Who ARE these people??? The Financial Meltdown...

[catnhatnh]

I ask this in a reply to a post this morning. Would DU economics majors please look at this info about something called the "PORTAL alliance" and give me a hint of what it means???

http://www.subprimeblogger.com/the-portal-alliance-coul... /

[leftstreet]

1. I agree with a comment there about using this crisis to harm other countries

in an effort to maintain (or return) US financial control.

This whole thing seems contrived to begin with.

[sandnsea]

2. Here's a press release

http://ir.nasdaq.com/releasedetail.cfm?ReleaseID=275224

"A group of leading securities firms and The Nasdaq Stock Market today announced their intention to form The PORTAL Alliance, an industry standard facility designed to serve the market for 144A equity securities."


What exactly are 144A equity securities?

[Idealism]

5. 144A equity securities are a way for banks to be able to raise capital quickly

without much, if any, oversight. They are outside the SECs jurisdiction, although the SEC see's transactions after the fact. 144A's can be resold immediately to other qualified institutions, in this case any company in the PORTAL alliance, without public registration. The usual restriction for a company to be able to deal in 144A's is a monetary threshold in excess of either $50 million in aggregate securities or $100 million (i forget which :()

[sandnsea]

7. Why'd they create this in Oct 2007?

And is the part of the Frontline series last night, where they said they were so intertwined that if one fell, then down the rest would go. Is it because of this Portal Alliance?

[murielm99]

9. I need to know more abut the Frontline series.

Someone else mentioned it today.

Do you have some information you could share about this series?

[sandnsea]

10. Inside the Meltdown

It's a thorough look at the meltdown from Bear Stearns on. I'm guessing the reason Tim Getihner is treasury secretary is because he's the one who unraveled what was going on, starting with Bear Stearns. It's just very good and easy to understand. I don't usually like to watch long programs online, but this one is worth it.

http://www.pbs.org/wgbh/pages/frontline/

[murielm99]

14. Thanks.

I bookmarked it so I can watch it tomorrow.

[Idealism]

11. While there is no way of knowing for certain the dollar amount behind 144A's

it doesn't seem that they will have enough of a market share of securities to affect the system, given one important reason: the investment banks were so highly leveraged that they had to purchase insurance (Credit default swaps) against other banks to minimize their exposure to risk. This makes certain lending very expensive. They invented 144A's to combat this problem, as they are unregistered, and thus, don't need to have insurance bought on them. 144A's are highly specialized, only to be used when you need to raise immediate capital. Like, say, around September 15th, when you had that claimed $500 billion run on money market accounts and all the sudden Lehman went under. The only problem is, if you are trying to raise capital by selling restricted (or controlled they are also called) securities, there is a small amount of firms who are able to buy them off you. Plus, these firms will also be looking to sell assets to sustain themselves in the event of a market crisis, so you have a cycle of these assets becoming a. harder to trade, and b. harder to price. Thus helping to fuel a collapse, because no one wants worthless assets, especially when they are hard to resell, especially when they are worried about their own solvency and need to raise cash as quickly as possible.

[sandnsea]

12. Who sells the credit default swaps?

When Lehman went, what happened to any credit default swaps related to them.

It looks to me like they knew they were going to have money shortages and created this Portal thing to help ease them through the crunch, and who did they expect to fail?

[Idealism]

15. Insurance companies sell CDS's

AIG being the biggest of these insurers. It is for this reason that they won't let AIG fail. The CDS market was an estimated $56 trillion last year until the downturn worth of "insurance policies" and their payouts. The last estimate that I saw was around $21 trillion.

Think of a bank:

You have long-term assets and you have short term assets.
Long term= mortgages, firm loans, etc
Short-term= derivatives, investments, etc

You (as a bank) get your funding by maturation of your assets. But, some short-term assets mature much faster than long-term assets, so you have a big problem of maturity mismatch. This means that you have long-term that have to be financed by short-term funds because you aren't getting paid off for 10 years at least. This short term funding is either by commercial paper (which is about a 3-month turnover period) and now more and more Repo markets. Repo financing can occur on a daily basis- immediate short-term financing. The repo markets are the best way for an entity to raise capital, because the idea behind repo lending is that if there is a problem in your bank, you will have to pay the "repo man" first, because they get rolled over overnight. But, like I said before about banks having to buy insurance against each others exposure, the repo market was susceptible to inflation- meaning it was not as cost effective as it once was. This problem is called the "couterparty credit risk." For this problem, they invented 144A's. Most banks do not have enough net value in securities to qualify for 144A's however, so the maturity mismatch helped drive this crisis.


Edit: It wasn't so much about the big I-banks looking at each other, asking "who is going to fall first?" It was them wanting to pay as little as possible for their financing, so instead of use the Repo market for their short-term financing, they wanted something more exclusive, and thus not prone to inflation that would cause them to not be price effective.

When Lehman went down, every CDS attached to them went with them. It turned out Lehman had more insurance against them then they had for them.

[sandnsea]

17. Reading everything

I'm getting the impression they were at the brink back in 2007 and wanted to avoid both the repo market and the exposure of the credit default swap situation.

Have banks always had the credit default swaps, or is that newish. And what about the bundling of mortgages, when did that start?

[Idealism]

19. Here are a few things to read if you are interested

http://wfhummel.cnchost.com/repos.html

Seems to be a decent overview of the Repo markets and repo contracts. Here is a paragraph I want to highlight:

Clearing Banks and Dealer Loans

A securities dealer must have an account at a clearing bank to settle his trades. For example, suppose ABC company has $20 million to invest short term. After negotiating the terms with the dealer, ABC has its bank wire $20 million to the clearing bank. On receipt, the clearing bank recovers the funds it loaned the dealer to acquire the securities being sold, plus interest due on the loan. It then transfers the sold securities to a special custodial account in the name of ABC. Since government securities exist as book entries on a computer, this is a trivial operation.

The next morning the dealer repurchases the securities from ABC, pays the overnight interest on the repo, and regains possession of the securities. Assuming a 5% repo rate, the interest due on the $20 million overnight loan would be $2,777.78, which is based on a 360-day year. If both parties agree, the repo could be rolled over instead of paid off, thus providing another day of funds for the dealer and another day of interest for ABC.

If the dealer is short on funds needed to repurchase the securities, the clearing bank will advance them with little or no interest if repaid the same day. Otherwise the bank will charge the dealer interest on the loan and hold the securities as collateral until payment is made. Since dealer loans typically run at least 25 basis points above the Fed funds rate, dealers try to finance as much as they can by borrowing through repos. By rolling over repos day by day, the dealer can finance most of his inventory without resorting to dealer loans. It is sometimes advantageous to repo for a longer period, using a term repo to minimize transaction costs.

Clearing banks charge a fee for executing dealer transactions. They prefer not to issue large dealer loans because it ties up the bank’s own reserves at little profit. In truth, there is not enough capacity in all of the clearing banks in New York to provide dealer loans sufficient to cover the financing needs of the large securities dealers.

Here is an SEC brief on Rule 144, it is the original form of "controlled securities." It has denigrated from there to 144A's, which are much less restricted.

http://www.sec.gov/investor/pubs/rule144.htm

Here is a short primer on Credit Default Swaps, it is a free signup to view the article:

http://www.mondaq.com/article.asp?articleid=68548

Credit Default Swaps were created in the late 1990s in order to hedge financial risks. Companies wanted insurance on their risky investments. The riskier the assets they purchase, the greater a need to hedge the banks exposure to such risk, and the more you need CDS's to mitigate that potential loss. The CDS market's enormity helped convince the SEC to lower required capital ratios from about 12:1 to around 35:1. The sheer stupidity of this SEC ruling still astounds me! A corporation loses 3% of its true asset worth, and they are practically insolvent! Stunning that they would allow this...

Mortgage-Backed Securities were invented decades ago, but they were to only be used by GSE's (government sponsored enterprise) to repackage mortgages that they were to buy from the FHA (federal housing administration) and later after the GI Bill, the Veterans Administration. Recall that soldiers returning from WWII were given almost zero-interest loans for houses as part of the GI bill, so the origination of MBS's were somewhere around the 1940s. Until Glass-Steagall I believe, only GSE's were allowed to purchase and bundled mortgages, effectively producing a monopoly for Fannie and Freddie. So after 1999, you see an explosion (coupled with new housing starts/real estate bubble) of MBS's.

Here are two well-written first hand accounts of the financial world and wall street. Prepare to get angry:

http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom#

http://theamericanscene.com/2008/12/23/ahi-quanto-a-dir-qual-era-e-cosa-dura-esta-selva-selvaggia-e-aspra-e-forte-che-nel-pensier-rinova-la-paura

[sandnsea]

20. I had a GI Loan in the 70s

So I am very familiar with that. Fannie and Freddie had a monopoly?? No, it looks to me like Fannie and Freddie did what they were supposed to do, handle govt guaranteed mortgages, and they did it very well. It blew up when they let the rest of the greedy fucks into it, and then tried to blame Fannie and Freddie for trying to keep up with what the crooks were doing. I don't believe that just because somebody knows how to make something legal, means they aren't still a crook.

I will look at the rest of it too, that part just caught my eye.

And on edit:

It's like every day there's something new on this banking mess. Today is the 144a and repo market. What are we going to find tomorrow?

[Idealism]

22. Until the repeal of Glass-Steagall

and the implementation of the Gramm-Leach-Bliley Act, Fannie and Freddie had a virtual monopoly on MBS, and that is why they worked and no one had problems with them. After 1999 is when commercial banks and investment banks merged and they were turned into security-writing corporations.

Fannie and Freddie did do their jobs, even now they are doing what they were intended to do: buy mortgages from banks and banking affiliates to allow these institutions more capital to in turn lend out to the public. Fannie and Freddie were just sold bad mortgages, but not just bad mortgages- they were also lied to. The credit rating agencies (Moodys, Fitch, S&P) started to rate junk paper as triple A (the highest rating you can give paper). The GSE's bought a mix of BB through AAA tranche MBS's, but more often than not these AAA's were full of sub-prime, and often, synthesized bonds. That is totally the rating companies fault, but not many people thing to finger them for blame in this mess. They deceived untold amounts of investors as to the credit-worthiness of the paper they were pushing, simply because they were paid more money to rate a security as AAA (because there was more demand for the best rated investment due to their supposed safe nature) than say a corporate bond or a BB trance security.

[sandnsea]

24. But the banks were in on the ratings

right? I haven't read all the details on that part of it, but I had the impression there was some incentive between the rating companies and banks to make the higher ratings. Was it just that a AAA was worth more? My husband sold insurance very briefly, a subsidiary of AIG actually, so I'm familiar with the importance of ratings. They're supposed to be above reproach, sacrosanct. This is really stomach churning when you think of what is really just plain old corruption.

[Idealism]

26. Yes the banks knew of the ruse, too

But, the banks just enabled the rating agencies to follow their greed. The money for both banks and the rating agencies was in the securitization of the mortgages. Here is a good article that sheds some light on the credit rating agencies and their shortcomings:

http://www.moneyweek.com/investments/stock-markets/the-great-credit-rating-scandal.aspx

Here is something to read if you want to know the extent of how greedy these bankers and rating companies were:

http://www.ft.com/cms/s/0/245bf02e-264d-11dd-9c95-000077b07658.html?nclick_check=1

The previous post I gave you a link about a wall street investor who talked about the foolishness behind CPDO's (constant-proportion debt obligation's), but I'll post the excerpt here to really get you to understand the degree of how screwed in the head the people who invented these things were:

From: http://theamericanscene.com/2008/12/23/ahi-quanto-a-dir-qual-era-e-cosa-dura-esta-selva-selvaggia-e-aspra-e-forte-che-nel-pensier-rinova-la-paura

And I can best illustrate the agencies’ disregard for the quality of their data sets by reference to a product unrelated to mortgages: the constant-proportion debt obligation, or CPDO.

This obscure little product was launched in late 2006 to great fanfare. And it was, indeed, an ingenious little fraud of a product. Here’s how it worked.

Some clever structurer noticed that, historically, investment-grade companies don’t default very often. Rather, they deteriorate for a while first, get downgraded to junk status, and eventually they default. That’s why the short-term ratings for relatively low-rated investment-grade companies may be reasonably high: even BBB companies are generally good for the next 90 days; if they weren’t, they wouldn’t be rated BBB. And this suggested the possibility of a trading strategy.

What if you bought a portfolio of investment-grade corporate debt and, every six months, purged it of the bonds that were downgraded to junk, replacing these with new investment-grade bonds. Obviously, you’d expect the downgraded bonds to underperform the remainder of the pool, so you’d have losses you need to make up, so assume you also sell out of a handful of bonds that have done well, and replace these with higher-yielding bonds that are still investment-grade, thus keeping your yield relatively constant. You’d still expect some losses if you wanted to keep your average rating relatively constant, though. So you need some excess yield to make up for these losses.

You find that yield by leveraging the portfolio. After all, it’s an investment-grade portfolio, very unlikely to default in the short term. You can borrow very cheaply short-term, invest in longer-term bonds, and earn the spread differential. If the bonds go against you, that’s OK, because you’re going to hold them to maturity and you’ll always be able to roll your short-term borrowing. And, if you can get a high enough degree of leverage, the excess in current yield from the differential between where you borrow and the yield on your portfolio should more than pay for the cost of rolling out of your losers every six months. And if you do that successfully, you’ve got a trading strategy that never loses principal, but has a surprisingly high expected yield. Sound good?

Well, it sounded great to the ratings agencies, who blessed this strategy by giving it a AAA rating.

How did they justify that AAA rating? By looking at the historic cost of rolling credit derivatives on indices of investment-grade corporate issuers, which generally have a high-BBB rating. These had been around for about three years when the first CPDOs were rated, and the roll had never cost more than 3 basis points. Factoring in that cost, at a leverage of 15-to-1, and using historic 6-month default rates for the portfolio (since the index would be rolled every six months), the proposed trading strategy would never lose money. Hence a AAA rating.

Let me reiterate that, just to drive the point home. The ratings agencies said: you can take a BBB-rated index, leverage it 15-to-1, and follow an entirely automatic trading strategy (no trader discretion, no forecasting of defaults or anything, just a formula-driven adjustment to the leverage ratio and an automatic roll of the index), and the result is rated AAA.

Needless to say, this worked out really well for all concerned. But that’s not really the point. The point is: the notion that you could grant a AAA based on a trading strategy for which there was at best three-years of data (three years that encompassed not a single recession, I’ll note) is mind-boggling. And, worse than that, nobody at the agencies apparently stood up and said, “wait a second: how can you turn a BBB into a AAA by leveraging it 15-to-1? That’s impossible!” Which, of course, it is.

I want to be very clear about something: we’re not talking about a CDO where the AAA investor is providing leverage, and there are subordinate investors below who bear the first risks of loss. This was a trading strategy; the investor in the AAA CPDO had first-loss risk with respect to a BBB portfolio. The trading strategy was just supposed to generate enough returns to create “virtual” subordination to justify the AAA.

When I first heard about this product, I thought: whichever agencies rated this thing have lost their minds. When people asked me whether it made sense as an investment, I said: it’s an outright fraud. You’re practically guaranteed to lose money. I never bought or sold one of these things myself, and neither did anyone else in our group. But the existence of such a ridiculous product should have been a wake-up call about just how divorced from reality the agencies were. And if they were out to lunch on something as straightforwardly absurd as the CPDO, how out to lunch were they on other products, ones that were far more significant to the markets and the economy, where the absurdity of their assumptions was less-obvious?

There is volumes to read here on just the links I posted, if you are interested. I'm going to sleep, good night.

[sandnsea]

29. Every day there's something new

So what's this stuff?

http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=114x57643

[catnhatnh]

18. If you wrote a book I would buy it...

So where on-line do I find a real basic primer as good as you? I don't know if you get how really esoteric and counter-intuitive this is for people not inside finance. We're still wondering why our pants are down and it hurts so bad while you are describing the mere $21 trillion we just took. And no-that is not hostile, just confused.

[Idealism]

25. Post #19 has tons of information to read

No books for me, I just try to do my part to enlighten DU'ers who ask questions :)

[B o d i]

21. re: "Who did they expect to fail", Paul Krugman wrote this almost a year ago

http://krugman.blogs.nytimes.com/2008/03/31/the-north-atlantic-conspiracy/

April 9, 2008
The plot against Iceland

On a gloomy North Atlantic evening in January, a group of international hedge fund managers gathered in the stylish bar of 101 Hotel in downtown Reykjavik at 8pm for a drink before dinner. They had been flown to Iceland by Bear Stearns, the US investment bank that two months later had to be rescued. Bear had organised the excursion to discuss the bizarre state of Iceland’s economy. What transpired at this dinner has entered into legend within Iceland’s close-knit financial community.

An executive who works with a big Icelandic bank recalls: “Upon entering the bar I was approached by one of the hedge fund managers. He informed me that all people in this party – except for him, of course – were shorting Iceland.” The executive says the fund manager described Iceland’s profit-making potential as the “second coming of Christ”.

“As dinner progressed – some people actually decided not to eat at all but just sit at the bar – and more drinks were downed, the conversation and questions started to get more hostile and short positions openly declared,” the executive says.

What started as an alcohol-fuelled evening has become a full-blown investigation by Iceland’s Financial Supervisory Authority into an alleged speculative attack by hedge funds on Iceland’s currency, banking system and stock market. Jonas Jonsson, director-general of Iceland’s FSA, says the authorities are “searching whether some parties have systematically been distributing negative and false rumours about the Icelandic banks and financial system in order to profit from it”.

[Idealism]

23. Iceland, to be blunt, got what they deserved.

Icesave was in essence a Ponzi scheme, and the Icelandic government bought into the neo-liberal bullshit of unfettered free market capitalism. The system creates class warfare, and Iceland was the casualty in this battle, though the UK (cities,corporations, et al) and foreign investors are not much better off at this point.

[B o d i]

27. Is the whole thing a Ponzi scheme? Or, maybe a better question is, how big IS the Ponzi scheme?

:shrug:

[Idealism]

28. Depends on how you define "ponzi scheme," I believe

If you think of a ponzi scheme as any scam that "Robs Peter to pay Paul" then yes, it is definitely along those lines. If you do think along that vein, however, then our entire system of http://en.wikipedia.org/wiki/Fractional_reserve">Fractional-reserve banking is one giant ponzi scheme (which a growing number of people are starting to believe) that utilizes "monopoly-game money" called http://en.wikipedia.org/wiki/Fiat_currency">Fiat currency, that is essentially money made out of thin air.

[catnhatnh]

13. I appreciate your further postings.

Are you saying this was a kludge fix to game the system amongst insiders or like that?

[Idealism]

16. It is another way that the big investment banks to maximize their bottom line

I guess you could say it is an 'inside game,' because it is supposed to be exclusive to those banks who have in excess of $100 million in securities, but the SEC let them do this- same how the SEC changed the leverage-to-capital ratio's for banks. What does that say about the SEC? lol.

[Idealism]

3. Theres no way this is going to be the meltdown this person thinks it can be.

The credit default swaps market dwarfs this, considering CDS's could be bought by any company. Not to mention that this doesn't make much sense from a profitability standpoint either.

[catnhatnh]

4. I am "this person"

So instead of minimizing why don't you explain what is going on and what the 144 means?

[Idealism]

6. See post #5

[catnhatnh]

8. Nice, circular almost.

That's why I ask questions of people who claim economic understanding-so after they are done, I know I am wrong but have no explanation why.