Federal Reserve losing control

[MASONIC PLOT]

There is certainly good reason for the man to be frightened.

By the way, did anyone take my advice last year and buy silver when it was 10 dollars an ounce and gold when it was 450, today you would have doubled your investment, if you did.

[Ben D]

Nah, I don't gamble on things I know so little about but good for you Masonic Plot.
Now what is your prognosis from this point?

[Joe Hillshoist]

MP good to see you around, hope you are good, and your little patch of paradise is doing well.

I didn't buy silver when it was 10 bucks (or 7 which is when I wanted to get it) but I wish I had tho cos now I'd have 200 bucks worth of silver.

Take care.

[antiaristo]

.

This is noteworthy because of the name.

CARLYLE!

Carlyle Capital Adds to Fears Of Forced Sales
By MARGOT PATRICK and RAGNHILD KJETLAND
March 6, 2008 11:50 a.m.

LONDON -- Carlyle Capital Corp., a listed investment company managed by a unit of private-equity firm the Carlyle Group, added to worries about forced liquidations of residential mortgage-backed securities after failing to meet margin calls on its $21.7 billion portfolio Wednesday.

Carlyle Capital said Thursday that it has received a notice of default from one of the banks that helps finance its portfolio of Freddie Mac and Fannie Mae securities through short-term repurchase agreements, known as repos, and that it expects to receive at least one more default notice after falling short of margin requirements with four lenders.

It said seven repo counterparties had demanded an additional $37 million Wednesday to keep funding in place. It met the requirements of three of them, which it said had indicated "a willingness to work with the company during these tumultuous times."

Carlyle Capital as recently as Monday had reassured investors on its funding lines, saying it had $2.4 billion in undrawn repo lines and that it had increased a credit facility provided by the Carlyle Group by 50%, to $150 million. Its lenders as of Dec. 31 were: Bank of America Corp., Bear Stearns Cos., BNP Paribas SA, Calyon, Citigroup Inc., Credit Suisse Group, Deutsche Bank AG, ING Groep NV, J.P. Morgan Chase & Co., Lehman Brothers Holdings Inc., Merrill Lynch & Co. and UBS AG.

The repurchase agreements outstanding at that date had an average maturity of 20 days. Carlyle Capital's longest-dated repo line is for three months. The company leverages its $670 million equity 32 times to finance a $21.7 billion portfolio of residential mortgage-backed securities issued by U.S. housing agencies Freddie Mac and Fannie Mae. All of the securities are rated Triple-A and are considered to be implicitly guaranteed by the U.S. government.

Carlyle Capital said Thursday that it has been subject to margin calls and additional collateral requirements totaling more than $60 million over the past week, and had met all calls up until March 5.

(more)

http://online.wsj.com/article/SB120479022207116361.html

Just shows. People are desperate for cash, and they are cutting one another's throats to get their hands on it.

You know about sharks and blood in the water.

[chiggerbit]

Carlyle Capital has struggled from the outset. The firm had to postpone its initial public offering of stock last summer just as the credit crunch was first taking hold,....

Carlyle Group started Carlyle Capital in 2006....

Pretty stupid timing.

[ninakat]

from Jim Sinclair:

Although the failure of Carlyle Corp. looks negative to the name, ask yourself a question of who lost and how much. The answer is investors in an entity named Carlyle Capital, a unit of the private firm Carlyle. The investors in the main were not the Carlyle Group.

[ninakat]

also, here's the latest from Jim Sinclair:

Posted On: Friday, March 07, 2008, 5:52:00 PM EST

Slipping Out Of Control
Author: Jim Sinclair

Dear Extended Family,

First I told you “This Is It!” and clearly this is, in fact, it.

I have demonstrated to you that there is no practical solution to this gathering of problems caused by unbridled greed and the lack of regulation to facilitate it.

Now I am telling you that it is “Slipping Out Of Control”

Attempts to use tools that have no practical power to cure the problem are pushing the problem over the hill.

In the Weimar Republic the great plan to depreciate the currency in order to depreciate war reparations written in it was to let it “get out of control.” The currency began a march to zero and gold therefore went to infinity in terms of that currency.

I do not expect such a situation percentage wise. I pray the situation that is now “Slipping Out Of Control” does not go to such ends. The Weimar case study however is a duplicate of today’s conditions.

All you need to do is replace the words “war reparations” from the Weimar case study with “over the counter derivative meltdown in credit and default derivatives” and you have a similar situation in economic history to which you can compare today.

Gold is going to a minimum of $1650.

Every category of gold shares will participate, with many substantially outperforming gold as shorts are forced to cover.

“This is it” and it is “Slipping Out Of Control.”

Eliminate as many intermediaries between you and your assets. Own the Swiss and Cando treasury instruments. Have at least 1/3 of your liquid net assets in gold and precious metals shares. For some it will be more.

Under no circumstances use margin.

Hard assets are about to make their entrance onto the stage of the establishment equity investors.

Before you go opt for a gold ETF read the original prospectus thoroughly.

Do not try and save the world. The world will think you are crazy and get annoyed. You can only protect yourselves. The saddest thing is Joe Six Pack is LOST, sacrificed on the sick altar of greed.

Regards,
Jim

[isachar]

This is spot on.

DOWn Jones average going to the basment, along with the economy. Thanks, George. Look out below:

http://www.lewrockwell.com/north/north611.html

Bernanke on the Mortgage Market House of Cards
by Gary North
by Gary North


DIGG THIS

The worst is not behind us. The worst is yet to come. I have this on the highest authority – from the man who has openly admitted that his organization has no solutions to offer except month-old data on the extent of the housing crisis.

When the public at last figures this out, there will be financial blood in the streets.

When I first read Ben Bernanke's March 4 speech, I was amazed at how gloomy he was in full public view. He concealed this gloominess with academic bloviation, which is his version of Greenspan's FedSpeak. But if you pay attention to what he says, you can find out much of what he is thinking. This was not true with Greenspan.

Bernanke spoke on the need for banks to reduce interest rates for busted home owners. This indicates just how scared he is. To argue for a rewriting of millions of contracts to favor debtors is one more example of the asymmetric nature of mortgages. Lenders lose; debtors win.

His long, tedious, and thoroughly academic speech revealed an academic economist whose career has not yet hit the inevitable brick wall: the unforgiving realities of capital markets, contracts, and an economic crisis. He may still believe that footnotes will save his reputation. They won't.

He is presiding over a stock market decline that threatens to turn into a collapse. Yet he pretends that being a boring professor in public will somehow calm international stock markets. It won't.

Greenspan was incoherent. Bernanke is boring. His rhetorical strategy in his speeches is to drone on and on about what is now obvious to all of his listeners. He thereby avoids concentrating on looming disasters that are not yet obvious to his listeners. But, unlike Greenspan, he eventually does hint at what is not yet obvious. I slog through his speeches in search of those hints.

Bernanke's public strategy for the last six months has been to offer a series of detailed analyses of how the horses got out of the barn. He has no clue as to how to get them back in.

REDUCING PREVENTABLE MORTGAGE FORECLOSURES

The mortgage market, as we all know, is the heart of the current problem. It is a gigantic carry trade market, and it always has been. Mortgage lenders are borrowed short and lent long, which is the essence of the carry trade. Now this trade has been disrupted because what should have been obvious in 2005: the inability of subprime borrowers to pay off their loans. This has become public knowledge. The mortgage lenders cannot raise the short-term capital necessary for the game to go on as before. Here is what is obvious to most investors at this point.


Over the past year and a half, mortgage delinquencies have increased sharply, especially among riskier loans. This development has triggered a substantial and broad-based reassessment of risk in financial markets, and it has exacerbated the contraction in the housing sector. In my remarks today, I will discuss the causes of the distress in the mortgage sector and then turn to the key question of what can be done in this environment to reduce preventable foreclosures.
This newly reassessed risk is based on a discovery, namely, that Greenspan's ludicrously loose monetary policies, 2000–2003, have led to a housing bubble crisis. But Bernanke will never admit this in public.

He is now in search of new suppliers of pools of capital who are willing to rush in and bail out the mortgage-lending market. Who wants to be first? Nobody. But the crisis will get much worse if lenders don't enter this market to provide loans for visible deadbeat borrowers. This must be done very soon.

If the deadbeats walk away from their homes, and if new lenders are not found to fund replacement owners, America will experience hundreds of billions of dollars of property equity decline by the end of 2009. He will not say this directly, but this is the problem. Squatters and the weather will take over occupancy.

Who, then, should rush in where angels fear to tread? Local banks, says Bernanke. They did not create the crisis, but they must solve it.


Although I am aware, as you are, that community banks originated few subprime mortgages, community bankers are keenly interested in these issues; foreclosures not only create personal and financial distress for individual homeowners but also can significantly hurt neighborhoods where foreclosures cluster. Efforts by both government and private-sector entities to reduce unnecessary foreclosures are helping, but more can, and should, be done. Community bankers are well positioned to contribute to these efforts, given the strong relationships you have built with your customers and your communities.
Local banks got out of the mortgage market two decades ago, after the savings & loan debacle took its toll. Government-guaranteed mortgage lenders entered, pooling trillions of dollars of mortgages based on a broad geographical base of loans from around the country. This was done in the name of asset diversification. It also cut costs of local monitoring. The statisticians assessed the risk, and nobody was hired locally to monitor the loans and collect monthly payments. So, local banks took commissions for originating loans locally and then passed the loans on to Fannie Mae and Freddie Mac.

Local banks went into commercial real estate instead. Their banks are now at risk. The Comptroller of the Currency, John Dugan, on January 31 gave a speech to the Florida Bankers Association. He made this unsettling observation.

Over a third of the nation's community banks have commercial real estate concentrations exceeding 300 percent of their capital, and almost 30 percent have construction and development loans exceeding 100 percent of capital.
Here in Florida, as in other states where housing is so important to local economic growth, the concentration levels are more pronounced. Over 60 percent of Florida banks have CRE loans exceeding 300 percent of capital, and more than half have C&D loans exceeding 100 percent of capital.

When the commercial real estate market begins to fall in the recession, as it will, local banks will have their hands full. Where will they get the capital to head off foreclosures in the residential estate market?

So, no one is available locally to monitor the empty houses or screen replacement home owners. The cost of monitoring is rising. The number of people locally to do the job has declined.

Bernanke now thinks that local banks are ready, willing, and able to take over their old tasks. But how? No one has been trained to do this for 20 years. The people with these skills have retired. The local banks got cut out of the mortgage market except as loan originators, which economic idiots could do, and did.

Why would any local bank step in now? Not to get rich, surely. Only to keep from getting poorer in a national banking crisis. Here is Bernanke's message: "Heads, you lost; tails, you will lose even more. Step right up! This way to the guillotine!"

Then he went into his now-famous "Let me give you a history of the foul-up instead of offering a solution" routine. Or, as I have often described it, blah, blah, blah.

MORTGAGE DELINQUENCIES AND FORECLOSURES

Here is what we all know. So, he calls it to our attention.


Mortgage delinquencies began to rise in mid-2005 after several years at remarkably low levels. The worst payment problems have been among subprime adjustable-rate mortgages (subprime ARMs); more than one-fifth of the 3.6 million loans outstanding were seriously delinquent at the end of 2007. Delinquency rates have also risen for other types of mortgages, reaching 8 percent for subprime fixed-rate loans and 6 percent on adjustable-rate loans securitized in alt-A pools. . . .
Boring. Useless. Irrelevant. In other words, a Ph.D. academic economist's career strategy. "Bore them into submission." It won't work.

It's going to get worse, he says. Yes, he says this in a boring way. Pay attention anyway. Watch for key phrases, such as this one: "some further declines in house prices are likely." They surely are!


Delinquencies and foreclosures likely will continue to rise for a while longer, for several reasons. First, supply-demand imbalances in many housing markets suggest that some further declines in house prices are likely, implying additional reductions in borrowers' equity. Second, many subprime borrowers are facing imminent resets of the interest rates on their mortgages.
Ed McMahon used to ask Johnny Carson, "How bad is it?" Bernanke plays the role of Carson, but without the humor.


In 2008, about 1-1/2 million loans, representing more than 40 percent of the outstanding stock of subprime ARMs, are scheduled to reset. We estimate that the interest rate on a typical subprime ARM scheduled to reset in the current quarter will increase from just above 8 percent to about 9-1/4 percent, raising the monthly payment by more than 10 percent, to $1,500 on average. Declines in short-term interest rates and initiatives involving rate freezes will reduce the impact somewhat, but interest rate resets will nevertheless impose stress on many households.
In other words, we have not yet begun to see the carnage in the subprime market. The problem is refinancing. No one wants to lend strapped, stressed debtors any more money.


In the past, subprime borrowers were often able to avoid resets by refinancing, but currently that avenue is largely closed. Borrowers are hampered not only by their lack of equity but also by the tighter credit conditions in mortgage markets. New securitizations of nonprime mortgages have virtually halted, and commercial banks have tightened their standards, especially for riskier mortgages. Indeed, the available evidence suggests that private lenders are originating few nonprime loans at any terms.
This situation calls for a vigorous response.

Ah, yes, the ever-popular "vigorous response." And what has the FED's response been? To deflate. The financial press has not yet caught on. The FED has not inflated. It has deflated.

What additional vigorous response does Bernanke have in mind? Administered how? How fast? With who in charge? Using what for money? At whose expense?

Here comes neighborhood blight, like a thief in the night. Here comes the collapse of collateral for millions of bonehead loans.


At the level of the individual community, increases in foreclosed-upon and vacant properties tend to reduce house prices in the local area, affecting other homeowners and municipal tax bases. At the national level, the rise in expected foreclosures could add significantly to the inventory of vacant unsold homes – already at more than 2 million units at the end of 2007 – putting further pressure on house prices and housing construction.
He said steps are underway to solve this problem. He gives no proof of how these steps can work or if they are working now. He said: "Policymakers and stakeholders have been working to find effective responses to the increases in delinquencies and foreclosures." Oh, yeah? So what?

There is a big and growing problem. This problem was created by loose money policies under Greenspan and by national mortgage lending agencies (GSE's). But the economic hit will be taken locally. "Troubled borrowers will always require individual attention, and the most immediate impacts of foreclosures are on local communities. Thus, the support of counselors, lenders, and organizations with local ties is critical." But where are these local agencies? What incentives do they have to step in?

In short, forget about the busted borrowers. What about the troubled lenders? Busted and troubled lenders? Who is going to finance borrowers who have no credit, no extra money, and no jobs in a recession?

"O course, care must be taken in designing solutions." Spoken like a true academic. What care? Administered by whom? "Solutions should also be prudent and consistent with the safety and soundness of the lender." Like what, for instance?

Bernanke then droned on and on about the Federal Housing Administration's plans, as if the FHA had money to solve the problem, as if the FHA were involved in this massive pile of bad mortgage loans. The FHA is a peripheral player, yet this is the main government agency in the housing loan market. So, he talked about the toothless FHA. This indicates that the government has no tools or plans to intervene. But what else could he have done? He dared not admit that the government has insufficient money and leverage to solve this crisis.

He then called for a vague "loss-mitigation arrangements." Like what? Administered by whom locally? At whose expense? With losses to be borne by whom?


In cases where refinancing is not possible, the next-best solution may often be some type of loss-mitigation arrangement between the lender and the distressed borrower. Indeed, the Federal Reserve and other regulators have issued guidance urging lenders and servicers to pursue such arrangements as an alternative to foreclosure when feasible and prudent.
Guidelines? That was what the mortgage industry needed ten years ago.

The response system is running out of time, yet foreclosure costs are high – thousands of dollars per home – and the courts are jammed. Meanwhile, an empty house falls in value within weeks, as crackheads or weather take their toll.

You want to know what is coming? This: gigantic equity losses. Yes, Bernanke is boring. Read him anyway. The financial media are not reporting on this.


Loss mitigation is made more attractive by the fact that foreclosure costs are often substantial. Historically, the foreclosure process has usually taken from a few months up to a year and a half, depending on state law and whether the borrower files for bankruptcy. The losses to the lender include the missed mortgage payments during that period, taxes, legal and administrative fees, real estate owned (REO) sales commissions, and maintenance expenses. Additional losses arise from the reduction in value associated with repossessed properties, particularly if they are unoccupied for some period.
He was talking about abandoned homes and equity losses. This is happening already. This is not a maybe. This is a sure thing. The loss of equity will undermine the loans. Look at his estimate: 50% of principal balance.


A recent estimate based on subprime mortgages foreclosed in the fourth quarter of 2007 indicated that total losses exceeded 50 percent of the principal balance, with legal, sales, and maintenance expenses alone amounting to more than 10 percent of principal. With the time period between the last mortgage payment and REO liquidation lengthening in recent months, this loss rate will likely grow even larger. Moreover, as the time to liquidation increases, the uncertainty about the losses increases as well.
Who is going to write new loans at anything like today's home prices? Nobody who is not already stuck with the bad loan. But these lenders are running short of capital.

I love the man's use of language. Consider the words "limited" and "considerable." He seeks to convey calm. The reality of what he is describing does not point to calm in the mortgage markets anytime soon.


The low prices offered for subprime-related securities in secondary markets support the impression that the potential for recovery through foreclosure is limited. The magnitude of, and uncertainty about, expected losses in a foreclosure suggest considerable scope for negotiating a mutually beneficial outcome if the borrower wants to stay in the home.
Can any of this actually work? He used the phrase "less likely." I agree entirely.


Unfortunately, even though workouts may often be the best economic alternative, mortgage securitization and the constraints faced by servicers may make such workouts less likely.
So, how bad is it? Very bad and getting worse. The default rate is rising.


Despite this progress, delinquency and default rates have risen quickly, and servicers report that they are struggling to keep up with the increased volumes. Of course, not all delinquent subprime loans can be successfully worked out; for example, borrowers who purchased homes as speculative investments may not be interested in retaining the home, and some borrowers may not be able to sustain even a reduced stream of payments. Nevertheless, scope remains to prevent unnecessary foreclosures.
Scope remains. I see. Scope. When I hear "scope," I think of a mouthwash that covers bad breath.

He made it plain: borrowers will be allowed to escape their debts. Once again, the asymmetry of the mortgage market becomes visible. Borrowers win. Lenders lose.


Lenders and servicers historically have relied on repayment plans as their preferred loss-mitigation technique. Under these plans, borrowers typically repay the mortgage arrears over a few months in addition to making their regularly scheduled mortgage payments. . . .
Loan modifications, which involve any permanent change to the terms of the mortgage contract, may be preferred when the borrower cannot cope with the higher payments associated with a repayment plan.

Lenders are balking at writing down principal. Surprise! Surprise! If they write it down, they have to record this in their books as a loss. They don't want to do this. They prefer to conceal the loss with negotiated rates.


Lenders tell us that they are reluctant to write down principal. They say that if they were to write down the principal and house prices were to fall further, they could feel pressured to write down principal again. Moreover, were house prices instead to rise subsequently, the lender would not share in the gains.
Then what can be done? Fannie Mae and Freddie Mac must come to the rescue. But with what? They are under siege. Their credit ratings are held up in the same way Wile E. Coyote was held up when he overshot the ledge of a cliff. He has looked down, but he is still hanging in mid-air. We await the inevitable fall.


The government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, likewise could do a great deal to address the current problems in housing and the mortgage market. New capital-raising by the GSEs, together with congressional action to strengthen the supervision of these companies, would allow Fannie and Freddie to expand significantly the number of new mortgages that they securitize. With few alternative mortgage channels available today, such action would be highly beneficial to the economy. I urge the Congress and the GSEs to take the steps necessary to allow more potential homebuyers access to mortgage credit at reasonable terms.
CONCLUSION

The man droned on for another four pages of text. All of it boiled down to this: the FED has no solution. All that the FED can do is share data. As a professor, Bernanke believes in data. As the head of the FED, he has no answers, but he has lots and lots of data to share.


I would like to comment briefly on Federal Reserve System efforts to reduce preventable foreclosures and their costs on borrowers and communities. The Federal Reserve can help by leveraging three important strengths: our analytical and data resources; our national presence; and our history of working closely with lenders, community groups, and other local stakeholders. A major thrust of our efforts is sharing relevant and timely data analysis of mortgage delinquencies with community groups and policymakers to efficiently target resources to areas most in need.
If you think the FED can solve the mortgage crisis, it's time to re-think your understanding of the FED. Bernanke has confirmed Franklin Sanders' aphorism: "The Federal Reserve has only two policy tools: inflation and blarney."

Bernanke is running low on blarney.

[isachar]

A Quick Look At The Credit Crisis

by Michael Doliner

http://www.swans.com/library/art14/mdolin31.html

(Swans - March 10, 2008) By now most people know that the "subprime" crisis is no such thing. What has happened is the final result of the long decay of the rate of profit (1) in the American economy. As productive activity no longer paid, investors turned to interest on credit to provide sufficient rates of return. During the first part of the twenty-first century they devised new ways to lend. Bankers and mortgage brokers offered credit to just about anybody who breathed, and credit built upon credit. Mortgages were only one area in which they did this, but looking at them gives a good illustration of what is happening.

The note guaranteed by a mortgage is a promise to pay a debt, usually in monthly installments. The note provides its owner with a stream of income and he can sell the note for a lump sum. Mortgage brokers have sold the notes for a long time, but recently they have done so in new ways. Wall Street got into this game by creating new debt instruments (bonds) called Collateralized Debt Obligations (CDOs) and Structured Investment Vehicles (SIVs). They are nothing more than collections or bundles of notes (backed by mortgages) that can be sold to investors. If someone can borrow money for a lower interest rate than is on the note then he can use the borrowed money to buy many notes. Thus they built a pyramid of debt. Since Japan has been lending money at practically zero interest, this pyramid grew huge.

These Wall Street bundles looked like practically foolproof sources of income. Actuaries judged the likelihood of homeowners defaulting on their mortgages from past performance and assured everybody they were safe. Given that investors were buying large bundles of loans the likelihood of default could easily be factored into the price. The likelihood of default on riskier loans could be offset with lower prices. Wall Street divided the bundles of loans up into "tranches" with the riskiest giving the largest rewards.

But to make all this even safer Wall Street brokers bought insurance through "monoline" insurance companies whose business is to insure bonds. They insured buyers of bonds against default. These monoline insurance companies had, before this, insured primarily municipal bonds. These rarely default and the monolines had a sweet deal. But this new source of business seemed even sweeter. Because their business had been so solid up until this time these monoline companies all had Aaa ratings with Moody's, Standard & Poor's, and Fitch, the world's three ratings agencies. Their ratings transferred to the bonds they insured, making the mortgage-backed bonds Aaa investments even though many of the borrowers were "subprime." With all this insurance, investors, including staid conservative banks, gobbled up these investment vehicles.

The game seemed so good that the most sophisticated investors, including banks such as Citibank and J.P. Morgan, and brokerage firms such as Bear Sterns, invested in these vehicles and encouraged their clients to do likewise. Many Hedge Funds joined them. Foreign countries jumped in. The final owners of the notes were very far away from those who originated them. Local mortgage brokers wrote the mortgages but then quickly sold them. These "account executives," who were supposed to check on the borrowers' ability and inclination to pay, had no incentive to be too careful, and were soon fired if they were. Mortgage brokers made money on the number of mortgages written, not on their quality. They were not hurt when the borrower defaulted.

All this led to an enormous increase in the amount of mortgage money available and a loosening of the standards for loans. Since mortgage brokers didn't care, people were given mortgages they couldn't possibly pay. People out of work refinanced their houses, increasing their debt but remaining afloat on the proceeds. Thus there were more buyers with more money looking to buy houses, and the prices of houses skyrocketed.

With all these questionable loans on ever inflating property values, eventually the defaults began to dribble in. And soon there were enough of them to make the owners of the CDOs and SIVs nervous. People who had money in hedge funds heavily invested in these vehicles wanted to take their money out. But when the hedge funds tried to sell the CDOs and SIVs to pay off the investors they found there was a very weak market for them. Word of the defaults had gotten around. Since these hedge funds had borrowed most of the money to buy these securities, they had to sell a lot of them to get much capital back. In July 2007, two Bear Sterns hedge funds collapsed. (2) Share prices for other funds fell off a cliff. The market for CDOs and SIVs suddenly ended. Nobody wanted to buy them, period.

The sudden end of the market for mortgage-backed bonds turned off the gusher of money that Wall Street had been pouring into mortgages. Banks now had to look at mortgages as if they were taking the risks themselves, and they became a lot more careful. In the heyday they had offered no money down mortgages and even lent more than the value of the property, allowing the new owner to emerge from the deal with money in his pocket. They had given money to people with dubious credit histories and insufficient income. No more. With more stringent guidelines and demands for larger down payments the buyer pool shrank and buyers could buy less house. A housing market geared to a large demand suddenly found it had a smaller one. Mega-builders in Florida, California, and elsewhere found that houses in their giant projects were not selling, and they stopped building. The booming real estate market ended, and prices began to fall.

With falling prices mortgage defaults increased. Those who had been refinancing their houses to pay the mortgages were stuck. Speculators who had bought houses expecting to flip them at higher prices were also stuck and wanted out fast. Adjustable rate mortgages that had been sold with ridiculously low "teaser rates" began to reset to much higher rates that the borrowers couldn't pay. They defaulted. The snowball of real estate decline began to roll.

As defaults increased, the CDOs and SIVs that banks, brokerage houses, and other clever investors still owned became less and less attractive. But these securities retained their Aaa ratings because the monoline insurance companies backed them, and the monolines had Aaa ratings. When people began looking at the monolines it became obvious that they were woefully undercapitalized. Their exposure to the mortgage backed securities was something like one trillion dollars, of which about $130 billion had gone bad, (3) and their capital amounted to about $15 billion. Clearly, they should already be out of business. At least they should lose their Aaa rating. But if they lost their Aaa rating then the bonds they insure would also lose their Aaa rating. If that happened those bonds would no longer be investment grade and the banks, because of banking regulations, would have to sell them. But there is no market for these things now. The banks would have to take huge losses, probably going bankrupt. These liabilities seem to be as large as the entire American banking system. So even though the monolines were insurance companies nobody wanted them to actually pay off on their policies, for that would put them out of business. Their Aaa ratings were worth more than their cash.

But it didn't take an Einstein to see that the monolines were essentially insolvent. The ratings agencies, Moody's, Standard & Poor's, and Fitch, threatened to downgrade their ratings as a result. To avoid this, a number of "bailout plans" were floated, consisting, essentially, of banks lending money to the monolines. The ratings agencies, aware that a downgrade of the monoline ratings might bring down the whole system, reaffirmed the Aaa ratings of the monolines, even though none of these bailouts could possibly cover the real liabilities, and none of them has materialized in any case. For anyone who would lend money to the monolines, essentially bankrupt businesses, would have to be crazy.

When the ratings agencies reaffirmed the monolines' bogus Aaa ratings they completely discredited themselves, essentially putting themselves out of business. The ratings were so obviously fraudulent that nobody will believe them again. However, a whole new paradigm developed in which fraudulent ratings may not matter. Even though nobody believes in the monolines' Aaa ratings they serve their purpose anyway. For the banking regulations specify Aaa ratings for investment backed securities and say nothing about the plausibility of these ratings. The mortgage backed securities will retain their "investment grade" rating as long as the monolines retain their Aaa ratings, no matter how obviously bogus. The stock market has caught onto the game. When news of a bailout appeared the market rallied, even though these clever traders could not have helped knowing that the bailout would never happen and was, in any case, insufficient. They knew the drama was a farce. They simply agreed en mass to play along. The alternative was a collapse of the whole system.

The American economy now depends upon all the players going along with good news they all know is bogus. Nobody wants the entire system to fail, so they play along with the game. Although the mortgage backed securities are nearly worthless, nobody wants to find out just how worthless they are. So nobody puts them on the market and nobody tries to collect on the monoline insurance. To shore up the monolines' bogus Aaa rating the banks float news of bogus bailout plans no one is likely to put into practice unless he is a complete idiot. The ratings agencies take these obviously bogus bailout plans at face value, ignore the fact that even if they were to be implemented they would be woefully inadequate, and reaffirm the monolines' bogus Aaa ratings. So everyone pretends that these mortgage-backed securities, sometimes inadvertently called toxic sludge, are still valuable. Stockbrokers go along with the game by pretending these bailout plans are really good news even though they know they are bogus, and they bid up stocks. As long as this continues the banks and brokerage houses can keep these securities off their balance sheets and in hedge funds. Since everyone's exposure is hidden nobody knows who is holding these worthless securities and is thus essentially broke, so nobody wants to lend any money to anybody.

So much for credit as a source of profit. The whole credit system is frozen up. It is like someone holding his breath. How long can he go on? Who knows, but not long. At the bottom of the whole pile the lowly mortgage payer is still having his problems. Defaults and foreclosures are increasing dramatically, and housing prices are declining. The credit freeze is accelerating the decline. This has produced something new. Many homeowners are discovering that their houses are worth far less than they owe on them. "Not since the Depression has a larger share of Americans owed more on their homes than they are worth. With the collapse of the housing boom, nearly 8.8 million homeowners, or 10.3 percent of the total, are underwater. That is more than double the percentage just a year ago, according to a new estimate of the damage by Moody's Economy.com." (4) Thus even though they might be able to pay the mortgage, they find no real inclination to do so. Whereas people used to feel morally obligated to pay debts they had contracted for, they no longer do. A new Web site shows them how to walk away without any liability. (5) As these people walk away, prices will fall still further. The idea that paying one's debts is essential to an upright and honorable life seems no longer current. The old threat of damage to one's credit rating no longer seems so scary. Homeownership, now that prices are falling, no longer seems so attractive. Renting is looking good. The whole idea of homeownership as a source of security seems to have vanished. Credit card defaults and car loan defaults are rising almost as fast as mortgage defaults. To repay or not to repay is now seen as a purely business, rather than a moral, decision. This pulls out the supports from all the mathematical models upon which the system is based.

The really fun news is that this is only the tip of the iceberg. "Credit default swaps" can be thought of as freelance monoline insurance on any kind of debt obligation. But unlike with monoline insurance, nobody knows who is obligated to pay or whether he is able to do so. It is estimated that there are about $43 trillion in credit default swaps. (6)

With frozen credit markets, capitalism has come to an end. Making things doesn't pay, and now you can't lend money to make money. What is a capitalist -- excuse me, entrepreneur, going to do? Naturally he will look to the Fed for a rescue. Free markets are fine and dandy unless I need a bailout. The Fed has the right to print money and lend it to banks. Great business if you can get it. The Fed, to unclog the arteries of the credit system, lowers its interest rate. But to whom are you going to lend money? Nobody knows which banks are already bankrupt, and now even the little guy is no longer finding his obligation to pay all that much of an obligation. In the end the whole credit system depends upon the social convention that debts ought to be repaid, and this social convention seems to be dissolving. When people begin walking away, lower interest rates are not going to help.

Meanwhile everybody is edging towards the exits. Every investor would like to get out without anyone else noticing that he has left. Once it becomes obvious that everyone wants out the rush to the exits will keep everyone from leaving. But don't worry. I'm sure the Bush administration has a plan.





Notes

1. "United States economy at the turn of the century: Entering a new era of prosperity?," by Fred Moseley, The Capital & Class, Spring 1999.
http://findarticles.com/p/articles/mi_q ... 35963/pg_1 (back)

2. "Dissecting The Bear Stearns Hedge Fund Collapse," by Investopedia Staff (undated).
http://www.investopedia.com/articles/07 ... llapse.asp (back)

3. "Monoline Insurance: There's a New Sheriff in Town...," by Barry Ritholtz, seekingalpha.com, January 29, 2008.
http://seekingalpha.com/article/62029-m ... ff-in-town (back)

4. "Moody's: 8.8 million Homeowners Underwater," February 21, 2008.
http://calculatedrisk.blogspot.com/2008 ... water.html (back)

5. "Should You Walk Away? - Educate Yourself On Your Rights If You Face Foreclosure."
http://www.youwalkaway.com/ (back)

6. "Investment Outlook: Pyramids Crumbling," by Bill Gross, PIMCO ("one of the largest specialty fixed income managers in the world"), January 2008.
http://www.pimco.com/LeftNav/Featured+M ... y+2008.htm (back)

[rrapt]

Thanks Isachar, that is the most straightforward story on the debt crisis I've seen, and it clarifies greatly for me the non-economist. I'm sending it on to a couple of money managers I know, who may be well aware of all this, but just in case...

So far like most I've hung on to the old assurances even though I know they are bullshit now, for lack of a better plan. Time to shake off the shackles of convention and get real imaginative now wrt retirement $$ (I'm over 60) and the condition of the economy we rely on to live. Huge issue here, even life & death I have to say. Fortunately I own my home, cars and furniture free and clear.

[isachar]

Thanks Isachar, that is the most straightforward story on the debt crisis I've seen, and it clarifies greatly for me the non-economist. I'm sending it on to a couple of money managers I know, who may be well aware of all this, but just in case...

So far like most I've hung on to the old assurances even though I know they are bullshit now, for lack of a better plan. Time to shake off the shackles of convention and get real imaginative now wrt retirement $$ (I'm over 60) and the condition of the economy we rely on to live. Huge issue here, even life & death I have to say. Fortunately I own my home, cars and furniture free and clear.

rrapt, my recommendation for next several months is move any U.S. investments to inflation-adjusted bonds - sometimes called TIPS. Swiss francs prolly wouldn't be a bad idea either. mebbe some silver, too. Should be some really good real estate deals in the next couple months too, if you're so inclined. Rental housing/apts should do well as many of those unfortunate enough to sadly lose their homes in this mess or compelled to walk away from excessive upside down mortgage debt will need to rent.

regards, good luck, and best to ya.

[freemason9]

Thanks Isachar, that is the most straightforward story on the debt crisis I've seen, and it clarifies greatly for me the non-economist. I'm sending it on to a couple of money managers I know, who may be well aware of all this, but just in case...

So far like most I've hung on to the old assurances even though I know they are bullshit now, for lack of a better plan. Time to shake off the shackles of convention and get real imaginative now wrt retirement $$ (I'm over 60) and the condition of the economy we rely on to live. Huge issue here, even life & death I have to say. Fortunately I own my home, cars and furniture free and clear.

rrapt, my recommendation for next several months is move any U.S. investments to inflation-adjusted bonds - sometimes called TIPS. Swiss francs prolly wouldn't be a bad idea either. mebbe some silver, too. Should be some really good real estate deals in the next couple months too, if you're so inclined. Rental housing/apts should do well as many of those unfortunate enough to sadly lose their homes in this mess or compelled to walk away from excessive upside down mortgage debt will need to rent.

regards, good luck, and best to ya.

What's your take on this?

http://www.msnbc.msn.com/id/23572266/

Economists see U.S. avoiding recession
Downturn still seen possible if housing crisis deepens

LOS ANGELES - The U.S. economy will suffer as the slumping housing market eats away at job creation and consumer spending, but the nation should avoid slipping into a recession this year, according to a new economic report.

A recession could still happen though, if the credit crisis that has stifled the housing market deepens, preventing consumers from buying big-ticket items like cars and businesses from spending on equipment, according to the quarterly Anderson Forecast by the University of California at Los Angeles.

"We don't see that happening," said Edward Leamer, director and co-author of the forecast released Tuesday. "This is a tough call, but I will be very surprised if this thing actually precipitates into recession."

The forecast anticipates job growth remaining sluggish in 2008, with the U.S. unemployment rate rising to 5.5 percent by the end of the year. The February rate was 4.8 percent.

The forecast expects the economy to post gross domestic product growth of about 1.5 percent this year, rising to about 3 percent growth in 2009. GDP grew 2.2 percent in 2007, the weakest showing in five years.

The no-recession forecast runs counter to the outlook among many economists and financial pundits, who contend the economy has already started to shrink amid rising unemployment, job losses, record oil prices, and the lingering effects of the housing and credit crises.

The U.S. lost 63,000 payroll jobs last month, the second consecutive month of job losses. The last time the U.S. posted a two-month drop in payroll jobs was in 2003, when employers were still struggling through the aftermath of the 2001 recession.

Leamer said the nation may be experiencing negative economic growth in the current quarter. Economists generally look for at least two consecutive quarters of negative growth before they make a recession determination.

The biggest risk of recession comes from the credit crisis that emerged last year as home values began to tumble and the number of mortgage defaults and foreclosures soared, the economist said.

Major financial institutions were racked by credit losses as the value of securities backed by mortgages sank, causing the traditional outlet through which banks borrow money to seize up.

The credit woes have deepened the housing slump, making it harder for would-be homeowners to borrow money and for homeowners to refinance. But consumer spending, while weakened, hasn't declined severely due to credit problems, Leamer notes.

"Americans are not as wealthy as they thought they were, and that's going to factor into consumer spending going forward, but it doesn't cause a recession because consumers all realize their lack of wealth at different points in time," he said.

Another potential factor in a recession would be widespread job losses. Leamer, who has maintained a no-recession forecast in recent quarters, said that's not likely.

"So far the labor markets are slowing but not collapsing," he said.

The forecast calls for the nation's housing doldrums to continue "for a long time," Leamer said.

He expects housing starts, which fell from a high of 2.3 million units in January 2006 to 1 million units this January, to bottom out in the summer.

[chiggerbit]

"Americans are not as wealthy as they thought they were, and that's going to factor into consumer spending going forward, but it doesn't cause a recession because consumers all realize their lack of wealth at different points in time," he said.

What he means is, people will realize their lack of wealth when they become unemployed, which he hopes is not all at one time.

[rrapt]

Freemason,

He says *IF the credit crisis deepens* we might still get a recession. We're in one now in spite of any skewed numbers that say otherwise.

Read Doliner as presented by isachar above, and decide which of these guys you want to believe. I'd suspect that Leamer of UCLA is parroting a govt line but I've not seen the creds of either of these writers. So I use my own sense & experience to make the judgement, which is admittedly personal. To me now, any presentation by media or institution including govt is suspect.

You should see our local newspaper; they have a fixed practice of including a pic of prez Dub in every daily issue. Do I believe anything they print? No.

[Byrne]

Hedge Funds Reel From Margin Calls Even on Treasuries (Update1)

By Tom Cahill and Katherine Burton

March 10 (Bloomberg) -- The hedge-fund industry is reeling from its worst crisis in a decade as banks are now demanding more money pledged to support outstanding loans even when the investment is backed by the full faith and credit of the United States.

Since Feb. 15, at least six hedge funds, totaling more than $5.4 billion, have been forced to liquidate or sell holdings because their lenders -- staggered by almost $190 billion of asset writedowns and credit losses caused by the collapse of the subprime-mortgage market -- raised borrowing rates by as much as 10-fold with new claims for extra collateral.

While lenders are most unsettled by credit consisting of real estate and consumer debt, bankers are now attempting to raise the rates they charge on Treasuries, considered the world's safest securities, because of the price fluctuations in the bond market.

``If you have leverage, you're stuffed,'' said Alex Allen, chief investment officer of London-based Eddington Capital Management Ltd., which has $195 million invested in hedge funds for clients. He likens the crisis to a bank panic turned upside down with bankers, not depositors, concerned they won't get their money back.

The lending crackdown is the worst to hit the $1.9 trillion hedge-fund industry since Russia's debt default in 1998 roiled global credit markets and required the U.S. Federal Reserve to pressure the securities industry to arrange a $3.6 billion bailout of Greenwich, Connecticut-based Long-Term Capital Management LP. Today, hedge funds are being forced to sell assets to meet banks' margin calls, resulting in the dissolution of the funds.

``There has to be more in the next weeks,'' Allen said. ``There are people who have been hanging on by their fingernails who can't hold on much, much longer.''

`Mercy of Counterparties'

Ivan Ross, founder of Westport, Connecticut-based hedge fund Tequesta Capital Advisors, received a call from his bankers on Feb. 22 demanding he put up more money or risk losing his loans. Ross was unable to meet the margin call as the market for mortgage- backed debt seized up, preventing him from selling securities to raise the cash. Four days later, lenders liquidated his $150 million fund.

``Because it's impossible in this environment to move among dealers, you're at the mercy of counterparties,'' said the 45-year- old Ross, who has managed hedge funds for 13 years, including a stint handling mortgage-backed debt for billionaire George Soros. ``To the extent they want to shut you down, they can.''

The demise of Tequesta revealed the deathtrap for hedge funds caught in the credit maelstrom of banks selling mortgage-backed bonds as fast as they can while demanding more collateral from clients who use the securities to back loans.

Carlyle Fund

On Feb. 24, London-based Peloton Partners LLP gave up a ``night and day'' effort to stave off demands from banks, including Goldman Sachs Group Inc. and UBS AG, for as much as 25 percent collateral for securities that once required 10 percent, according to investors in the fund. Peloton, run by former Goldman partners Ron Beller and Geoff Grant, liquidated the $1.8 billion ABS Fund, its largest.

The same day, about 5,000 miles (7,770 kilometers) away in Santa Fe, New Mexico, JPMorgan Chase & Co. told Thornburg Mortgage Inc. that it had defaulted on a $320 million loan because it couldn't meet a $28 million margin call, according to U.S. regulatory filings.

Thornburg, the home lender that lost 93 percent of its market value in the past year, was near collapse March 7 after it failed to meet $610 million of margin calls. Chief Executive Officer Larry Goldstone said in a statement the company fell victim to a ``panic that has gripped the mortgage financing industry.''

Repo Agreements

Carlyle Capital Corp., the debt-investment fund started by private-equity firm Carlyle Group of Washington, was suspended from trading in Amsterdam on March 7 after it couldn't meet margin calls, and its banks seized and sold assets.

``Banks are reducing exposure anywhere they can and the shortest way to do that is to cut leverage,'' said John Godden, chief executive officer of London-based hedge-fund consultant IGS AIS LLP.

Hedge funds are mostly private pools of capital whose managers participate substantially in the profits from their speculation on whether the price of assets will rise or fall.

The managers that trade fixed-income securities generally borrow money through repurchase agreements, or repos. In a repo, the security itself is used as collateral, just as a homeowner puts up the house as collateral for a mortgage.

Collateral `Haircuts'

Banks usually limit their risk on repos by lending less than the value of the securities used as collateral. Tequesta was able to borrow $95 on $100 worth of AAA rated jumbo prime mortgages in early 2007, meaning the bank took a $5, or 5 percent so-called haircut. By last month, the amount required had risen to as much as 30 percent, Ross said. Jumbo mortgages are loans of more than $417,000, typically used to finance more expensive homes.

The losses started in mid-2007, when prices of subprime loans, those to homeowners with bad credit histories, started tumbling because of a surge in delinquencies. The contagion spread to other credit markets, including bonds backed by student loans and credit cards and now mortgages backed by federal agencies, which have an implied guarantee from the U.S. government.

Prices keep falling, with yields on mortgage-backed debt issued by agencies such as Fannie Mae rising last week to the highest level relative to U.S. Treasuries since 1986. Costs to protect corporate bonds from default are close to a record high.

Under such circumstances, lenders have no choice but to ask clients to put up more cash. For AAA rated residential mortgage backed securities, banks have raised haircuts 10-fold in the past year to 20 percent, according to estimates from Citigroup credit analyst Hans Peter Lorenzen in London.

Treasury Swings

On AAA asset-backed securities, banks are demanding a 15 percent haircut, up from 3 percent last summer. Corporate bond haircuts have gone to 10 percent from 5 percent, bankers said.

At least one bank has raised Treasury haircuts, which range from 0.25 percent to 3 percent, depending on the length of the loan and the creditworthiness of the borrower, said bankers, who declined to be identified. They said they wouldn't be surprised if the practice becomes more widespread, not because they expect the U.S. government to default, but rather because there have been bigger price swings in the Treasury market, which affects value.

Some banks may have been late to raise haircuts for their biggest hedge funds because they are lucrative clients, said Jochen Felsenheimer, head of credit strategy at Milan-based UniCredit SpA, Italy's biggest bank.

``Until now, hedge funds have been the big winners of the crisis and this could be as well due to banks not having yet drawn down their margin,'' Felsenheimer said.

Survival of Fittest

Carlyle said in a March 6 statement that margin prices requested for securities weren't ``representative of the underlying recoverable value'' of its securities. Lenders started to liquidate its portfolio of $22 billion of AAA rated mortgage debt issued by Fannie Mae and Freddie Mac.

``It's not a question of prime brokers deciding which firms live and which don't,'' said Odi Lahav, head of the European Alternate Investment Group at Moody's Investors Service in London. ``They're trying to manage their own risk. There's a Darwinian aspect to survivorship in this industry.''

Some managers set themselves up for a stumble by taking on too much leverage and not anticipating that terms could change, said Christopher Cruden, CEO of Lugano, Switzerland-based Insch Capital Management, which oversees $150 million for clients.

``If you're going to dance with the devil, there comes a time when your toes are going to be stepped on,'' Cruden said. ``Prime brokers are there to do business, not be your friend.''

To contact the reporter on this story: Tom Cahill in London at tcahill@bloomberg.net; Katherine Burton in New York at kburton@bloomberg.net
Last Updated: March 10, 2008 05:47 EDT

See also

Fed to Lend $200 Billion, Take on Mortgage Securities (Update7)

By Scott Lanman

March 11 (Bloomberg) -- The Federal Reserve, struggling to contain a crisis of confidence in credit markets, will for the first time lend Treasuries in exchange for debt that includes mortgage-backed securities.

&

U.S. Stocks Rally on Fed's Plan to Lend Up to $200 Billion

By Eric Martin

March 11 (Bloomberg) -- U.S. stocks rallied the most in five years after the Federal Reserve said it will pump $200 billion into the financial system to shore up banks battered by mortgage- related losses.