Episode 71: Dave Paterson
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In this week’s episode, we are welcomed by funnyman DAVE PATERSON:
– Dave explains the bail-outs
– We look at the new shows that are on television
– We look at the shows each of us are doing and review the shows we’ve done. Some are good. Others, well, not so much.
Basically you have very opaque vehicles paying a higher than realistic yield to investors. But they were Mortgages and mortgages are relatively safe right? Usually, yes since the loan to value ratio is typically in the 70% to 80% range which provides lenders with a fairly high margin of safety in the risk of default. However, they also combined shit loans in some cases NINJA loans (No Income, No Job or Assets) with quality loans which dilutes the quality of the pools. Now, the wall street guys lever up the pools to provide even higher yields, but still won’t tell anybody exactly what’s in them other than mortgages and most people think mortgages are safe.
Ratings agencies came in and looked at them and more or less thought, hey it’s mortgages, but really didn’t understand what was in them so they gave them a high rating. Pension funds and insurance companies didn’t do their own research and relied on the ratings agencies and bought these things blindly. (As an aside, many PM’s I’ve spoken with here didn’t touch these things because they didn’t’ understand them.) Why did they buy them? Greed, because they were paying a higher yield on a “guaranteed” security.
So when people started defaulting on their mortgages the payments stopped. When the payments stopped, people holding the pools wanted to sell. But because of the mix of shit in the pools and the fact that most were starting to see a stop in payments nobody wanted to buy the crap. So you have billions and billions, quite possibly trillions ties up in this shit and nobody wants to buy it until they know what’s in it.
Now because of Mark to Market Rules, companies holding this crap have to value it at the lower of cost or market. Because nobody wants to buy this shit, the market value is essentially $0. So now companies are holding pools of mortgages that are worth something (only 22% of the mortgage market was in sub prime and even there you’re looking at about a 30% default rate so the impact isn’t as bad), but they have to mark them down to essentially zero. Now, just for fun, add in the fact that the investment banking sector relies on credit to operate. But, you have trillions tied up in shit and nobody wants to lend to anybody and you get a liquidity crisis. Basically nobody is lending money to anybody which grinds the economy to a halt.
It’s really kind of cool, since I don’t know how they’re going to get out of it. The US government is in a difficult position because they really should let all these companies fail which will create the unwinding or deleveraging of all these pools and will ultimately speed up the healing process. Only the best run companies will still be in business, which is why we have markets and capitalism and stuff. However, if they do that, regular people will get panicked and cause run on the banks making things even worse essentially killing the US economy.
So here we are. The government/Central Bank needs to inject billions upon billions into the markets every day to insure proper liquidity and allow markets to work. (Injecting billions isn’t handing over billions, they are essentially making a ton of overnight loans to banks so it’s not like a never ending bottomless pit of money)
So, stay tuned. Apparently this ended up being a bit long. Not unlike one of TVA’s setups – Boo Ya!