The infamous CDO fiasco explained

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lendingmaestro_IHB

lendingmaestro_IHB

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<p>Hey guys and gals,</p>

<p>This is probably the best article I've read describing the impact of the mortgage-back security disaster, it's poor risk gradings, and the perptrators. The most fascinating aspect of the article is where the author proposes the US FED and Treasury were complicit in the meteroic rise of these MBS bonds. By destroying the yields on treasuries, and publicly supporting "ARM" mortgages they all but forced bond funds, pension funds, public retirements, etc., to purchase these ticking time bombs.</p>

<p>The article is a bit lengthy but it's a must read.</p>

<p><a href="http://www.financialsense.com/fsu/editorials/ash/2007/1024.html">http://www.financialsense.com/fsu/editorials/ash/2007/1024.html</a></p>

<p> </p>

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And LM is Johnny on the spot on the lending news. I got confirmation that they did indeed shut down their wholesale side. Good catch LM!
 
Link on Calculated Risk:





<a href="http://calculatedrisk.blogspot.com/2007/10/boa-exits-wholesale-mortgage-business.html">http://calculatedrisk.blogspot.com/2007/10/boa-exits-wholesale-mortgage-business.html</a>
 
<a title="Permanent Link to What Caused the Bubble Rally?" rel="bookmark" linkindex="7" href="http://www.irvinehousingblog.com/2007/10/01/what-caused-the-bubble-rally/">What Caused the Bubble Rally?</a>





<p>Many mistakenly believe the lower interest rates themselves were responsible by directly lowering mortgage interest rates. This is not true. Mortgage interest rates declined during this period, and this did allow borrowers to finance somewhat larger sums with the same monthly loan payment, but this was not sufficient to inflate the housing bubble.


</p>

<p>...


</p>

<p><strong>The lower Federal Funds rate did cause an expansion of money supply, and it lowered bank savings rates to such low levels that investors sought other investments with higher yields. It was this increase in liquidity and quest for yield that drove huge sums of money into mortgage loans.</strong></p>

<p>This is where another of the lending industry’s innovations comes into play: structured finance. Debt is money. If you can find a way to create more debt, you create new money. The problems comes when you create more debt than there is cashflow to service it which is where we are now. There is a tipping point where the debt service exceeds the cashflow, and when this tipping point is reached, the entire debt structure collapses in a deflationary spiral. The structured finance products such as collateralized debt obligations and their derivatives are highly leveraged instruments with a very sensitive tipping point. This is why the hedge funds at Goldman Sachs imploded so quickly and so completely.</p>

<p>With a huge influx of capital into the secondary mortgage market, the industry was under tremendous pressure to deliver more loans to hungry investors. This caused the already-low loan standards to be all but eliminated. All of the worst “innovations” in the lending industry occurred during this period: Negative Amortization loans, Stated-Income loans (Liar Loans,) NINJA loans (no income, no job, no assets,) 100% financing, FICO scores under 500, one-day-out-of-bankruptcy loans, etc. The joke was if you could “fog a mirror” or if you “had a pulse,” you could get a loan for as much as you wanted to buy a house.</p>
 
It is my speculation that most folks do not want to think about what happens when the CDOs lose value. The opposite of debt creation is deflation and B-52 only has one trick for deflation. The CDOs are leveraged up. The credit crunch has just begun.
 
<p>If defaltion rears it head we're in for a world of hurt. B-52 will fly to rthe escue to stem the problem with his carefully researched and theorized solution to a 1930s problem and launch it upon a 21st century global financial system.</p>
 
<p>I would think that massive contraction in credit lines would be deflationary as well, but oil is at all-time high, dollar at all-time low. WTF is going on people???</p>

<p>We have entered the Bizarre-O world people.</p>
 
Remember Milton Friedman: "<strong>inflation</strong> is always and <strong>everywhere</strong> a monetary phenomenon."





There just is a delay between monetary inflation and price inflation. That is why Venezuela has only 18% inflation right now.





Honestly looking at the data I think 50 bp cut is the right move of the fed today. I'm fairly hedged though for whatever the Fed may do.

 
<em>" Honestly looking at the data I think 50 bp cut is the right move of the fed today."</em>





Don't you think this would create rampant price inflation?
 
The GDP report seems to confirm deflationary recession with a GDP deflator of 0.8%. For that number to be in the ballpark with core inflation at 2.1% consumers must be substituting to less expensive goods. The NAR report shows a -22% Year over Year decrease in September, that is certainly deflationary. The consumer confidence, CEO confidence, and home builder confidence numbers look atrocious. Credit availability looks relatively unavailable in conversations I have had with banks. If you are concerned with a recession accompanied by a reduction in money supply you cut interest rates to spur money supply growth.
 
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