Trouble in Hedgistan: âIts gonna get a lot worseâ
By Mike Whitney
07/21/07 "ICH" -- -- Two columns of black smoke can be seen rising over Wall Street and disappearing into the ice-blue New York sky.
Terrorism?
Not quite. The plumes of smoke are all thatâs left of two major hedge funds which blew up just weeks ago leaving nothing behind but a few smoldering embers and a mound of black soot.
The compiled assets of the Bear Sterns High-Grade Structured Credit Strategies Fundânearly $20 billionâhave vanished into the miasma of cyber-space where they will soon be joined by $1.4 trillion of other, equally worthless, Collateralized Debt Obligations (CDO).
If you look carefully, you can almost see the mangled and bloodied bodies of the CDOs, the CSDs, the RMBS and the other shaky debt-instruments being pulled from the wreckage and tossed unceremoniously on the bonfire.
Is this how it all ends? The first whiff of trouble in the housing market and thenâin a flash--all the funds in âHedgistanâ begin teetering towards earth?
âNo Valueâ-âNo Bidsâ
According to Bloomberg News, Bear Sterns announced last week that thereâs âlittle value leftâ in one of its funds and âno value leftâ in the other.
Nothing, nada, zippo.
The news was like a bucket of cold water dumped on the stock market leaving slack-jawed traders shuddering in trepidation.
What does it all mean?
Does that mean that the entire hedge fund empireâwhich is built on a foundation of dodgy loans and quicksand---may be headed for the crapper?
No one really knows. But a pall has settled-in over downtown Manhattan where gloomy-looking men in pinstriped suits are waiting for the other shoe to drop.
Yâsee, the hedge fund industry is based on the bizarre notion that one does not have to produce anything of value to make boatloads of money. You donât even need assets any more---just a risky loan that can be transformed into an investment grade security through the magic of âsecuritizationâ a sprinkling of Wall Street snake oil.
Abrah Kadabra---presto-chango!
Itâs like taking shards of bottle-glass and selling it as the Hope Diamond. Whoâs gonna notice?
The only catch is that--now that these toxic CDOs are going to auction--there are no bids. Thatâs a bad thing.
âNo bidsâ means that $1.4 trillion of shaky investments have no discernable market-value. The CDOs were graded âmark to modelâ which translates into âmark to fantasyâ. It means that the investment bankers and hedge fund managers got together over Martinis one night and pulled a number out of a hat.
Now no one wants to buy them. Theyâre worthless.
The skydiving hedge funds just pulled the CDO rip-chord and nothing came out but confetti.
Aaaaaaaahhhh!
And thatâs just half the story. Thereâs trillions of dollars in derivatives riding on these shaky CDOs. Thatâs enough to bring down the whole market in a heap once interest rates rise or liquidity dries up. Now itâs just a matter of âwhenâ now, not âifâ.
This illustrates an important point, though. It shows what it takes to be a good hedge fund manager:
Take a shabby sub-prime mortgage; chop it into âinvestmentâ, âmezzanineâ and âequityâ tranches. Bundle it with other equally suspect mortgage backed securities (MBS). Decide (arbitrarily) what the CDOs are worth Tell your banker. Leverage at a ratio of 10 o 1. Take 2% âoff the topâ plus salary for your efforts. Buy a summer home in the Hamptonâs and a Lexus for the wife. Wait for the crash. Then repeat.
Congratulations; you are now a successful hedge fund manager!
Oh yeah; and donât forget to prepare a few soothing words for the investors who just lost their entire life savings and will now be spending their evenings squatting beneath a nearby freeway off-ramp.
âWeâre so very sorry, Mrs. Jones. Can we get you some cardboard-bedding to keep off the rain?â
The problems that are appearing in the stock and bond markets all started at the Federal Reserve when Fed-Chief Alan Greenspan opened the sluice-gates in 2003 and lowered interest rates to 1%. (Way below the rate of inflation) Since then, trillions of dollars have flooded into the markets creating multiple equity bubbles in real estate, stocks and credit.
Serial bubble-maker Greenspan is to finance-capitalism what Wrigley is to chewing gum. The greatest flim-flam man of all time.
The Fed has tried to conceal the massive increase to the money supply, but the evidence is everywhere. (Many analysts now calculate that inflation is running at roughly 13%) Food and energy have skyrocketed. Housing prices have soared. Everything has gone up except the cheapo imports which the Fed uses to manipulate the inflation stats.
The gigantic housing bubble is mostly Greenspanâs doing. After printing-up mountains of cash and creating artificial demand through low interest rates; he promoted his product-line with the typical huckster sales-pitch. âMaestroâ advised us that the extension of credit to all-Godâs creatures, worthy or not, is a good thing.
Hereâs a clip of Alan praising subprime lending in a speech on April 8, 2005:
"With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. . . . As we reflect on the evolution of consumer credit in the United States, we must conclude that innovation and structural change in the financial services industry have been critical in providing expanded access to credit for the vast majority of consumers, including those of limited means. . . . This fact underscores the importance of our roles as policymakers, researchers, bankers and consumer advocates in fostering constructive innovation that is both responsive to market demand and beneficial to consumers."
Yes, of course, with all these âadvances in technologyâ and new-fangled âcredit-scoring modelsâ why would we need to verify a loan-applicantâs income or require that he scrape together a measly $5,000 for a $450,000 mortgage?
Thatâs all so 20th Century!
Now that foreclosures are mushrooming at an unprecedented pace, the Fed is trying to distance itself from the problem by blaming the banks for their shoddy underwriting practices. But the guilt lies with the Central Bank. Its all part of their whacko plan to crush the dollar and create a police state.
It may sound trite, but âinflation is theftâ. Unfortunately, inflation is also part of the ruling classâ strategy to rob the poor, fuel the stock market with cheap credit, and move jobs overseas. It is the autocratâs method of âsocial engineeringâ---shifting wealth from one class to another by simply printing more money and pumping it through the system via low interest rates. Remember, bankers know that people will ALWAYS borrow money if lending standards are relaxed and the money is cheap enough. At 1%, the Fed was basically losing money on every transaction, but persisted with their plan anyway.
Anyone who cares to go back and trace interest rates moves for the last 7 years will see that the Fed is really a political organization that decides monetary policy entirely on the basis an elite agenda that supports endless war, outsourcing of American jobs, and domestic repression.
Are you surprised?
Now, a bad situation is about to get a whole lot worse. Consumer credit rose last month by a whopping 12.9%---credit card debt by 9.8%! Since housing prices have flattened out, homeowners can no longer borrow on their dwindling equity (Mortgage Equity Withdrawal; MEWs) which is forcing the maxed-out American consumer to use plastic even though rates are averaging from 18% to 27% monthly.
Automobile repos have also hit historic highs. But the real damage is showing up in the subprime market where the percentage of defaults continues to rise unabated.
In itself, a correction in real estate is not enough to bring down the whole economy. Unfortunately, the contagion from the subprime meltdown has spread to the stock market, the insurance industry, banking and pensions. Not even Secretary of the Treasury, Henry Paulson or Fed-master Ben Bernanke are claiming that the subprime problems are âcontainedâ anymore. Just this week, the scholarly looking Bernanke said to Senators on the Hill that the housing market has âdeteriorated significantlyâ.
Itâs about time. If anyone still has any doubts about the magnitude of fiasco, I recommend they look over these eye-popping charts which tell the whole story. The housing blowdown will spread the carnage from âsea to shining seaâ.
http://www.itulip.com/forums/showthread.php?p=12232#post12232
The faltering housing market has drawn attention to an even more colossal credit bubble that is limping towards earth as loan requirements tighten and liquidity dries up.
The prevailing fear on Wall Street is that we may be seeing the beginning of a global credit crunch.
The danger is not just the subprime loans or even the mortgage companies that made the loans, but the overall risk to the secondary market where these loans have been sold as CDOs to the tune of $1.8 trillion.
In this new deregulated environment, the banks donât have to rely on savings anymore to make the loans. They simply originate the loans, take their commission, and sell the debt as CDOs. Theyâre even allowed to sell the risk of default through credit default swaps (CDS) which are a form of insurance that minimizes the banks exposure. These weird innovations have spawned riskier and riskier loans and increased the likelihood of damage to the broader market.
