As I research the alarming condition of the financial sector and Henry Paulson's bailout of Fannie Mae and Freddie Mac, which will cost taxpayers probably a trillion dollars, I wanted to share some highlights:
Remember those complicated financial instruments called mortgage-backed securities, where investment houses bought mortgages, pooled them together and sold them as bonds to many, many investors? As everyone knows now, many of these mortgage loans are defaulting. The market for mortgage backed securities dried up months ago. No one can sell them. And financial firms which hold an estimated trillions of dollars of them are afraid to unload them in a fire sale. That is one reason for the credit crisis. No one knows how much of these toxic assets any other entity holds.
Mortgage backed securities are a subset of what is known as collateralized debt obligations, or CDOs. CDOs are derivatives, which simply means they are financial vehicles derived from underlying assets.
The other day, Merrill Lynch sold $6.7 billion of these CDOs, originally valued at $30 billion, basically getting 22 cents on the dollar. However, in order to sell these almost valueless CDOs Merrill had to lend $5 billion to the buyer. Which means Merrill will be lucky to realize 10 cents on the dollar. This is the mark-to-market price for now. The price keeps getting lower. And there are probably many hundreds of billions in dollars, if not trillions, of these "assets" floating around. Companies are desperate for cash. Often they are selling their crown jewels to raise money right away.
Another story from the Wall Street Journal today: A former Credit Suisse broker, one Julian Tzolov, is believed to have fled to his native Bulgaria. He and a fellow broker, Eric Butler, were the targets of federal prosecutors who were investigating their role in marketing auction rate securities. Auction rate securities, issued by municipalities, nonprofits like the Metropolitan Museum, and student loans, were considered as liquid as cash. They were sold that way, always. But (surprise!) they've turned out to be backed by the same toxic subprime mortgages as those other CDOs. The firms that employed these brokers misrepresented them as only backed by solid gold assets.
The $330 billion auction rate market has frozen and no one can get their money out. This includes very substantial companies, many Israeli, like Teva Pharmaceuticals, who had to take a $52 million charge on them.
Do not assume a broker is telling the unvarnished truth when their overriding concern may be to protect themselves and their company rather than their client.
The bottom hasn't dropped in the housing market. High fuel costs, rising unemployment, rapid withdrawal of consumer discretionary spending which comprises 70% of GDP, etc. are melding together in a horrendous cycle. I'm offering unsolicited advice, which is to insure your investments before you lose more money. Spread it out among different banks so you can take advantage of the FDIC until it, too, needs to be nationalized