Once again…Forget Subprime In San Francisco, But How About Alt-A?

70%?!
That is a pretty staggering statistic, as it means that 70% of people are more than willing to lie. I’m sure that some of those people can afford the homes they live in even if they wouldn’t have qualified based on their actual incomes, but the most probably can’t. Which means what percentage of people don’t have even the basic financial knowledge?

“Whether or not the buyer can make the payments is not hugely material unless they are unable to quickly sell their property once they realize they are in trouble. A lack of liquidity in the resale market is what leads to foreclosures.”
Not entirely. It’s whether they are able to sell their property quickly **and** whether they can sell it for more than they owe on it.

And this wave (which is more significant for SF imho) has just begun. I couldn’t guess how much farther down the market will go or how long it will take to get there. But it is quite clear that we are nowhere near the bottom. The ideas being bandied about by the government re Fannie and Freddie may (but likely won’t) slow the pace of the decline a bit, but to the extent they do they will also prolong the slide.

It’s still “A” paper.

“And California has the largest concentration of Alt-A loans. If my math is right, California has about $303 BILLION of these loans, or 30% of all of them ”
and as we’ve all seen, “California” has been getting hit very hard for over two years at this point

“The reset is not going to crush every one. And most self employed people “exaggerated” their income. It doesn’t mean they can’t afford there mortgage now.”
Sparky,
You can say all those same things about sub prime loans. 60% are performing just fine. But the pricing pressure from the minority of loans that went bad decimated the market price in areas in which those loans were prevalent.
No one believes that 100% of the alt-A loans are going to go bad. Not by a long shot. But alt-A loans are to SF what sub prime loans were to Stockton: they are going to bring a lot of homes back onto the market under distress conditions.
The sub prime problem was resets: people thought they could refinance before the reset or shortly after it (if there were penalties). The teaser rate was artificially low, the later rate was higher, but if you couldn’t refinance because the LTV wouldn’t support the loan, you could just keep paying your loan. The payments were higher, but not infinite, and you weren’t likely to do any better anywhere else, so lots of people just sucked it up and kept paying.
Contrast that with someone who stated their income on a 3/1, who, after the end of that period is expected to come up with $1M and who will never qualify. Even if they can get another alt-A loan, they will have to come up with $200K or more just for the downpayment, and more if the price has sunk. That person has no real choice. They are going to dump the home. Especially if they stretched to get it in the first place (meaning they have not had the opportunity to save up anything for a down payment because they could barely keep up with the payments) and they put nothing or nearly nothing down.
I was looking at a $2M+ property in 2006, when a secretary bought it out from underneath me. That’s when I bailed the hell out of such a crazy market. Maybe her income has gone up like yours has, but I doubt she saved up $400K plus in the interim.
Those people are screwed. It won’t be everyone, but you can see how they could really care less about the interest rate being lower: it could be zero and they still wouldn’t qualify.

To Sparky @ 8:31 a.m.: You write “I also exaggerated my income. Not on the year previous but on the earlier years.”
Didn’t you sign and affirm on your mortgage application that all of the information you supplied on the application was true and correct under penalty of perjury? And aren’t you now admitting here on SocketSite that you have engaged in the commission of a fraud? You lied and misrepresented material facts about yourself in order to induce the other party in a business transaction to consumate that transaction on terms that the other party would not have agreed to had you not lied and misrepresented material facts about yourself.
Do you really think so little of yourself that you value SF real estate more highly than you do your personal integrity? You say you started a company (but you’re also a self-confessed liar, so who knows if that’s true.) Please tell us the name of your company so that we can steer clear of it in the future. You’d be doing us all a favor.

I actually think the 70% number is low (and in any case, how did they come up with it?).
The alt-A stuff won’t be a problem in SF unless there’s a tech recession. I don’t know anyone in tech who is having trouble finding work. Yet. Everyone is paying lip service to “a tough market”, which you didn’t hear 2 years ago.
Also telling: not a single commenter on the advice threads directly mentioned job loss as a risk (I may have missed it). Those still employed in tech will (generally) have no problem with any alt-A reset, as some folks have mentioned.
Tech (generally) is unlevered, so it’s only affected when its levered customers (or investors!) cut back, and this (generally) happens last.
In the last tech slowdown (which was trivial), I had two friends with small tech consultancies blow up almost overnight when their one- or two- customers suddenly cut back. SF is chock full of little consultancies like this, all feeding off the largess, as it were, of unlevered big tech (include big pharma, and biotech too).
This should be interesting to watch, that’s for sure!

How? Did the mortgage lender lie?

one interjection:
what most people forget is that the problem is NOT really the numbers of Alt A’s that blow up. The problem is the massive amount of LEVERAGE that was used in the secondary markets.
Some of these firms are levered 30x, 40x, 60x, and even more. there are some firms that are levered 10-30x on instruments that are themselves levered 10-30x. Thus, even 1-3% losses can wipe out investors. a 3% loss on an investment that is levered 30x is 90% loss as example
As those investors get wiped out there are fewer and fewer people willing to do the deals going forward.
Thus, as someone mentioned, the problem is the people on the margins, because only a few of them defaulting can bring the big firms to their knees.
There is a reason why Lehman Brothers, Washington Mutual, Wachovia Bank, and American International Group may be going the way of Bear Stearns and Countrywide and Fannie/Freddie.
As for tech: who are some of the largest purchasers of tech?
answer: the financial industry.
I’ll leave the rest to your imagination.
The wild card right now is the Federal Government. Will they truly nationalize the entire housing industry? The entire banking industry? If they do, how many losses will they be willing and able to take?
not to be alarmist, but there was a major breakdown in the capital markets (massive unregulated leverage into untested financial instruments on a worldwide scale across all credit instruments), and it is unclear if the breakdown can be fixed. This is not to say that we will all be eating dogfood and living in shanty towns.
However, it will be some time before we can get “business as usual” with Wall Street firms packaging (mortgage/credit card/auto loan/commercial/business loan) securities for sale on the secondary markets!

Hey Mark D., I’d do it again. In this market I wouldn’t qualify for a loan for the house I bought a while back. Even with more money down. Why, because I made 10x more money in March than my whole ’07 tax return. Just due to payment cycles/job completions/retention.
I do think some % of people will default and continue the value decline in SF. I posted earlier because the way things are often set up here it is very doom and gloom. Like the 70% people who exaggerated there income didn’t put a big chunk down, and didn’t only exaggerated 3 years ago’s income (for example). Lot’s of people with Alt-A and Option Arms will be just fine.
Mark D., I’ll tell you what, you tell me your name and e-mail address on here and I’ll e-mail you my information. Then you can never hire me. My company name and info. on this site; no way.
I’m sure no one will scrutinize your pristine record of never lying, fudging, exaggerating, or mis-representing.

Sheesh Mark D., that was unnecessarily harsh on sparky.
From what sparky states, this was exactly the ideal scenario for no-doc loans. sparky signed with good faith that he had a business plan that could support loan payments. Both sides of the contract knowingly took a risk.
The alternative would be for sparky to apply for a mini-venture funding, providing business plans, pro-formae, etc. to the banks. What a headache ! And in the end the funder needs to go out on a limb anyway to have confidence in the business plan.

“You have all seen for over a year, nay as much as two years, that there is far more liquidity in San Francisco than any of you ever estimated.”
Yup, allow me to be the first to admit that the “RealSF” has held up longer than I expected. And yet, Wile E. Coyote is eventually going to look down and remember that the law of gravity is still in effect.
The rot has started in the southern neighborhoods and it’s spreading my dear ghost.

What a tantalizing statement Publius. How can something that happens now change the “intent” that was present when the contracts were entered into?

Anyone who doesn’t think tech is struggling should drive around Santa Clara for an hour. I did and it’s shocking: the large buildings are about 30% vacant. It looks like a scene out of Detroit.
I know of at least three venture capital firms who, though they are not closing up shop, are downsizing significantly. One I know of is moving out of a 6600 square foot facility at the end of next month that has more than 20 people and is looking for a single office of 200-300 square feet: they said they were going into “hunker down mode”.
One of my businesses that supports tech companies is off by about 2/3 over last year. We’re delivering services at a rate that’s around 6x what’s coming in. It’s surviving almost entirely on the backlog. By the end of the year we will have burned through that plus everything that comes in between now and then. We cut hiring to zero six months ago. By next summer, we’ll probably start laying people off, if normal attrition doesn’t take care of it.
Drive around the tech company buildings in Santa Clara like I did two weeks ago. You’ll be shocked. There *is* a lot of money in this area, Mr. ghost, but it’s drying up quickly, and that is making people less willing to spend. Everyone who runs a business in Silicon Valley is witnessing it first hand.

“Also, santa clara has kind of looked like that since 2002, but I admit I don’t have to drive around there anymore, so maybe it’s even worse now?”
I’ve been working down in the valley since 2006 (was in SF prior to that). When I first got down there, I was shocked at the number of vacant large buildings…does not seem to have increased appreciably since then (though it certainly hasn’t gotten better either).

$2 million houses going to secretarys??
is that a figure of speech or did this really happen??

Really happened (it was a condo). I assume she’s still living there and that if I want, I’ll be able to buy it from the bank in the next year or two.

Sparky’s actions were clearly the commission of a fraud.
Under common law, three elements are required to prove fraud: (i) a material false statement made with an intent to deceive (scienter); (ii) a victim’s reliance on the statement; and (iii) damages.
Sparky has admitted to the first element of common law fraud (and says in his post at 10:27 a.m. that he’d do it again).
The lending entity relied upon Sparky’s materially false statement, so the second element of common law fraud is met.
The third element of common law fraud is also present when the lending entity under-priced the loan to Sparky based upon Sparky’s material false statements rather than upon Sparky’s true financial history. This under-pricing of the loan is damages to the lending entity.
Therefore, notwithstanding Publius’ post at 11;40 a.m. to the contrary, there’s little question in my mind that Sparky’s actions, as Sparky himself has described them, fit the definition of common law fraud, and fraud is a crime.
Sparky – I’m not your attorney, but if I were, here’s what my advice to you would be: It is never to your advantage to admit to the commission of a crime on a non-privileged basis, nor is it ever in your interest to state your readiness to commit a future crime, irrespective of whether such statement is privileged or non-privileged. Accordingly, at a minimum, you should stop admitting to any past crimes, and you should also refrain from asserting your willingness to commit future crimes.

sparky,
Touche again! And you told me on another thread that you were the first homebuyer I had met that wasn’t a “secret fraudster”!
Seriously, though, notwithstanding Mark D.’s cogent analysis and advice, I’d respectfully submit that fraud would be difficult to show here. The key in my mind is element 2 in Mark D.’s analysis, the very common legal principle of RELIANCE (usually in contract claims, the idea of detrimental reliance – namely, that a party relied on a representation to his DETRIMENT). This also impacts element 1, the very common idea of MATERIALITY (the lie has to be about something important to the other party’s decisionmaking process).
Here, the lenders set up a system that they KNEW invited fraud. There is no question about this. The lenders KNEW that borrowers were overstating income. In fact, Tanta at Calculated Risk (a former mortgage executive) has chronicled many times how the lenders went out of their way to PREVENT any examination of the actual facts and income of a borrower. They did not want to have any knowledge that the borrower was actually lying because they wanted “plausible deniability”.
You see, if the originating lender had any information that cast doubt on the idea that – say – an “agronomist engineering specialist” (who couldn’t speak a word of English and signed the loan document with an “x”) was actually an illiterate strawberry picker, the originating LENDER would have been party to a fraud when it passed the loan off for packaging in MBS. That knowledge would have made it difficult to get that “agronomist” into a $720K house in Gilroy. And that would have meant no commission dollars, and the system just couldn’t stand for that.
These considerations of reliance and materiality – which were common apparently – raise considerable questions as to whether the originating lender “relied” on any misrepresentation. In addition, they also raise questions as to whether the borrower withheld a “material” fact, although these questions are more subtle IMO. Arguably, the “true” income of the borrower was not a “material” fact, although I recognize that reasonable attorneys could disagree here. That’s what judges are for! (Good luck finding any solvent borrowers and lenders to really create good case law in this mess!)
Typical fraud evident in all bubbles. Can you believe that people who ostensibly had greater than double digit IQs back in 2004-07 tried to deny that there was a bubble! As I’ve written, everyone was a secret fraudster in this fiasco, and please do not waste any sympathy on any of them as it blows up.

“Once again SS bites the hands that feed. You all clamor for information.”
We do. We love information. But it’s good for posters to remember that we are not hanging around a bar shooting the breeze. You’re posting things to an archived and publicly available site and some discretion is a good thing.
One of the things about the Enron scandal that struck me was how many e-mails of the form:
Hey John!
So how’s the illegal price fixing scheme going? The other members of the conspiracy would like an update.
were retreived from the enron computers by prosecuters. It’s a new era, and we’re all just speed bumps on the information super highway.

Sorry, for anything written on here in the last few days. My 6 year old had taken over my computer and wrote all kind of incorrect information.

And now the re-invention; Sparky-the-bull uberbull waiting to jump into purchasing after the can’t come soon enough RE value nose dive.

Jimmy, watch what you say on here you may be sued for slander.

“Didn’t you sign and affirm on your mortgage application that all of the information you supplied on the application was true and correct under penalty of perjury? And aren’t you now admitting here on SocketSite that you have engaged in the commission of a fraud? ”
After I originally read this comment from Mark D, I thought the thread just degenerated into stupidity like some threads here do. And I thought, what self-rightous, holier-than-thou, arrogant prick! I mean his comment was so off topic and just came out of nowhere.
But the thread has turned into one of the more interesting ones, packed with some real insight.
Anyways, back at least partly OT, it appears the federal government is refusing to rescue (or appearing to do so) Lehman Brothers by putting up real tax payer dollars like it did with Fannie/Freddie/Bear Stearns.
http://www.nytimes.com/2008/09/14/business/14spiral.html?_r=1&ref=todayspaper&pagewanted=print&oref=slogin

mark d, with ya bad self runnin things, what’s up with ya bad breath onion rings?
well i’m mark d and i’m back from the dead/
callin out valuable posters like a d**h**d/
givin valuable legal advice. you’d be wise to take notice/
what’s your real name so i can avoid closenes

chuckie:
we’ll just have to see what the end result of these talks will be. I’m guessing we’ll find out before asian trading opens later today, even tough china/japan are closed.
my personal feelings is that Lehman will be left out to dry and the resolution will come without explicit taxpayer money. But as you know, there are fun ways to play with numbers so that the taxpayer money is given implicitly instead!
the reason Lehman is going to be left out to dry is because there are bigger problems right now
1) washington mutual. if they go down they will possibly bankrupt the FDIC and Treasury will need to bail out the FDIC (that could cause bank runs)
2) AIG. AIG is outside of Federal Reserve/Treasury control. in fact, they are regulated by the STATE insurance boards. but the problem: the state insurance boards don’t understand Credit Default Swaps-which is what is bringing AIG down. AIG going down would be HUGE. I suspect that there will have to be “bending” of authority so that the Feds can assist.
There is also Merrill and Wachovia coming up as well…
so Lehman is in the unfortunate place where they thought they were too big to fail, but there are 2 bigger fish to fry right now, and then 2 more bigger fish that may jump on the hotplate as well.
The federal government can only do so much.
This is unraveling faster than I had thought. It’s a little unnerving.

Some CD’s are not FDIC insured; I’d check if I were you.

diemos: you have no argument from me. All major commercial banks will have their insured deposits covered (and likely many of the non-insured deposits as well), and if/when the FDIC runs out of money it needs to be bailed out by Treasury. There isn’t a man alive who thinks otherwise. (at least not a man alive who understands anything about banking)
We would immediately enter the biggest depression in human history if any commercial bank the size of WaMu failed and the insured depositors weren’t made whole. Double that if the FDIC weren’t bailed out. imagine it… if FDIC failed then ALL of our money in ALL banks would be at risk. everybody in the country would immediately run to their banks to get their cash before the bank ran out of money!
which is why I do not think that the Fed/Treasury/FDIC will allow WaMu to go down. I’m gueesing that the Fed/Treasury/FDIC have some sort of plan or trick up their sleeves to keep the big boys from falling. (Wash Mutual, Wachovia Bank, etc). But this is one reason why they are being more vocal about the banks in trouble, to allow depositors time to get under FDIC limits.
it is also why Lehman is unlikely to get a hand. They are an investment bank and thus MIGHT be able to fail without killing our economy.
(looks like they’re gonna go BK as I write this, but details still not out)
chuckie: if you bought the WaMu CD they’ve been advertising of late it is FDIC insured. as is BofA’s 5% CD. (of interest: you can immediately pinpoint the banks in trouble or in need of cash by seeing who offers above-market CD rates)

I agree with tipster here. No big deal if Lehman goes Whisky Tango Foxtrot, and it looks like that is what is going to happen. Well, maybe it’s a big deal if you are one of the 25,000 or so employees there. Practically all of them are surplus to the economy.
The real news in the casino appears to be what is happening with Merrill (looks to be acquired by BoA) and AIG. Tomorrow should be an interesting day in the markets. The terror that the Fed is not willing to backstop the entire financial system has to be balanced against the apparent willingness of BofA and private equity groups to act as knifecatchers (perhaps with some behind the scenes support from the Fed).
What is – and has been – missing is any inkling that the Fed is willing to “print” its way out of this, which comes as no surprise to me, and obviously no surprise to the USG debt market (rates have been falling, not rising). My gut feeling is that there is – and has been – a deal behind the scenes among the Fed, the BOJ, Bank of China and ECB regarding US money supply growth. Although people here throw the idea around that the Fed has been “printing” like mad, if that’s true, we have no evidence of it.
In fact, narrow money supply growth rates have been trending DOWN for years now, and appear very steadily disinflationary even in the face of the obvious turmoil in the credit and asset markets. Don’t trust me – go to the Fed’s own chart:
http://research.stlouisfed.org/publications/mt/page10.pdf
(Look at the long term chart of base money growth.) Any printing would show up there as an increase in base money, or I don’t understand this as well as I think I do. If anyone out there who has referred to the Fed as “printing” (NVJ?) can point to an aggregate that shows that the Fed is “printing” money, I’d love to see it. Just for reference, M3 does NOT reflect direct Fed action, so its growth would not be evidence of the Fed printing (which requires an expansion of the Fed’s balance sheet).
I agree with those who posit that the FDIC will fail. No question about that. But again, whether the Fed will “print” currency to make everyone whole is a leap of faith. There are MANY options open to a monopoly central bank when faced with “bank runs”, including the imposition of all sorts of controls (as in the crises of the 1990s) right up to and including the granddaddy of them all pioneered by our own FDR in one of his first acts: the “Bank Holiday”.
If China and BoJ are calling the shots, we should keep in mind that the PRIMARY goal of the USG and the Fed is not to make the population “happy”, especially because they know that it won’t work anyway (if a country could “print” its way to wealth, there would be many more wealthy countries!). Its goal is to preserve the international financial system, as the US derives immense benefits from having the reserve currency. Chief among these is the ability of the US to live beyond its means, and for the USG to fund itself at absurdly low rates. Whatever is being discussed and agreed at those behind the scenes meetings, there is one thing IMO of which you can be sure: the interests of indebted households and “ordinary” Americans are the FURTHEST things from their minds. Any belief otherwise requires, well, a giant leap of faith.

“How do you think The Fed gets the money into the money supply?”
They do it in one of two ways. The most common is they PURCHASE treasuries or other assets on the open market, “printing” the currency to do it with. This is known as POMO (“permanent open market operation”. I don’t think they have done a POMO since March 2007, but honestly I don’t know that for sure.
The second way is to reduce reserve requirements.
Both of these show up in the adjusted monetary base aggregate. This series adjusts for changes in reserve requirements, so that the figures are comparable period to period.
All the other programs (TAF, TSLF, PDCF, etc.) are LENDING facilities. They are supposed to be paid back. Will they? Well, I suspect not all of them. And that’s why I ultimately do expect some large scale printing. But I also expect much of it to be foisted onto the taxpayers, and I do not think the printing will be anywhere near enough to stave off what is coming. This is similar to what Japan did in the late 1990s and early 2000s, and was of course not enough to stave off the deflation of assets and the collapse in monetary velocity as lenders no longer want to lend. That’s always been my message for people who care about this stuff: beware leveraged assets (like real estate) and do not assume that the Fed and the USG care about YOUR well being. They have much bigger fish to fry.
“And I said that The Fed will just start up the printing presses before letting the FDIC fail, I never said that they have started doing it yet.”
My apologies, NVJ. The only reason I mentioned your name (with a ? mark) with regard to printing is because you wrote this, which to me sounded like you were saying the Fed is ALREADY printing:
“The Fed will just keep printing money: so far they have successfully walked the precipice between deflation and “real” inflation, the kind where wages go up, not just prices, quite well….[snip] Posted by: NoeValleyJim at September 8, 2008 5:52 PM”
https://socketsite.com/archives/2008/09/its_the_end_of_the_gses_as_you_know_them_do_you_feel_fi.html
But I can see where you probably just meant that the Fed WILL resort to printing. In that regard you and I don’t disagree. It’s just that I do not think the printing will be enough to walk that tightrope, and certainly not enough to offset the deflation in asset prices that is coming.
Time will tell! But it’s worth noting that if one agrees with me (which I have been spouting CONSISTENTLY on SS for at least 9 months now), one would have been long treasuries, short US credit, out of real estate, flat/short US equities or at least “light” in equity exposure, out of muni bonds, short financials and short (or flat) emerging markets, and long (or at least relatively flat) the USD. That portfolio has worked very well this year I can assure you!
An inflationary portfolio would – at the very least – have been short US treasuries and short the dollar, which for the most part would have been a very painful trade these past 9 months (particularly the last two or three). And, of course, long leveraged real estate, which would have been a mistake EVERYWHERE this year, even in the “real” SF I’m afraid (though not too bad – yet).

God save Akron!

“Good grief, this sounds like the Viet Nam Domino Theory all over again”
No, it’s a manifestation of the positive feedback loops that are inherent in any system that allows financial entities to invest using borrowed money.
An asset price falls. If it’s enough to impact the entities capital ratios then they have to sell assets to bring them back into line. That causes asset prices to fall and impacts the capital ratios of other firms which then have to sell which then depresses asset prices further. If eventually the entities equity is wiped out then it can’t repay it’s leverage and you can get into cascading cross-linked defaults. A chain reaction where everything implodes.
The more leverage financial entities are allowed to take on the easier it is to trigger the chain reaction. Limiting leverage makes the system more robust by providing each financial entity with a larger cushion of equity with which to absorb losses and break the cascade. Limiting leverage also prevents the entities from driving up asset prices and thus limits the potential losses that need to be absorbed on the downside.
If we lived in a world where no financial entity was allowed to lever up more than 4x and thus had a 20% equity cushion to absorb losses I would agree wholeheartedly with the “let ’em fail” bunch. (and note that shareholder equity doesn’t count in this calculation, only a liability that appears on the entities balance sheet and can be written off to cancel losses on the asset side counts.) In that system you could safely let them fail without taking down the whole financial system.
We don’t live in that world.
Our system is highly leveraged, enough to easily support a chain reaction in my opinion. I think we already saw the initiating event when the Bear Sterns hedge fund tried to sell their CDOs last year and only got a bid of 5 cents on the dollar. Only Dr B’s alphabet soup of lending facilities prevented price discovery in the MBS market and kept the implosion in abeyance. We’ll see whether he can perform a controled de-leveraging or whether it’s going to blow up on him (and us).
Benjamin Bernanke!
He’s our man!
If he can’t save us!
Nobody can!
and of course it goes without saying that the CORRECT solution is to never allow the system to get in this state in the first place. But now that we’re here shock therapy would kill the patient.
If you ever saw the movie “spaceballs” there’s a scene where the commander decides that lightspeed is too slow and demands to go to LUDICROUS speed. Discovering that this is in fact too fast the commander orders his subordinate to stop the ship. He replys, “Sir! We can’t stop. It’s too dangerous. We have to slow down first.”
I’m afraid that’s very apropo to the situation we’re currently in.

What is the difference between reducing the reserve requirement and allowing a bunch of dubiously valued assets be used as reserve? Ultimately, they have the same effect, which is to allow the banks to lend more, putting more currency into the M2. There is a whole range of things that both The Fed and Treasury can do to make sure we don’t suffer a deflationary collapse. I am sure there are a bunch of things that no one has ever thought of too, which we will see more of in the coming months.
I am not sure exactly how the Argentine hyperinflation came out, or the Brazilian or the German, but it really doesn’t matter. Whoever controls the printing press always has that option. It is always disruptive and there are some economic consequences, of course, but it happens more often than most people want to think about. In the last hundred years, I can think of two Brazilian defaults, two German defaults, two Russian defaults, one Chinese default, one Japanese default. I am sure there a raft of smaller economy defaults that I am not aware of. It seems it happens at least once every year, right now to Zimbabwe.

I have a technical question about credit default swaps. When one party buys a CDS from AIG, they are expecting AIG to make good in the event of a default by the primary bond issuer, right? How do they take into account the possibility of an AIG insolvency? Why pay for this insurance or option in the first place if the solvency of the other party would be in doubt (presumably from the same factors that prompted the first party to get a CDS)?

Insurance companies are heavily regulated because there are few things more profitable than selling insurance policies, pocketing the premiums, and then declaring bankruptcy the first time somebody wants to get paid. Allowing financial companies to run wild writing insurance policies that they had no means to make good on will be one of things future historians will point to when they write the analyses of what went wrong.

Hmmmm Let’s see.
1. The banks have all lent out 50x their capital at 4% interest to homeowners.
2. Most of those loans are performing.
3. The banks borrow short term to keep those loans funded and they keep rolling over the debt.
4. If inflation creeps up, the short term debt will get more expensive right away, while the longer term debt stays the same or gets incrementally more expensive, being subject to caps.
Therefore, with higher interest rates, more of the banks will file for bankruptcy, as their costs exceed the money they make on the loans.
So I think it’s pretty clear the printing of dollars will be avoided at all costs. The fed is boxed into a corner: it can’t inflate. Any other ideas?

Mark D – Don’t be too sore.
I just need to point out that you stated that “Sparky’s actions were clearly the commission of a fraud.” You then offered your perfunctory prima facie analysis as support for this conclusion. Now, you state that issues remain for a fact finder to determine. Therefore — by your own admission — there is not “clearly” anything here. Also, whether or not your argument could be sustained before a finder of fact is a red herring. Such an argument would never see the light of day in court.
And to be fair, you have had some pretty definitive and harsh things to say to others on the board. Your comments regarding a “crime” being committed is what got to me most. Perhaps if you tempered your comments a bit, you wouldn’t get the response you have.
That being said, don’t take anything I said too seriously. It was just some good-natured ribbing.

Wow, I wonder what king of trick the Fed will be pulling out of its hat tomorrow. Financials will be slaughtered. I think WAMU will be next Week-End’s story.

tipster:
I disagree with your analaysis.
I don’t like the word “printing” because it doesn’t really mean anything. what people are really talking about is money creation. there are several mechanisms through which the Federal Reserve can help the banks which also may increase money supply.
The Fed controls short term interest rates. the banks are borrowing short term and lending long term. The Fed can, if it chooses, lower Fed Funds Rate to 0%. This will affect the short end of the curve helping banks where they need it (lowering short term interest rates). They can combine it with lowering reserve ratios.
Lowering reserve ratios will increase the amount of money banks have to lend, and lowering the FFR will give banks lower rates in which to do it. So clearly they will benefit from this.
The 2 tricks
1) getting the banks to then lend out that money (the so-called “pushing on a string” theory)
2) longer term interst rates will eventually likely go up, the fed has no control over longer dated paper.
3) it will cause massive price inflation ELSEWHERE in the economy. (this is what caused the brakes in the current setup… too much Fed Easing too quickly spurred commodities and oil bubble)
4) keeping our creditors happy.
remember: the banks get the money FIRST. thus, they get more benefit of “new” money compared to people who get it later.
ZIRP obviously won’t cure the problem… but it can buy time. it is also inflationary (monetary wise). Your argument that it cannot be done is thus incorrect IMO.
But it’s an easy theory to test: let’s just watch and wait how long it takes before the Fed lowers the Fed Funds Rate… and also how long before a “surprise” announcement about lowering reserve ratios.
(FWIW: I consider active slowing of monetary deflation to be the same thing as monetary inflation)
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Now that said: to date the Fed has increased liquidity to the banks BUT THEN STERILIZED that liquidity which goes back to Satchel’s point that there is no “printing” (hate that word) or monetary creation. But I fear we may be nearing the end of sterilized intervention (for example: the Fed buying equities directly… is this a step towards monetization of debt?)
American monetary and fiscal policy is focused on deflation, because that is from where our Great Depression arose. so we tend not to worry as much about inflation. Other parts of the world worry about hyperinflation, because that is in their history (e.g. Germany/EU).
I thus believe that our history of Deflationary Depression will color our future decision making process… so that when push comes to shove we will inflate. (heck that’s what we have been doing the last year and a half). but we will stop shy of hyperinflating if possible.

I think tipster is right in the short term, ex SF-er in the long term. The key IMO in a fiat system like we have that relies on private credit creation is the overall level of debt in the economy. There is NO WAY to “force” private lenders to lend against overvalued assets, and there is NO WAY to get private employers to raise wages in real terms. Money “creation” will be hoarded by the banks to cover up their past sins. Monetary velocity will collapse, taking real output with it.
The examples of hyperinflation have almost always happened in instances where the government was a LARGE direct employer, consumer and investor. In the US, the share of government spending (including Federal and state) is only about 20-21%. HALF of the Federal budget (more or less) is transfer payments. Access to “first money” here will do little to incent banks to reflate because in REAL TERMS the prices of assets are all TOO HIGH. Why lend when you know you CANNOT earn a return?
IMO we will undergo a debt deflation, and I will go further to say that the Fed WANTS this. They know that ponzi schemes do not continue forever, and they have been trying to engineer this deflation before complete collapse ensues. They are trying to moderate the pace of declines so that the bulk of the loss is not sustained by the banksters. In this endeavor, they are a bit constrained by the foreign central banks and the knowledge that loss of the USD as a reserve currency would be catastrophic. The pain of the population is the LAST thing on their minds, and I simply do not understand why people have this almost child-like belief that the USG and the Fed are looking out for them. They DO NOT fear protests by the population – have you seen any so far?
IMO, only when asset prices are lower, and there is less overall debt (either through repayment, default, retructuring, etc.), will banks and individuals respond to reflation efforts. Until then, there simply isn’t the capacity or desire to continue the debt ponzi scheme. Japan has been waiting for these “reflation” conditions for 17 years already, but I think the US will go quicker. A large scale shooting war always remains a possibility for jump starting the economy, just as it was at the end of the 1930s (that’s what brought us out of the Great Depression, NOT FDR’s New Deal).

Sounds like we don’t disagree, enonymous. I’ve posted a number of times that I believe the defationary period will most likely last 2-4 years. That’s of course just a guess, as all these “predictions” are. In the meantime – until I see a sustained increase in base money for a sustained period of time (say, money printing in excess of 10% for 6 months or more) I will stay long US treasuries and flat-long USD.
What is not a guess is this: the USG and the Fed will not sacrifice the USD (and its place in the world AND the ability of the USG to fund itself at low rates) just to salve the pain of an indebted household sector. The population will be forced to EAT the loss, and it will be very painful indeed (but necessary).
My bet is that the USG will be there to help here and there with make work programs (infrastructure, “green” technology ventures, etc.) and various forms of welfare, which will have the effect of sucking out productive capital and prolonging the downturn. All these types of activities will increase the role and power of government, which is of course what government seeks. The Fed has tremendous powers, but they do NOT have the power to stop a deflation – only to shift around the losses. If smart bureacrats could stop the fall of asset values, the Great Depression could have been avoided, to say nothing of Japan’s experience in the 1990s, Indonesia’s in 1997, Russia’s in 1998, the Chinese stock market this year, etc.

So, any new thoughts now that we’re seeing the bailout package stall?