CDS's off their balance sheets when AIG went bankrupt).

It's important to note that the bast majority of CDS's are still outstanding, because the whole market has not defaulted. The goal of the bailout was to prevent any part of the market from defaulting and creating some kind of cascade ... so far we have been able to do that.

[PeterMP]

You'll never find what you are looking for unless there is an open Federal Investigation, FBI the works to investigate this, because these guys were working in secret and refuse to open their books, heck even Bloomberg failed to get them open.

Well, the bigger thing I'd like to see addressed is the last bailout. We were told it would be transparent and that they'd buy up these securities and work w/ people to stay in their homes just like they did in the Great Depression.

And then boom almost over night it is like, 'Sorry, we changed our minds. We are just going to give this money to the banks w/ no strings attached.'

And of course congress just said 'sure whatever.'

And like your piece points out, we really don't know where that money went. Just that it wasn't enough.

[AsburySkinsFan]

It's important to note that the bast majority of CDS's are still outstanding, because the whole market has not defaulted. The goal of the bailout was to prevent any part of the market from defaulting and creating some kind of cascade ... so far we have been able to do that.

Exactly right if the whole market goes or even a substantially large portion of the market defaults then its all over but the crying. The really scary thing right now is that the recession seems to be feeding off itself as such the more layoffs we see the more foreclosures we are going to see and the more foreclosures we see the more securities are going to decline and the more those securities decline the more the derivatives will pay out...ugh...what a bloody nightmare!

Again, like you said DjTj, its all about stopping the foreclosures, people need to have a way to pay for their mortgages, do that and the house of cards will remain standing...at least long enough to find a way to stabilize it.

[AsburySkinsFan]

Well, the bigger thing I'd like to see addressed is the last bailout. We were told it would be transparent and that they'd buy up these securities and work w/ people to stay in their homes just like they did in the Great Depression.

And then boom almost over night it is like, 'Sorry, we changed our minds. We are just going to give this money to the banks w/ no strings attached.'

And of course congress just said 'sure whatever.'

And like your piece points out, we really don't know where that money went. Just that it wasn't enough.

True enough, only one thing...we were never told by the previous Administration that we'd know where it was spent Congress said that we would when they passed it, but then it was up to Paulson to reveal it, and he simply decided not to. In the end that $350 billion just seems to have vanished, I believe that it was used to pay for the derivatives which is why we aren't hearing where it went because if people understood what really happened and how the rich were betting against them there would be a ground swell of anger rise up across the country and the world.

[PeterMP]

It's important to note that the bast majority of CDS's are still outstanding, because the whole market has not defaulted. The goal of the bailout was to prevent any part of the market from defaulting and creating some kind of cascade ... so far we have been able to do that.

That's nonsense (the last part). If that was the goal, then they'd actually have done something to help people stay in their houses and to shore up those mortgages instead of giving the money to banks that did who knows what with it.

The bailout had little to nothing to do w/ decreasing defaults despite what we were told. I THINK it was about backstopping institutions that really were (and potentially still are) bankrupt before the larger public figured it out.

[GibbsFactor]

So most seem to think that a deregulated market coupled with greed led to this. Why, then, do we have a monetary system that caters to that instinct? I'd think the logical way to counteract greed is within the monetary system, not to make laws because the monetary system is so dreadful flawed. Putting flawed humans in charge of controlling greed is futile at best.

[DjTj]

That's nonsense (the last part). If that was the goal, then they'd actually have done something to help people stay in their houses and to shore up those mortgages instead of giving the money to banks that did who knows what with it.

The bailout had little to nothing to do w/ decreasing defaults despite what we were told. I THINK it was about backstopping institutions that really were (and potentially still are) bankrupt before the larger public figured it out.

Not defaults of individual mortgages, but defaults on mortgage-backed securities, credit-default swaps, and other derivatives based on mortgages ... and perhaps more importantly defaults of any large banks. After Lehman Brothers fell, that seemed to be the priority - don't let any more banks fail. And the government has at least been successful at doing that.

As long as banks are capitalized, they can weather a decent number of defaults on mortgages. It seems like the bailout focused its attention at the top (the megabanks) rather than the bottom (the homeowners).

[PeterMP]

So most seem to think that a deregulated market coupled with greed led to this. Why, then, do we have a monetary system that caters to that instinct? I'd think the logical way to counteract greed is within the monetary system, not to make laws because the monetary system is so dreadful flawed. Putting flawed humans in charge of controlling greed is futile at best.

The same sort of things happened under the gold standard.

[zoony]

So most seem to think that a deregulated market coupled with greed led to this. Why, then, do we have a monetary system that caters to that instinct? I'd think the logical way to counteract greed is within the monetary system, not to make laws because the monetary system is so dreadful flawed. Putting flawed humans in charge of controlling greed is futile at best.

The same sort of things happened under the gold standard.

I was about to post the same thing.

That said GibbsFactor, you do have a point that the money supply was too fast and loose for far too long. Lots of us have been saying that for years; however we had a staunch monetarist in charge of the money supply for a long time in this country.

Monetarist economic theory is on the brink of fail if not past the tipping point. Thanks for nothing Friedman you moron

But Greenspan did go before congress and say he was sorry, and made a mistake. So we have that going for us.

...

[AsburySkinsFan]

But Greenspan did go before congress and say he was sorry, and made a mistake. So we have that going for us.

...

You've heard of the shot heard 'round the world, well his acknowledgment was a supernova...and yet relatively few heard it or understood what it meant, yet there will be few if any who aren't affected by this mistake and the mistake of nearly two generations.

Pure question here: I'm not following how greed is counteracted through a monetary system nor how it worked with the gold standard, if it did much less how it would work or not under the current system of voodoo money.

[PeterMP]

You've heard of the shot heard 'round the world, well his acknowledgment was a supernova...and yet relatively few heard it or understood what it meant, yet there will be few if any who aren't affected by this mistake and the mistake of nearly two generations.

Pure question here: I'm not following how greed is counteracted through a monetary system nor how it worked with the gold standard, if it did much less how it would work or not under the current system of voodoo money.

Well, clearly, low interest rates had a role in the current situation and that was a monetary policy decision. I'm not sure that you can blame ONLY the low interest rates for the problem. People that are greedy (and willing to do unethical/illegal things) have shown a propensity to screw things up do matter what the interest rates. In fact, the S&L crisis happened in the mid-to-late 80's when rates were pretty high (now- it didn't get as far out of control. That's one of things that is so troubling about this incident- it managed to "hide" for a long time).

GF's (along with some others here) answer to everything appears to return to the gold standard so I'm assuming that was his point.

It ignores the fact that similar sorts of things happened on a gold standard (in general recessions and depressions, but even market manipulations). In fact, there were people that tried to make money by manipulating the (appearant) gold supply and carrying out speculative attacks against currencies with a gold standard.

http://www.econbrowser.com/archives/2005/12/the_gold_standa.html

[McD5]

https://www.technicalindicatorindex.com/subscribers/guest-articles/McHugh%27s%20Article%20Rebate%20Three%20Years%20Income%20Taxes%202009.pdf

[GibbsFactor]

GF's (along with some others here) answer to everything appears to return to the gold standard so I'm assuming that was his point.

It ignores the fact that similar sorts of things happened on a gold standard (in general recessions and depressions, but even market manipulations). In fact, there were people that tried to make money by manipulating the (appearant) gold supply and carrying out speculative attacks against currencies with a gold standard.

http://www.econbrowser.com/archives/2005/12/the_gold_standa.html

I don't want to go back to the gold standard. I just want something changed with what we are doing now. Any solution is okay with me. It just so happened that the only person mentioning this had a quasi-gold standard feel but wasn't the "old gold standard". It was modified substantially. It was based on actual assets in hand, not futures. But like I said, our current system is systematically flawed and we will continue having these issues as long as we maintain this debt driven economy.

[techboy]

Asbury, one big mistake you are making is to talk about these hedge funds as if they were some monolith of evil conspirators. There are a lot of hedge funds, and while a few of them have been successful, a whole bunch more have gone down the tubes in the last couple of years.

In point of fact, that's one of the reasons the markets dropped so precipitously: many hedge funds miscalculated and were forced to unload a lot of positions immediately, flooding the market and driving down prices.

Further, there's no need to postulate conspiracy when simple greed and stupidity are an adequate explanation. These derivatives are/were exceptionally complicated instruments, and a lot of players (supposedly "professionals" and "experts") badly misjudged the risks.

That actually leads to me to another observation, which that if AIG couldn't properly assess these instruments, what makes you think that you understand them so well after reading an article in the Village Voice which is long on speculation, but short on facts?

Finally, when it comes to the opaquity of hedge funds. Again, don't substitute conspiracy where greed works. Most of those funds

A) Don't want their "strategies" to come out

and

Don't want their clients to realize what insane leveraged risks they're taking to earn those exorbitant fees they charge.

https://www.technicalindicatorindex.com/subscribers/guest-articles/McHugh%27s%20Article%20Rebate%20Three%20Years%20Income%20Taxes%202009.pdf

Oh, so you do still follow Dr. McHugh... You suddenly went strangely quiet in the Investments thread, and I was wondering...

[AsburySkinsFan]

Asbury, one big mistake you are making is to talk about these hedge funds as if they were some monolith of evil conspirators. There are a lot of hedge funds, and while a few of them have been successful, a whole bunch more have gone down the tubes in the last couple of years.

When I reference the hedge funds in this crisis I am specifically doing so with an eye to those that did focus on the derivatives, obviously the failed ones didn't cause the impact that the unscrupulous ones did.

Further, there's no need to postulate conspiracy when simple greed and stupidity are an adequate explanation. These derivatives are/were exceptionally complicated instruments, and a lot of players (supposedly "professionals" and "experts") badly misjudged the risks.

Sure there was a lot of greed running around, however you cannot ignore the fact that there were those betting on the failure of the markets, and as I said before I cannot shake the feeling that there was manipulation from some of those hedge fund managers in the devaluation of the securities. Did I say I had facts to back this up? No, I just said I cannot shake the feeling, and what's more is that the motive and opportunity were obviously in place.

*edit

As for AIG valuing the securities, well they were doing the same thing everyone else was doing, looking at the supposed grading of those securities for their investment potential as these things were so complex that it was easier to basically outsource the grading to someone else.

[McD5]

.

Oh, so you do still follow Dr. McHugh... You suddenly went strangely quiet in the Investments thread, and I was wondering...

Yes, for over a year and a half now.

In just Wednesday, Thursday and Friday alone....even the most novice of investors could have seen their portfolios increase by as little as 12%, as much as 36% by following his calls.

His next phi date is the 18th of this month. I hope to post a thread on it as it approaches.

On his last phi date, he called for the market to go straight up that day, by up to 1,000 points. We closed up 952 points.

And of course his phi date prior is what has made him famous most recently--saying the mkt would crash 3,000 points or more immediately, to begin specifically on September 29th.

Ten days later, the market was down 3,300 points. The biggest drop in history.

The end of that 3,300 point crash? The exact calendar date he said we would go up 1,000 points.

But who cares? Some people try to convince you to believe that market timing is impossible--even when someone calls a 3,000 point drop, or a 1,000 point rise to the exact day.

It is best saved for a new thread. That investments thread was already on page fifty or so.

[iheartskins]

To be clear on something, hedge funds, as their name implies, often put in place a variety of hedges so that if the market in which they primarily trade collapses or the currency of their book depreciates on a relative basis, the manager will be able to pay out investors in the fund an amount at least equal to their capital contributions--that's a fundamental tenet of risk management and diversification within a hedge fund's portfolio.

And frankly, something that every institutional investor demands.

Many, many long/short funds had CDS and other derivatives in place so that if the entire value of their equity book when bottom up, then the CDS and other derivatives might pay out--thus, the hedge was put in place to hedge against a disaster scenario.

I've seen the books and records for guys who did exactly that--

What most of you should realize is that hedge funds (like all investment managers of all stripes) tend to do best when the economy is charging forward and things are doing well and do the worst when the economy is struggling.

But what about the shorts, you might say? Shorts only become interesting if there's downside potential--which suggests overvaluation in the market--i.e., the opportunities are there if there's a hiccup or a bump in the road, but they evaporate if the market gets too distressed.

This is what's killing the performance of nearly all relative value strategies right now and what's making distressed look like a great strategy...

So what does that mean? Yes, there are the VERY VERY few Paulson & Co's of the world that are doing great in the current market because they had huge short books (both directly and through optionality), but most managers (in both the registered and unregistered world and in the U.S., Singapore, Japan, the UK and globally) are not doing very well right now--in fact many of them are closing up shop because of a terrible, terrible 2008. Check the Russell 2000 and the Lipper indexes if you don't believe me.

Yes--there are definitely going to be unscrupulous people who take advantage of a negative situation for their own benefit, and yes greed and fear are strong, perhaps the strongest, ultimate drivers of money making on High Street and Wall Street. As they are in most business ventures, IMO.

But there hasn't been, at least IMO, some grand experiment or conspiracy to drag the economy down--it's just doesn't make sense and it's not good for anyone.

There's been greed. There's been morally repugnant behavior. But that wasn't, IMO, the predominant behavior of hedge funds, lawyers, bankers, mortgage brokers, realtors, the rating agencies, the Fed or any specific constituency--though there were people in each of those camps who did act with repugnant greed.

In sum, the blame can be located in a number of places and simplifying the blame to sellers and buyers of CDS or to AIG doesn't really capture the nuance of the situation and how we got here.

Tangentially, I highly recommend for those of you who are interested, "When Genius Failed" about LTCM.

[iheartskins]

In point of fact, that's one of the reasons the markets dropped so precipitously: many hedge funds miscalculated and were forced to unload a lot of positions immediately, flooding the market and driving down prices.

Not exactly--the reasons so many funds had such bad drawdowns was because their liquidity profile (i.e., monthly/quarterly on 30/45/60 days notice) did not match the liquidity profile of the portfolio. So, when investors were clamoring for cash, the only way to get it was to sell down the book to generate cash--

Further, there's no need to postulate conspiracy when simple greed and stupidity are an adequate explanation. These derivatives are/were exceptionally complicated instruments, and a lot of players (supposedly "professionals" and "experts") badly misjudged the risks.

Well, your derision aside, I think the misjudgment was largely based on flawed assumptions--assumptions that nearly everyone bought into (i.e., Lehman and Bear Stearns weren't going to go insolvent overnight) prior to the economic environment collapsing. But "greed" was defiinitely a major driver. ISDA's are not that complicated if you understand how they work--

That actually leads to me to another observation, which that if AIG couldn't properly assess these instruments, what makes you think that you understand them so well after reading an article in the Village Voice which is long on speculation, but short on facts?

Again, the issue was less that they couldn't asses them, but that their investment thesis was flawed. That's a different animal.

Finally, when it comes to the opaquity of hedge funds. Again, don't substitute conspiracy where greed works. Most of those funds A) Don't want their "strategies" to come out and Don't want their clients to realize what insane leveraged risks they're taking to earn those exorbitant fees they charge.

Ah, not really true on either account. Most HF pitch books have pretty substantial detail on a strategy, manager's provide monthly/quarterly trailing transparency (at least on a limited basis) and can be easily categorized (i.e., global macro, relative value, distressed, trend following, etc.) and assesed. As far as leveraged risks--that's just bunk. Any institutional investor (and any individual investor whose an accredited investor and QP) who reads the OM for the funds knows exactly what they're getting into. As to the fees, the performance fees are substantial, but the management fees are not disimilar to those charged on many registered mutual funds, particularly when you take into account commissions and trailing sales fees, etc.

[techboy]

Not exactly--the reasons so many funds had such bad drawdowns was because their liquidity profile (i.e., monthly/quarterly on 30/45/60 days notice) did not match the liquidity profile of the portfolio. So, when investors were clamoring for cash, the only way to get it was to sell down the book to generate cash--

Thank you for the more precise formulation.

Well, your derision aside, I think the misjudgment was largely based on flawed assumptions--assumptions that nearly everyone bought into (i.e., Lehman and Bear Stearns weren't going to go insolvent overnight) prior to the economic environment collapsing. But "greed" was defiinitely a major driver. ISDA's are not that complicated if you understand how they work--

My derision might be a little over the top, but it is based on things like this:

Lesson 1

Neither investment banks nor other active managers (including hedge funds) can protect investors from bear markets. All crystal balls are cloudy, which is why Warren Buffett concluded: "The only value of stock forecasters is to make fortune-tellers look good."1 If their money managers could protect you, why did firms like Lehman Brothers and Bear Stearns go belly up, and Merrill Lynch have to be rescued by Bank of America? It is in the best interest of these firms to manage their risks well. Yet, they have clearly demonstrated that they cannot.

As evidence of their lack of ability to forecast events, consider that in 2008, Lehman spent $751 million buying back its own stock at an average price of $49.60, and Merrill Lynch spent $5.27 billion buying back its stock in 2007 at an average price of $84.88.2 We can only conclude that with all the conflicts of interest that exist between these firms and their clients, there is no reason to think that they would manage their clients' risks any better. Investors don't need to pay Wall Street big fees to have their money managed. Large fees are only likely to make managers rich, not investors. Wall Street's best skill is designing products that separate capital from owners.

and this:

Lesson 11

One of Albert Einstein's more famous quotations is: "There are only two things that are infinite; the universe and human stupidity; and I'm not sure about the universe." If Einstein had lived long enough he would have added a third—the ability of Wall Street's investment bankers to create an endless stream of "innovative" products that exploit investors.

In my 13 years as director of research of the Buckingham Family of Financial Services, I have yet to review a single product that did not fall into the category that can be defined as a product meant to be sold, but never bought. Among the recent entrees are: Accumulators, Booster-Plus Notes, Buffered Notes, Principal Protection Notes, Reverse Convertibles, STRATS and Super-Track Notes. These are all complex derivative products, with the complexity designed in the favor of the issuer.

Again, the issue was less that they couldn't asses them, but that their investment thesis was flawed. That's a different animal.

Well, I don't know. My (admittedly limited) understanding is that many of these investment banks and funds thought they understood the risks, but ended up using so much leverage that they had to be right all the time. Which they weren't, and what hedges they had turned out not to be effective.

Ah, not really true on either account. Most HF pitch books have pretty substantial detail on a strategy, manager's provide monthly/quarterly trailing transparency (at least on a limited basis) and can be easily categorized (i.e., global macro, relative value, distressed, trend following, etc.) and assesed. As far as leveraged risks--that's just bunk. Any institutional investor (and any individual investor whose an accredited investor and QP) who reads the OM for the funds knows exactly what they're getting into. As to the fees, the performance fees are substantial, but the management fees are not disimilar to those charged on many registered mutual funds, particularly when you take into account commissions and trailing sales fees, etc.

Fair enough (though I would argue that many of those mutual funds charge outrageous fees too. )

[techboy]

It is best saved for a new thread. That investments thread was already on page fifty or so.

Oh, good. I thought it was because immediately following your proclaiming that Dr. McHugh had a 100% track record, you proceeded to be completely wrong about the next two calls based on his newsletter, including the "violent" 1000 point rally that still hasn't materialized, nearly three weeks later.

I'm certain, though, that the next time you happen to be right you'll let us all know all about it.