The black box economy

The Boston Globe ^ | January 27, 2007 | Stephen Mihm

[VegasCowboy]

Oh, and one more thing. As to carrying these as assets, the selling bank collected cash when they sold the risk. They ended up with cash and a liability on their books. If the mortgages start to default, this liability goes away and they actually benefit. The only assets at risk are those on the balance sheets of the purchasers of the CDOs, and only to the limit of the cash they paid.

[cinives]

http://www.financialsense.com/fsu/editorials/schiff/2007/0628.html
http://www.financialsense.com/editorials/lee/2008/0124.html
http://www.marketoracle.co.uk/Article3171.html

Some interesting Sunday reading for you.

BTW values can go negative if the “investment” was leveraged, as you noted. Oddly enough, some of this toxic stuff was leveraged, the CLO (collateralized loan obligations) in particular.

This is what happens when people sell risk down the line. It’s like the game of musical chairs. The music just stopped and they’re now all scrambling to find a chair. IMO CitiGroup, Merrill, possibly Bear Stearns, WaMu and a few others like Wachovia are the walking dead - they’re being propped up by outside investors(the sovereign wealth funds and the Arabs) and the Fed.

One more unanticipated hiccup and I think it all falls down.

[VegasCowboy]

BTW values can go negative if the “investment” was leveraged, as you noted. Oddly enough, some of this toxic stuff was leveraged, the CLO (collateralized loan obligations) in particular.

That's correct, but I think this issue is most pronounced at hedge funds. They can borrow and buy whatever they want with no regulation. Banks are a different story. If a bank borrows $10 million to buy a $10 million speculative CDO, the worst thing that will happen is that they will lose the $10 million investment and still have a $10 million loan on their books. Its all pretty evident on their balance sheets. If they have enough bad investments on their books, it could theoretically take them down. However, if they write off all such investments and are still standing, they may lose shareholder value but they'll survive. As you pointed out, foreign investors obviously believe there is some value left or they wouldn't be investing in them. You call it propping up; I call it opportunistic investing by foreign firms with ready cash reserves.

[bvw]

Fiat paper money is not.
Not money. Not in liquidation.
Strangely enough,
Only cold hard precious metal is liquid.

For of all metals
Gold is the most liquid-like
While solid.

[T Ruth]

Its apparent the author doesn't understand the subject matter very well, so I wouldn't get too concerned over this fear-mongering article. Basically, he doesn't understand derivatives; therefore they are "scary."

I think you are right. The author also says, "By cleverly exploiting regulatory loopholes, investment banks created new types of high-risk investments that did not appear on their balance sheets." It would seem to me that if these assets are not on the balance sheet, then there would be no need to write them down, and even if they were written down, the write-down would not hit the income statement. In other words, the big write-downs that we have seen must have been of assets that were on the balance sheet.