Wall Street Crisis for Dummies!
So as of this writing, the stock market has been going thru a roller coaster and ended up on the negative side even as the US Congress approved the bailout bill.
The world markets reacted in unison both in Asia as well as in Europe, while some of the European governments plan a similar strategy to bailout their own financial institutions.
Perhaps the only good news is that oil prices are plummeting as well.
It’s interesting to note that there were 2 news items I came across just this past weekend.
- CBS’ 60 Minutes - The Wall St Shadow Market
- A feature article on Keller, the ex-CEO of Washington Mutual
The Shadow Market talks about Jim Grant’s interpretation of what really happened. He’s the editor of “Grant’s Interest Rate Observer”, and is considered to be on the country’s foremost experts on credit.
In simple terms, there were 2 things that the investment houses did:
- Packaged the mortgages into complex paper investments.
- Offered “credit default swap” as insurance to back these paper investments.
Investment Securities Gone Wild
Physicists and other math geeks (hired by Wall St) created a complex formula to package both regular and subprime mortgages into unintelligible paper investments.
The intent of the formula was to minimize, if not eliminate risk. Each of these papers, literally consisted of hundreds of pages of small fine print, and were traded to other banks worldwide.
For whatever reason, a critical mass of the “smart bankers” throughout the world, bought into the idea that the US real estate market was going to skyrocket forever.
The Darker Shadow of “Credit Default Swaps”
To sweeten the deal, the same investment houses offered a “credit default swap”. This was a carefully worded term to avoid a label of “insurance”. The purpose is to get paid, in case the investment paper fails.
Wow! Talk about the used car salesman, selling you a guarantee against defects, on a car that is a lemon to begin with!
The problem is, the term insurance was avoided, in order to avoid regulation.
Regulation that would have required the “credit default swap” to be backed by real money. Since it wasn’t labeled “insurance”, there was no regulation to require real money behind it.
So the investment bank dummies … I mean dominoes, fell as soon as the over-spending US homebuyers started defaulting on their mortgage loans.
Tomorrow I’ll talk about Part 2 of how the mortgages started to default.