Wall Street Bank Run

[Waiting2go]

Wall Street Bank Run

By David Ignatius
Thursday, February 21, 2008; Page A15

It doesn't look like an old-fashioned bank run because it involves the biggest financial institutions trading paper assets so complicated that even top executives don't fully understand the transactions. But that's what it is -- a spreading fear among financial institutions that their brethren can't be trusted to honor their obligations.

Frightened financiers are pulling back from credit markets -- going on strike, if you will -- to escape the unraveling daisy chain of securitized assets and promissory notes that binds the global financial system. As each financier tries to protect against the next one's mistakes, the whole system begins to sag. That's what we're seeing now, as credit market troubles spread from bundles of subprime residential mortgages to bundles of other kinds of debt -- from student loans to retailers' receivables to municipal bonds.

Investors are nervous because they aren't sure how to value these bundles of securitized assets. So buyers stay away, prices fall further, and the damage spreads.

The public, fortunately, doesn't understand how bad the situation is. If it did, we might have a real panic on our hands. And there would be more pressure for bad policies -- ones that try to freeze the damage, rather than letting prices fall to levels where buyers will return and the markets will clear. Hillary Clinton's proposed moratorium on home foreclosures, in that respect, is one of the truly bad ideas of our time. It would make the situation worse by increasing even more the illiquidity and inflexibility of the housing market.

more:
http://www.washingtonpost.com/wp-dyn/content/article/2008/02/20/AR2008022002270.html

[Nova]

This article is about why the risks in derivatives have dried up the credit market for both derivatives & bonds.

"biggest financial institutions trading paper assets so complicated that even top executives don't fully understand the transactions"- these are derivatives. Or securities.

And banks traded them between themselves & sold them to investors. And buyers had to take the word of the seller about their value. So someone bought a bundled lump of loans, say backed by property. Historically, that would be consider safe. Because these have collateral. Plus, there was speculation that housing prices would rise forever. Who cares if the homeowner's credit was bad, as long as the property value was rising? So even loans bundled with poor rating were traded/sold. Now the subprime mess surfaced, housing prices are falling & now no one wants to buy them. Which has left big banks & investment companies holding securities that on their books are worth say $1000 but in real fact worth far less.

So how bad is this? How much risk do banks have from derivatives? I cut & pasted this from the "Bomb ticking for off balance banks."

"Australian banks have a big exposure to derivative markets. Their total shareholder value of $110 billion is dwarfed by the size of the banks' collective exposure to derivative markets of $12.9 trillion."

Granted, once we get to talking about billions or trillions, I can't grasp the numbers in real terms. BUT I can do math. The value of these derivatives is 100 times as large as the bank's value. So that means if just 1% of their derivatives are worthless, that is equal to the bank's total worth. Scary hunh? I used an Australian bank as my example. But I figure US banks are at least as bad off. Remember offering these exotic, risky loans originated here.

So even with the FED loaning banks billions thru TAF. The potential fallout is even higher. I think banks are gradually writing off their bad derivatives, so as not to crash the market. So maybe they will recover. But there are huge losses coming in the pipeline.

So why should we care? Banks gambled & lost. Let them take the hit. Generally, I agree with this. But the financial markets are all intertwined. Once investors get spooked about banking, they look for "hard" assets. And I think the rise in commodities (wheat, corn, fuel) & gold are partly driven by investors looking for somewhere "safe" to put their money.

How does this affect you & me? First, banks aren't as stable as they would like you to believe. Second, if your investment portfolio or pension depends on bonds, look into what type of bonds it holds.

Third, local & state government runs on bonds. This probably deserves more explanation. The monoline insurers (bond insurers) have had their rating trashed by the subprime mess. Even low risk loans (like municipalities) are having a hard time getting bond insurance. Plus, when municipalities go to auction their loans, no one is buying. Thus they have to offer better returns (higher interest) to get buyers. So it is costing municipalities alot more (in some cases they are paying 20%-25% interest) to sell their bonds. So on top of falling home values which yield lower property tax revenues. Local governments are paying thru the nose to finance their bonds. Net result, costs for local governments are going up. So expect higher property taxes & cuts in services. And be concerned if you are drawing a pension from local/state government.

This is my take on where we are. If I've made blunders in explaining the situation. Hopefully someone more knowledgeable will come along & clarify.

[jds6958]

This article is about why the risks in derivatives have dried up the credit market for both derivatives & bonds.

"biggest financial institutions trading paper assets so complicated that even top executives don't fully understand the transactions"- these are derivatives. Or securities.

And banks traded them between themselves & sold them to investors. And buyers had to take the word of the seller about their value. So someone bought a bundled lump of loans, say backed by property. Historically, that would be consider safe. Because these have collateral. Plus, there was speculation that housing prices would rise forever. Who cares if the homeowner's credit was bad, as long as the property value was rising? So even loans bundled with poor rating were traded/sold. Now the subprime mess surfaced, housing prices are falling & now no one wants to buy them. Which has left big banks & investment companies holding securities that on their books are worth say $1000 but in real fact worth far less.

So how bad is this? How much risk do banks have from derivatives? I cut & pasted this from the "Bomb ticking for off balance banks."

"Australian banks have a big exposure to derivative markets. Their total shareholder value of $110 billion is dwarfed by the size of the banks' collective exposure to derivative markets of $12.9 trillion."

Granted, once we get to talking about billions or trillions, I can't grasp the numbers in real terms. BUT I can do math. The value of these derivatives is 100 times as large as the bank's value. So that means if just 1% of their derivatives are worthless, that is equal to the bank's total worth. Scary hunh? I used an Australian bank as my example. But I figure US banks are at least as bad off. Remember offering these exotic, risky loans originated here.

So even with the FED loaning banks billions thru TAF. The potential fallout is even higher. I think banks are gradually writing off their bad derivatives, so as not to crash the market. So maybe they will recover. But there are huge losses coming in the pipeline.

So why should we care? Banks gambled & lost. Let them take the hit. Generally, I agree with this. But the financial markets are all intertwined. Once investors get spooked about banking, they look for "hard" assets. And I think the rise in commodities (wheat, corn, fuel) & gold are partly driven by investors looking for somewhere "safe" to put their money.

How does this affect you & me? First, banks aren't as stable as they would like you to believe. Second, if your investment portfolio or pension depends on bonds, look into what type of bonds it holds.

Third, local & state government runs on bonds. This probably deserves more explanation. The monoline insurers (bond insurers) have had their rating trashed by the subprime mess. Even low risk loans (like municipalities) are having a hard time getting bond insurance. Plus, when municipalities go to auction their loans, no one is buying. Thus they have to offer better returns (higher interest) to get buyers. So it is costing municipalities alot more (in some cases they are paying 20%-25% interest) to sell their bonds. So on top of falling home values which yield lower property tax revenues. Local governments are paying thru the nose to finance their bonds. Net result, costs for local governments are going up. So expect higher property taxes & cuts in services. And be concerned if you are drawing a pension from local/state government.

This is my take on where we are. If I've made blunders in explaining the situation. Hopefully someone more knowledgeable will come along & clarify.


Nova, you've got it imho...:thumb

[Nova]

Thanks jds. I've had to put alot of study into figuring out this stuff.

Anyway, let me raise a question. The big daddy of all bonds is the US treasure bond market. When do you think it will hit the skids? Or do you expect it will escape the tight credit crunch?

[jds6958]

Thanks jds. I've had to put alot of study into figuring out this stuff.

Anyway, let me raise a question. The big daddy of all bonds is the US treasure bond market. When do you think it will hit the skids? Or do you expect it will escape the tight credit crunch?

It is very evident that you have invested some time into DD and research. The article below discusses the topic well. Like many things related to the economy the current complexity and opportunity for creative intervention in the markets disrupts predictive power in timing. All that can be said with sincere certainty is that a collapse is highly likely to happen.

"Given the outlook for inflation, interest rates, the US economy and the US dollar, US bonds must rank among the least attractive investments on earth."

http://www.marketoracle.co.uk/index.php?name=News&file=article&sid=3709

There are some shreds of hope still held by the collective majority that offer some support. I would argue that the hope is likely to begin to fade fast. I believe the rarity of such economic events is what is also supporting the system. Because the events we are discussing are so rare, it is hard for many to accept the potential if not the likelihood of a broken dysfunctional economic system.

I do not believe the treasury bond market will be immune to this mess, in fact, it may act as a catylst propelling events forward. Timing is difficult to say. I expect an economic 9/11 event at some point in the near future. This could be as early as this summer or in 2009. It may not even be a domestic cause, but it will have domestic consequences. There are powder kegs littered all over the system. Some bigger than others, some explosions can be muffeled, some can be spinned and dismissed. The hard to ignore powder kegs are still sitting there but the fuse is lit.

[Nova]

Thanks. I understand where you are coming from.

[Logicon]

I've noticed that my bank is closing some of its branches and the ones still open are looking a little neglected. I don't know if this is isolated or if it is a trend coming.

I have always blamed NAFTA for this problem, but of course, we had those NWO folks who implemented that who are really to blame.

And then the housing market being used to measure the GDP was a serious mistake.

The interest rates on loans kept anyone from really owning a home and drove the prices through the roof because there was no profit to be made on the home after paying the interest up front and nothing being paid on the principal for nearly 25 years. When buying a home you had to borrow more money than the house was really worth just to be able to pay off the upfront interest that was still owed from the person who owned it before, even though they had no principal payment in the home at all. That was a pyramid scheme by definition. All you ever pay is interest.

That market had no choice but to come to a screeching halt after all the interest built on top of more interest on top of more interest............ Almost no principal is paid on any home unless you own it for 22-30 years. That is the reason the price of homes kept skyrocketing in such a short time. The interest amount wiped out all gains except for the banks that lent the money and they collected all that interest money and still could get the home back if you defaulted. This type of practice used to be called loan sharking, but not anymore. It is perfectly legal and acceptable to loan shark today.

[SummerSailing81]

We received our yearly statement from our county telling us what our home is valued at and it's down $22,000 from two years ago. Thankfully, we aren't planning on moving any time soon.

[Vandy]

We received our yearly statement from our county telling us what our home is valued at and it's down $22,000 from two years ago. Thankfully, we aren't planning on moving any time soon.

My county keeps insisting that the home prices are rising. Gotta keep that tax money coming in, you know.