Posted on 09/20/2008 9:46:19 AM PDT by koraz
Damn good analogy! Works for me.....
These esoteric derivatives are a relatively new device and they are sold on damn near every financial instrument there is. There are a estimated 50T worth of these things, and I don't think that is too exaggerated.
In 2000 or 2001, there was only about 1 Trillion worth, and this is where the greed began. The fees levied to process, write and move these things is what has fuels the investment banks and caused regular banks to get into investment.
The creation of these things was caused by some rules changes back during the Clinton admin.
You can rest assured however, that Republicans did not bitch much or stop the madness, as their major donors were profiting as much as the Dem's.
I got a note in the mail just yesterday, hawking these things on life insurance policies and reverse mortgages, another financial pimple on society soon to blow up IMO.
Investment is much like gambling. It moves and creates money and that money fuels more investing.
Like gambling, it has to be regulated, or illegal. There is no middle ground as it quickly becomes uncontrolled.
Capitalist societies use investment as heart that pumps the blood to all the parts of the society, and it's Incorporated into everything we do, yet few actually play the game. But all are affected and the economy lives of dies by it.
What is happening today, is a once in a 100 year event, but it is what it is. A world war would result in similar risk and cost.
This laptop keyboard is giving me fits.....
I am actually well versed in investing and financial derivatives. I am a CFA. I am asking the question since I have never encountered leverage CMOs.
In fact, I used to oversee investment managers that bought CMOs in that late 1990s. I took a long time discussing these with investment advisors and looking at the prospectus to understand the securities my company was buying. That is why I am asking the question. There was no leverage in the securities that we bought. I acknowledge that new securities might have been issued where leverage was employed. I am having a hard time understanding how it could be done. As with all things, I will understand it better once I see an example. I will try to google “leveraged CMOs” and see what I get.
That'a above my paygrade plus, I didn't get us into this mess.
When I referred to derivatives, I was not talking about the CMO's. Those are directly tied to mortgage packages, and are likely going to be part of the fed buy ups. I think they would have to be.
What is actually causing the credit seizures however, is the derivative products that are indeed levered as the total value of them far exceeds the base investments.
This stuff has all sorts of face values and are traded as investment grade paper, where they should be traded more like options.
What the fed wants to do, is stabalize the mortgage markets by taking them at 60-80% value or there abouts, and their related CMO's, and this should cause the dervitives or (I think they call them CDO's) to free up and begin clearing through the system as their value stabilizes, even though holders will take a serious haircut. At least they will have a value greater that zero which is what they are when they cannot trade.
I am not a accountant, so I probably misunderstood what you were looking for from me. I have been doing a lot of arguing with folks who don't understand the intricacy of this stuff,and have been keeping it pretty simple for effect.
I am a part time trader with a small portfolio that is now a lot smaller as a result of the rise of crude. I was on the wrong side of that...LOL.....anyhoo, I hope this clears that up about CMO's and these 3-5-7 year goofy derivatives that are more akin to junk bonds. I have never had one in my hand, but I am bombarded daily with requests to buy them.
Thanks for the info. It is nice to have a sensible discussion.
It really does come back to transparency. I will keep my eyes open to see more of a discussion on this. As you describe them, it is hard to see how they can be worth 60% or 80%.
BTW, another post had an article from some Univ of Chicago professors about the recent events. It is interesting. Too bad it doesn’t extend to the actions announced on Friday.
Collateralized debt obligations (CDOs) are an unregulated type of asset-backed security and structured credit product. CDOs are constructed from a portfolio of fixed-income assets. These assets are divided by the ratings firms that assess their value into different tranches: senior tranches (rated AAA), mezzanine tranches (AA to BB), and equity tranches (unrated). Losses are applied in reverse order of seniority and so junior tranches offer higher coupons (interest rates) to compensate for the added default risk. CDOs serve as an important funding vehicle for fixed-income assets. Some news and media commentary blame the financial woes of the 2007 credit crunch on the complexity of CDO products, and the failure of risk and recovery models used by credit rating agencies to value these products. Some institutions buying CDOs lacked the competency to monitor credit performance and/or estimate expected cash flows. On the other hand, some academics maintain that because the products are not priced by an open market, the risk associated with the securities is not priced into its cost and is not indicative of the extent of the risk to potential purchasers.[1] As many CDO products are held on a mark to market basis, the paralysis in the credit markets and the collapse of liquidity in these products led to substantial write-downs in 2007. Major loss of confidence occurred in the validity of process used by ratings agencies to assign credit ratings to CDO tranches and this loss of confidence persists into 2008.
We also know that the investment houses that have failed and those still standing further leveraged them as assets and sold more CDO's on that.
Do you see where I'm going with this?
I hate to use the expression, but the word "Ponsi" is becoming a legit term to describe this. I never thought I would ever use it for our financial system, but I don't know what else you can call it.
Even the street gets them mixed up with the legit CMO. As do I at times.:-)
I agree there is a Ponzi element to all this. We had a Ponzi scheme ever since we went off the gold element. A bank is a Ponzi scheme. If all the depositors tried to take the money out at once the bank would go bust. To me leverage is an issue but the root of the problem is that companies lent money to deadbeats.
My understanding was that CDOs may have included CMOs but other debt as well. Not just mortgages but corporate debt etc. So you would need to add the value of this other debt to the mortgages and compare it to the CDOs face value. There may still be leverage there but it would be less than what you are thinking.
during this time they were issuing debt in the form of CDO's on CDO's????????????????????
When the fed tried to negotiate a sale of Lehman prior to Bankruptcy, the buyers did due diligence and refused to buy it. Now I would guess the the Fed did everything it could. At some point, price always overcomes risk! But is this case, it did not.
Bear Sterns assets were not revealed because it's sold and under review, and the other, was sold to bank of America so fast the street's heads spun on their axis and are still spinning.
One day, this will all have to come out....at least I would think so......Hmmmmmm maybe not.
In any case, this unregulated mess was gong to blow up with or without the mortgage mess, and I think it could be just the tip or the top of a mountain of leveraged debt that has escaped the regulators. These CDO's could be three dollar bills dressed up as investment grade paper, and the ratings people would have to be complicit. All of them.
As long as everyone was fat and happy with fees, nobody rocked the boat, but they sure are screaming now.
iirc, there was a firm in the boca/ft lauderdale area that went bust due to margin’ed cmo’s, if this is what you mean.
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