Archive for the 'Recession Watch' Category
(Chronologically Listed)
The $50 billion Ponzi scheme
The New York Times has an outstanding and lengthy article tracing the rise of the Madoff investment firm that, in the end, turned out to be (in Madoff’s own words) a $50 billion Ponzi scheme:
The juggernaut began to sputter this fall as investors, rattled by the financial crisis and reaching for cash, started taking money out faster than Mr. Madoff could bring fresh cash in the door. He was arrested on Dec. 11 at his Manhattan apartment and charged with securities fraud, turned in the night before by his sons after he told them his entire business was “a giant Ponzi scheme.”
The case is still viewed more with mystery than clarity, and Mr. Madoff’s version of events can only be drawn from statements attributed to him by federal prosecutors and regulators as he has not commented publicly on the case.
But whatever else Mr. Madoff’s game was, it was certainly this: The first worldwide Ponzi scheme — a fraud that lasted longer, reached wider and cut deeper than any similar scheme in history, entirely eclipsing the puny regional ambitions of Charles Ponzi, the Boston swindler who gave his name to the scheme nearly a century ago.
“Absolutely — there has been nothing like this, nothing that we could call truly global,” said Mitchell Zuckoff, the author of “Ponzi’s Scheme: The True Story of a Financial Legend” and a professor at Boston University. These classic schemes typically prey on local trust, he added. “So this says what we increasingly know to be true about the world: The barriers have come down; money knows no borders, no limits.”
The entire article is worth reading. You not only get a grasp of how this effort slowly expanded from a small (if wealthy) group of investors largely in and around New York to a truly global clientel, you also see how many banks, foundations, and other institutions put in billions of dollars without realizing that their money was going to the Madoff fund.
There’s a Warren Buffet quote that’s going around a lot these days: “You don’t know who’s swimming naked until the tide goes out.” The collapse of the Madoff fraud is a powerful example of that; I might also argue that the collapse of GM and Chrysler are as well. I’m sure we’ll see more to come. ..bruce w..
Worldwide Banking System Leverage
For those of you who missed it, in this downward spiral we are now enduring, the amount of leverage (read, debt) is directly related to how fast your bank is going to go under.
Now from a blog named Infectious Greed, comes this chart extracted from a Bank of Canada report:
So according to the Bank of Canada, the banks in the EU have the highest ratio of debt to assets, with the US investment banks (like Goldman) coming up behind but shedding debt as fast as they can. Troublesome for the UK is that they continue to ramp up, and will soon overtake the Wall Street zombies in the amount of debt.
This charts, while informative, does not show the real danger zones: the banks in China, India, Brazil and Russia. My prognosis is the next big leg down will come to public light as a handful of countries, possibly including a big one, will follow Iceland into financial doom.
The financial crisis illustrated
“Because Secretary Paulson had struggled in previous attempts to explain what the big banks and brokerage houses had done to the U.S. economy, his staff prepared a visual aid that told the story in clear and graphic terms.”
Winner of Dave Barry’s caption contest for the above photo. ..bruce w..
CDOs explained (or, “Holy crap!”)
Alan Kohler at the Business Spectator down in Australia does his best to explain CDOs, CDSs, and SPVs, then gets down to brass tacks:
It is now getting very interesting. The three Icelandic banks have defaulted, as has Countrywide, Lehman and Bear Stearns. AIG has been taken over by the US Government, which is counted as a part-default, and Freddie Mac and Fannie Mae are in “conservatorship”, which is also a part default – a ‘part default’ does not count as a ‘full default’ in calculating the nine that would trigger the CDS liabilities.
Ambac, MBIA, PMI, General Motors, Ford and a lot of US home builders are teetering.
If the list of defaults – full and partial – gets to nine, then a mass transfer of money will take place from unsuspecting investors around the world into the banking system. How much? Nobody knows, but it’s many trillions.
It will be the most colossal rights issue in the history of the world, all at once and non-renounceable. Actually, make that mandatory.
The distress among those who lose their money will be immense. It will be a real loss, not a theoretical paper loss. Cash will be transferred from their own bank accounts into the issuing bank, via these Cayman Islands special purpose vehicles.
The repercussions on the losers and the economies in which they live, will be unpredictable but definitely huge. Councils will have to put up rates to continue operating. Charities will go to the wall and be unable to continue helping those in need. Individual investors will lose everything.
There will also be a tsunami of litigation, as dumbfounded investors try to get their money back, claiming to have been deceived by the sales people who sold them the products. In Australia, some councils are already suing the now-defunct Lehman Brothers, and litigation funder, IMF Australia, has been studying synthetic CDOs for nine months preparing for the storm.
But for the banks, it’s happy days. Suddenly, when the ninth reference entity tips over, they will be flooded with capital. It’s possible they will have so much new capital, they won’t know what to do with it.
This is entirely uncharted territory so it’s impossible to know what will happen, but it is possible that the credit crunch will come to sudden and complete end, like the passing of a tornado that has left devastation in its wake, along with an eerie silence.
Read the whole thing, a few times preferably. And for those of you keeping score as to how we got into this mess in the first place:
CDOs were invented by Michael Milken’s Drexel Burnham Lambert in the late 1980s as a way to bundle asset backed securities into tranches with the same rating, so that investors could focus simply on the rating rather than the issuer of the bond.
About a decade later, a team working within JP Morgan Chase invented credit default swaps, which are contractual bets between two parties about whether a third party will default on its debt. In 2000 these were made legal, and at the same time were prevented from being regulated, by the Commodity Futures Modernization Act, which specifies that products offered by banking institutions could not be regulated as futures contracts.
This bill, by the way, was 11,000 pages long, was never debated by Congress and was signed into law by President Clinton a week after it was passed. It lies at the root of America’s failure to regulate the debt derivatives that are now threatening the global economy.
Interesting times, folks, interesting times. ..bruce w..
What goes up must come down
Here’s a graph of US housing prices since 1975, both the stated prices and the same prices adjusted for inflation:
As you can see, once you adjust for inflation, housing prices have peaked and then fallen three times in the last 30 years.
I remember looking at a $35,000 house in the semi-rural area near Cherry Hill, New Jersey — five bedrooms plus a freestanding garage/workshop — in 1979. I didn’t buy it (and didn’t accept the job at RCA) because winter heating oil costs were around $300/month at a time when I was only grossing $1300/month. Oh, and inflation was moving towards double-digit values, as were mortgage interest rates. I remember all that quite well, which is why I’m not panicking about the current financial mess just yet. ..bruce w..
Yet another bailout request
Hell, this makes more sense than a lot of what Congress and the US Treasury are doing right now:
True fact: I own a Pets.com sock puppet. I keep it in my office to remind me of the idiocies of the late 90s Tech Bubble. Problem is, I’m not the one who needs reminding.
Hat tip to National Review Online. ..bruce w..
Daily Financial Moment Of Clarity
Statistics from Option Armageddon (click chart for a larger view):
Any wonder that Citi needs a bailout?
Financial Crash - Round 2 Warming Up
I am sad to report that some of the leading indicators show that the second wave of the ongoing financial crash is getting ready to start. In spite of the fact there was a huge rally back above 8000 on the Dow late Friday, the stock market is not what is driving this thing. The next big shock could be a few days to several weeks away. But first, some perspective on how far we have already come.
First, this graph from Doug Short:
Click on the graph for a larger / sharper image.
It shows that in percentage terms, the current market crash has exceeded the 1973 oil crisis, the tech crash of 2000 and the first leg down on the great depression.
