Trillion Dollar Meltdown.

[VeryMeanReversion]

Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash by Charles R Morris

I bought the book and read it last week. It's US-centric and has a reasonable amount of explanation of the banking and hedge fund side of the story. Much of it is already know by the HPC'rs but there was some info that made me think a bit more:

1. The mortgage market is dying fast because the bank are unable to securitise the debt and move it out to 3rd parties.

(Rather than dying, its just reverting back to the old model where depositors provide the funding)

2. Well, who were the 3rd parties then and why have they stopped buying?

3. The answer is that it was mostly a lot of hedge funds using high leverage. The subprime junk was turned into AAA using various credit instruments so it could be sold on to get the 20% upside fees. Once the gains ran out, the banks wouldn't lend to the hedge funds any more.

So far, so good. We know all this already.

My mistake was to think the losers were going to be the (rich) investors in the hedge funds, and any pension funds that bought into them.

However, what I had missed is that the hedge funds were themselves gearing up (5x mentioned in the book), so in the event of a big crash, the banks exposure is multiplied again.

So the banks provided loans to the hedge funds to buy the junk from the banks that loaned money to people that won't be able pay it back.

Anybody else think this was just a feedback loop for fee-generation?

VMR.

[BandWagon]

So the banks provided loans to the hedge funds to buy the junk from the banks that loaned money to people that won't be able pay it back.

Don't forget that the hedge funds were taking money from "investors", charging a 2% annual fee, plus 20% of any profits.

Of course they also had to make sure they took 0% of the losses on the downside.

Imagine if you could borrow money to bet on the horses, charge the lender a 2% fee for your services, take 20% of the winnings, and 0% of the losses.

How could you lose?

If you thought houses were a bubble, hedge funds were a balloon.

[Bloo Loo]

Don't forget that the hedge funds were taking money from "investors", charging a 2% annual fee, plus 20% of any profits.

Of course they also had to make sure they took 0% of the losses on the downside.

Imagine if you could borrow money to bet on the horses, charge the lender a 2% fee for your services, take 20% of the winnings, and 0% of the losses.

How could you lose?

If you thought houses were a bubble, hedge funds were a balloon.

Thats right, when a hedge fund blows, its other peoples money that is lost. course, early in the crunch, it was muted that this money was not in the real economy.

Now we know that its LIQUIDITY and banks balance sheets that get shot in the head.

Without the two items above in stock, PLUS nowhere to pop their mortgages off balance sheet, lending is limited to the old way.

The treasury simply dont understand it. 50bn here or there is helping, but not fixing, not by a long way.

Yesterday was a good news day, the crunch is over seemed to be yesterdays impression. I think not.

[VeryMeanReversion]

If you thought houses were a bubble, hedge funds were a balloon.

From a leverage (and hence risk) point of view, is that true?

Housing could bought with 100%/125% mortgages. Even at 95%, thats a 20:1 leverage.

If the hedge funds were using 5:1, that looks relatively safe.

However, due to the hedge-fund-> RMBS->Bank->Mortgage loop, the overall leverage is 100:1. Not much room for 1% drop in asset prices then.

I wonder if this was just a dodging scheme for capital adequacy rules:

e.g.

Case 1: Make two loans with a 10:1 reserve ratio, overall ratio is 10:

Case 2: Make one loan with a 10:1 reserve ratio, hedge fund then puts in back in the bank and uses that as the reserves for a new loan

=> Overall ratio is 100:1

So to use your analogy, the situation is a balloon full of bubbles!

VMR.

[Nationalist]

I suppose the real question is: where did the money for the boom come from ORIGINALLY?

And the answer is:

1) Your pension

2) Japan

3) Nowhere, they're just bits of paper and we printed more of them.

By which I mean 1) once the MBS paper was souped up to AAA rating pension funds were able to buy in, previously they were obliged to manage your retirement savings cautiously and all that lovely money was languishing in boring govt bonds and dull FTSE100 stocks, and 2) the Yen carry trade moved US$1 trillion out of Asia into the West (hope they never want it back!) and 3) M4 growth has been running at 12 to 13 percent pa for the last decade.

So to sum up: your old age will be bleak, you owe foreigners more than you will ever be able to repay, and that new-build flat which you took a 25 year mortgage on will fall down a couple of months after its 10 year NHBC guarantee runs out.

[Lepista]

So to use your analogy, the situation is a balloon full of bubbles!

It's a bubble bath....

Soon to be a bubble blood bath