That is the title of an email newsletter from John Mauldin, a pretty conservative financial advisor/writer. In the email newsletter that I got today, he had one of the most concise explanations of this weeks meltdown. Follow me for a link and a few excerpts - plus two pictures worth one trillion dollars
First - if you go to one of his websites you can see the first few paragraphs of his article, and then send him an email address for the rest of it.
Mauldin (via a talk given by another analyst, Rich Berg) talked about the whole process of packaging mortgages into different risk levels ("tranches") and selling them off. But here is (one of the) kicker(s). In talking about the lower level mortgages - the riskier "junk" level ones, this is what happened.
Then, since it was hard to sell some of the lower levels of these securities, HIB would take a lot of the lower level tranches and put them into another security called a Collateralized Debt Obligation or CDO. And yes, they sliced them up into tranches and went to the rating agencies and got them rated. The highest tranche was typically again AAA. Through the alchemy of finance, HIB took subprime mortgages and turned 96% (give or take a few points depending on the CDO) of them into AAA bonds. At the time, I compared it with taking nuclear waste and turning it into gold. Clever trick when you can do it, and everyone, from mortgage broker to investment bankers was paid handsomely to dance at the party.
Will we ever forget Charlie Prince's line, the CEO of Citigroup, saying that "As long as they are playing music, you have to get up and dance?" just a few weeks before the market imploded? Apart from having his rhythm being proven totally horrendous and overseeing an implosion which cost Citigroup tens of billions, it was a great statement of the zeitgeist of the financial world at the time.
Mauldin then spends a number of paragraphs explaining that if you actually knew the risk of various "tranches" or groupings of mortgage backed securities, in a "panic" type market like we've seen, you could probably make some good money. So why aren't the big banks doing that? His explanation:
If this is such a good deal, then why isn't everyone hitting the bid? Because these securities are very difficult to analyze. It is time consuming. You need to analyze every loan and develop your own valuations. You simply can't trust the ratings, as they are measuring something completely different.
And the real truth is that many of the various RMBS securities will in fact be totally wiped out or lose a great deal. Many are seeing default rates of 30% or more. You have to be very careful when you walk through this minefield. And in a time of crisis, it is not clear what the new rules will be. What if the government forces lenders to re-set mortgages at some loss level? What if the housing crisis gets worse? On the other hand, what if the government comes in and buys up all the bad mortgages in an attempt to stop the erosion in the home markets. The level of uncertainty in these times makes people a lot more cautious.
But what I really wanted to get to were his two graphs. Keeping in mind that the life blood of the economy, in terms of money flow, is commercial paper, look at these two graphs
What I took away from this was an economy that was going to come to a screeching halt. Think Boeing 747 meets Mt. Everest. Wasn't going to be pretty.
So once again - big business only like government handouts when it saves their sorry asses - but in this case it will save yours and mine too.
And have we finally learned that there is a reason for government beyond the libertarian and conservative view of building roads and providing for national defense?