Sunday, November 23, 2008

Tinkerbell, Where Are You?


I had planned to move full force into the new tactics by the Credit Card Industry to help it even out its, and its parent companies', losses. Unfortunately, we are coming face to face with the reality of the current crisis, and why it just will not stop generating scary headlines; the kind that send financial markets, stocks, bonds, entire businesses, and through job losses the public in general into a tailspin.

This weekend CitiCorp, the parent of CitiBank, CitiResidential Mortgage, and Citi this and Citi that, (when combined they do business in 100 countries, and employ 375,000 worldwide), was deemed to be on the edge and in need of a massive infusion of government money or some other type of intervention. It seems that what was touted as a failure of the residential mortgage backed securities ("MBS") market, has been disclosed to be a breakdown of all types of Pooled Loans. You may read about derivatives such as CDOs (Collateralized Debt Obligations), and Credit Default Swaps. (Derivatives are just a name for products that allow investments in loans and other types of financial transactions, by buying not the loan, but the right to share in the profits from the interest earned. Of course the idea is that the loan or transaction is secured by collateral, not unlike the arrangement in a simple home mortgage.)

With the second or third largest banking organization in the country in trouble, everyone who already hasn't, loses faith in the underlying assumption that his/her investment, assets, have any value: THERE IS A FURTHER EROSION OF CONFIDENCE. Once the spiral downward began, and the Government did not prevent it from accelerating (by saving Lehman Bros. with their portfolio of MBS and other derivatives), we had the IndyMacBank takeover by FDIC, because of a run on the bank (see earlier posts), and here we are.

What we have found out about the CitiCorp fall is that through its multiple entities, the organization had, at risk, $2 trillion, much of it being "off the books". The risk was partially in MBS but only t relatively small percentage when looking at the entire picture. A view develops that might explain why the Mortgage Backed Securities issue created an immediate firestorm. Financial institutions like Citi, JPMorganChase, and Bank of America had invested enormous sums in high yield, high risk investments. Not only did they have MBS, but they were holding all nature of derivatives, especially credit default swaps.

This was essentially a bet that there would be defaults in loans, and therefore the bank had to hedge its bets. In essence, bet against itself, with other institutions buying the investments derived from the loans made by the bank. It was selling part of each loan in a portfolio, with the Seller protecting itself by sharing the risk, and the buyer trying to out-guess the Seller, paying a discounted price for what might turn out to be a perfectly solid loan. This was not done loan by loan, but by billions of dollars worth of pieces of loans, all at once.

As it turned out, when the spiral down began, even good loans turned bad because businesses, which had been solid, began losing orders, and as credit became almost non-existent with no one knowing who would be available tomorrow to pay back a loan taken today, the speed increased until it over-powered all reason. Panic set in, and while the panic has subsided, the anxiety has not. Just as the run on the bank (see earlier posts) was and remains due to a lack of confidence in the system rather than a failure of the system, the market plunge was due to everyone trying to sell "bad" stocks all at the same time. Was there a reason for concern? YES. Panic? NO.

WE NEED THE TINKERBELL PROJECT. Remember in Peter Pan, when Tinkerbell was weak and in danger of dying, and Peter asked everyone to believe in Tink, and to say so out loud so Tink would know that everyone believed, and she would live? Well, we need to believe in the system. Is it flawed? YES. Dead? NO. Will we recover- certainly, but the price will have been steep. Tens of thousands of jobs lost, companies forced into liquidation because no one wanted its stock, pension and other retirement plans devastated by securities losses (remember the MBS issue).

Interestingly, those who were the first to stop believing were the biggest losers (financially), including many of the largest investment houses and banks in the Country. The rest of us were dragged along for the ride.

When the system stops believing in itself, when the so-called market makers and money brokers lose confidence and bet against themselves and others of their kind, panic will inevitably start. This has been the worst realization of that fact since the Depression. Perhaps, and hopefully, the worst is over. Just keep repeating "I DO BELIEVE, I DO BELIEVE, I DO BELIEVE..."

Author's Copyright by Richard I. Isacoff, Esq., November 2008

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