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Thursday, November 13, 2008

What to talk about in DC?

Well, what should be the order of the day in DC, when the G-20 leaders meet for a little pow-pow this coming Saturday Nov 15th in DC (Bush's going away party, or the Bush Bash?), when they try to come to terms with ways in dealing with this global credit squeeze of a financial crisis!?!?

It almost seems comical now. For one fact, the terms crisis and credit squeeze, does not give this thing true justice. For one, banks have money to lend. Reportedly, very many of them have money on their balance sheets. They simply don't want to lend. That's understandable, as it is their money to lend or not lend, in the first place. But, how will they make money, Youri? Well, they probably won't make money, as it is their function to lend money to make money. Where did this crisis in "not" lending come from? Well, it starts off simple enough!!

How it all began...
A long, long time ago, Banks and credit facilities, started lending these sub-prime rates, to people who ordinarily could not afford to get loans for homes. Many, if not all, of these loans were adjustable--ARM's. They would give you a teaser rate and then hit you up with the higher rate, after a period of time--most often, after a year or six month period. What happened was, folks started to default on their mortgages. Something that happens ordinarily enough to allot of people. But, they all started to go sour, at this one particular time...early to mid-last year.

So, I guess one's asking what does allot of people, who could not afford home loans, have to do with a hard earning tax payer like me? Even worse, what does a guy in, let's say, Brazil, have to do with sub-prime losses in the USofA? Well, this is where it gets a little tangled. But, we have to get it all in, as much as possible, before we can give any policy and economic recommendations.

We move further along...

Deeper into the ditch!
What was also happening, while folks were losing their homes-- because of bad economic times coming up in any event-- culminated into, what many folks say, is a weakening American economy, brought on by their (USA) losses in comparative and competitive advantages in many areas to other emerging economies; a weakening dollar, to add more fuel to the fire; financial diversification in Europe, which has eroded Wall St.'s advantage over time; an unsteady war in Iraq and Afghanistan, which has been depleting resources of the American people (which can be discounted in any event, because money not spent, is money not in good use. Why have loads of cash, if you can't and don't spend it? Or, in the bank's case, make money by investing--as they have been doing!); and continual heavy losses in manufacturing jobs coupled with the lack of any technical innovation, brought upon America by lobbyists who keep things, for the most part, 'status quo'--the example in the Detroit auto-industry and the labour unions which hog-tie those manufactures, come to mind at current.

So, while America, normally goes through a dip in GDP around a Presidential election period (slightly a year before and a little less than a half a year afterwards), it was being hit with a triple whammy; 1. Loss in production due to lack of innovation and loss of competitive advantages 2. Investors keeping their powder dry, until the election season is over and the new President, charts out his agenda in full 3. The financial squeeze, brought on by sub-prime losses, which will be explained now.

Sub-prime to the credit squeeze!
Apparently, small commercial banks were not the ones holding the bag on bad loans. They were selling their debt instruments to larger banks and investment banks, like Lehman Bro's and having Lehman Bro's backed by insurers like AIG, for the debt instruments swapped.

Credit default swaps, or, CDS, is a way a company or bank, sells the debt of another bank or company to an investor and the investor, in turn pays off the debt to the first bank for the second bank/company, and, in the event the company does not pay its debt, defaults, the investor gets a one time payment from the first bank for its investment. Basically, its legalized gambling in the event a company goes belly up and the investor gets paid.

For more technical terms, turn to investopedia and wikipedia:

http://www.investopedia.com/terms/c/creditdefaultswap.asp

http://en.wikipedia.org/wiki/Credit_default_swap

But, some banks, were trading mortgage related debt--sub-prime to be exact. Of course, investors got paid tremendously when things went bad. Bank's that backed these CDS and the insurers who back the banks who back the CDS, were the ones left holding the bag.

Enter in the credit squeeze!
Now that some banks were making huge amounts of money in CDS, through them raising capital from investors who bought it (most through third party) on one end and on the other end, some insurers who backed investors who bought CDS related instruments, things were ok--until the intangible happened!! People, especially in the sub-prime debt related industry, began to default on their loans. Banks who sold CDS, lost huge amounts of money. They had massive pay outs to undisclosed investors. People who owned stocks in those banks, started to pull their money in a "bank run" style and it all started from there from bank to bank.

What made it worse, is that no one knew exactly where these bad loans were, who really owned the debt and how many times, these ARM/sub-prime CDS loans were traded--some of these loans, were traded from third and fourth party banks and companies. So, you may have gotten your sub-prime loan from somewhere in North Carolina, that bank may have traded it to a company or bank in North Dakota, that bank may trade that CDS to a bank in Britain (because of the growing sophistication and interconnecting of global finance) who may in turn, trade that to investors in Dubai who then in turn, have no clue that the folks in Britain, will sell the CDS they got from North Carolina, unknowingly, to a company/investor in Russia and on and on it went.....until it all stopped...NOW! At the worse time-- an already weakening US economy with war and Presidential election to boot!

What happened, is what is happening now. No one, commercial banks, investment bank's and credit unions, want to lend to other banks and credit unions, because no one knows how much the other bank is exposed to these sub-prime related CDS. No one wants to lose their money. And, with that, the bank's who are exposed to CDS related debt, investors are pulling out in a bank run style, leaving them in a further difficult position--as was with Bear Stearns and Lehman Bro's, who were bought, respectively, for pennies to the dollar.

Inter-bank rates and lending, came to an almost standstill. In a capitalist society, if no one wants to lend money, then, obviously, it can't run--Obama said we have to first "fix the plumbing in our capitalist system"...(after he is REALLY the President, he noted of course) Hahahaha...time is coming up soon, Mr. Obama. You can't hide behind Bush, for too much longer. It will soon be yours to fix!

In any event, and related, its no secret that every time the US goes through an election cycle, capital seizes up. Check global growth figures for the last 20 years, and US GDP figures for the same year, you would find a strong correlation with the Presidential election and GDP. The political cycle, is the only cycle that matters now. Industries and sectors, have their own respective clocks. If you want to chart Macro-economic policy, you have to watch the election cycles!

Enter in the "regulators" at the G-8, sorry, G-20 summit!
What in the world would these guys talk about? They know less than the guys on Wall St. True. If they did, they would have seen this coming and have pre-empted the oncoming disaster. They did not. The only entity, who gave warning, albeit a very weak sounding one, was Goldman Sachs-- partly because they were making a killing off of all what went bad, by hedging against the people who hedged with sub-prime debt. Smart, but, really, they have insiders on the policy making front in the US. Their former chiefs are now the Governor of NJ, Treasury Secretary and World Bank President, respectively!

So now, we meet this Saturday, to most likely, affirm what the world already knows--the US is in a recession (has been by my standards, for at least early last year) and no one knows how deep this 'toxic soup' of bad debt had spread!

But, here is what I would do:
1. I would end all of the third and fourth party CDS trading. There is no way, a debt can end up in Dubai, from North Carolina, as explained in the earlier example and no one knows how to get it back or account for it. By doing this, would de-leverage companies, from unsuspecting risk and debt, to entities, they have no idea or clue about. This would cut the spread of the crisis, if things were to go bad again, down to the folks who initiated the original contract.,

2. Forget about the IMF, for a little bit. We need domestic legislation and cooperation. The last thing we need, is another international organization, meddling in the affairs of good countries. This credit crisis, is a mistake and a disaster of a mistake. Albeit at the wrong time. But, a mistake of greed-- none the less. There is no need to fling into the mix international organizations, for them to find out that when it comes to super-powers, like the G-8, there is very little for them to do or very little from them, that is wanted to be done by the respective countries.

What's needed is a private fund of funds and a de-leveraging effort by individual G-20 countries as well as a total and complete unwinding of these sub-prime CDS; the latter, will take some time, if it ever is fully recovered. Fact is, so much stealing, after financiers and traders found out that it was a total and complete mess, that a good portion of the losses will never, EVER be recovered--and some of that money, can be found in designer shops on the South of France, the hotels in the Bahamas or in Rio, or, some other exotic place.

These G-20 countries, need to back their international banks that involved themselves with sub-prime traded debt--them and the investors, who bought third and fourth party CDS debt. Practically, the problem is private. So, it has to have a private element to it. Bringing another administrative governmental type organization, will do very little to solve the issue of this happening again, unless it is after-the fact.

We want to prevent this type of credit crisis from happening again, instead of re-acting when it happens again!

This is just for the credit squeeze. The package and "stimulus" hog wash, hog-wash is really what it is, should be left up to the individual governments who are looking to hand out government cheese on the cheap.

Other than that, there is nothing to meet in DC for, unless those two items are on the table and discussed front and centre!

Youri
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