Signs of the Economic Apocalypse, 3-26-07

From Signs of the Times:

Gold closed at 657.30 dollars an ounce on Friday, up 0.5% from $653.90 at the close of the previous Friday. The dollar closed at 0.7528 euros Friday, up 0.3% from 0.7509 at the previous week’s close. That put the euro at 1.3284 dollars compared to 1.3318 at the end of the week before. Gold in euros would be 494.92 euros an ounce, up 0.8% from 490.99 for the week. Oil closed at 62.28 dollars a barrel Friday, up 9.1% from $57.11 at the end of the week before. Oil in euros would be 46.88 euros a barrel, up 9.3% from 42.88 euros for the week. The gold/oil ratio closed at 10.55, down 8.5% from 11.45 at the close of the previous Friday. In U.S. stocks, the Dow closed at 12,481.01 Friday, up 3.1% from 12,110.41 for the week. The NASDAQ closed at 2,456.18 Friday, up 3.5% from 2,372.66 at the end of the week before. In U.S. interest rates the yield on the ten-year U.S. Treasury note closed at 4.61%, up seven basis points from 4.54 for the week.

Oil spiked last week, rising 9% on concern about the British provocation of Iran. Stocks were up as well, the Dow had its best week in four years, as there was some good news on the housing front for a change. Existing home sales increased by almost 4% in February. Optimists seized on that and predictably blew it out of proportion. These sales represent contracts were entered into in December, when weather was unseasonably warm and the bad news about the housing market was not as prominent in the media. But still, a rise is better than a fall.

U.S. Economy: Existing Home Sales Surge in February

By Shobhana Chandra

March 23 (Bloomberg) -- Sales of previously owned homes in the U.S. unexpectedly surged last month by the most in three years, a sign that the housing market is probably past the worst of its slump.

Purchases increased 3.9 percent in February to an annual rate of 6.69 million, the National Association of Realtors said today in Washington. Sales have risen in each of the past three months, a streak not matched since April 2004 in the midst of the five-year housing boom.

Gains in home construction, mortgage rates near a 14-month low and an increase in loan applications from a year ago are helping lay the groundwork for an industry rebound. Stocks advanced as traders took the figures as an endorsement of the Federal Reserve's forecast that the economy will grow at a moderate pace.

“We expect the drag on the economy from housing will be gone by mid-year,” said Dean Maki, chief U.S. economist at Barclays Capital in New York. The rebound in sales is “an important development.”

Even with last month's sales gain, some economists noted that the supply of unsold properties continued to climb. Mounting defaults on subprime mortgages -- loans to people with patchy or poor credit histories -- may throw more properties onto the market and weaken prices. Sales were down 3.9 percent from a year earlier.

“Most of the housing adjustment is completed,” said Eric Green, chief market economist at Countrywide Securities in Calabasas, California. “We're just not seeing the subprime problem in these numbers yet.”

Delinquencies

Countrywide Financial Corp., the largest U.S. mortgage lender, said this week that delinquencies on some subprime home loans may climb to 9.89 percent, exceeding a company record set in 2000. The firm is among lenders to tighten standards.

At the same time, lower prices and rising incomes are making homes more affordable, along with a decline in mortgage interest rates. The National Association of Realtor's affordability index rose to an almost two-year high in January, the group reported earlier this week.

Resales were forecast to drop 2.5 percent to a 6.3 million annual rate last month, according to the median of 63 forecasts in a Bloomberg News survey, from January's originally reported 6.46 million. Estimates ranged from 6.1 million to 6.51 million.

Warm Weather

Last month's jump in sales partially reflects the closing of contracts signed in December, when unseasonably warm weather brought out more house hunters, David Lereah, the Realtors' chief economist, said at a briefing in Washington.

More stringent lending standards, after a wave of defaults in the subprime market, will limit sales this year, said Lereah, who estimated “we could be losing between 100,000 and 250,000 home sales” annually over the next two years as a result.

“It will spill over into the overall housing sector, but will be somewhat contained,” Lereah said. “With the economy being healthy, this is a problem, not a crisis.”

Existing home sales averaged 6.51 million last year, lower than the 7.06 million average for all of 2005.

The median price of an existing home fell 1.3 percent last month from a year ago to $212,800, the Realtors group said.

“The real key here is that prices have come down seven consecutive months,” Lereah said in an interview. “It seems to be working.”

Supply of Homes

The supply of homes for sale increased 5.9 percent to 3.748 million last month, representing a 6.7 months' supply at the current sales paces. That compares with 6.6 months at the end of January.

Resales of single-family homes rose 3.7 percent in February to an annual rate of 5.88 million, the report said. Sales of condos and co-ops rose 5.3 percent to an 810,000 rate.

Purchases increased in all regions of the country except the West, where they were unchanged. They rose 14.2 percent in the Northeast, 3.9 percent in the Midwest and 1.6 percent in the South.

Monthly figures on home resales are compiled from contract closings and may reflect sales agreed upon weeks or months earlier. New home sales, which are recorded when a contract is signed, are a more timely barometer of the housing market than home resales. The Commerce Department may report next week that new home sales rose to an annual rate of 985,000 last month from 937,000, according to the median forecast in a Bloomberg survey.

Resales account for about 85 percent of the housing market.

Builders broke ground on new homes at an annual rate of 1.525 million last month, rebounding from a nine-year low in January, the Commerce Department said this week.

That report helped ease concern that increasing defaults by subprime borrowers are hurting the housing recovery.

Foreclosures are still on the rise, however. The state of Ohio announced plans to issue $100 million in taxable bonds to help citizens of the state refinance their ballooning mortgages. Ohio, where deindustrialization has hit employment hard, deserves credit for acting on the problem. But it is ironic that they raised funds by issuing more debt. Not only that, but government would have been wiser to have done some elementary regulation to prevent predatory lending practices in the first place. This could be the tip of the iceberg as far as government bailouts for the housing crash as banks, financial institutions and individuals may need help at a scale that could exceed the Savings and Loan debacle in the early 1990s.

Ohio Plans Bonds to Bail Out Homeowners Strapped by Mortgages

By Martin Z. Braun

March 23 (Bloomberg) -- Ohio, which had the highest foreclosure rate among the 50 U.S. states at the end of 2006, plans to issue $100 million in taxable municipal bonds next month to help homeowners refinance mortgages they can't afford.

Proceeds of the bond issue by the Ohio Housing Finance Agency will provide financing for about 1,000 loans with a fixed rate of about 6.75 percent, said Robert Connell, the agency's director of debt management.

“We believe that it is incumbent on this agency to do something to assist these folks to enable them to keep their homes,” Connell said. “A $100 million bond from this agency is not going to solve Ohio's foreclosure problem. We hope to at least make a dent.”

A March 13 survey by the Mortgage Bankers Association found that Ohio had highest rate of homes in foreclosure nationwide. The state, whose economy has suffered amid declines in manufacturing, also had the highest rate of subprime loans in foreclosure. Subprime mortgages are granted to people with poor credit histories or high debts and often have rates at least 2 or 3 percentage points above safer prime loans.

Earlier this month, Ohio Governor Ted Strickland, a Democrat, formed a task force to stem home foreclosures in Ohio. The group will develop strategies to assist homeowners facing foreclosure and educate homebuyers.

April Rollout

Ohio will begin rolling out the refinancing program on April 2, Connell said. The loans will be limited to homeowners whose income is up to 125 percent of the median income of their county.

“It will be available to the residents of Ohio to take them out of their adjustable-rate mortgages, their interest-only mortgages and avail them the opportunity to move into a fixed rate mortgage which may now benefit their individual financial situation,” Connell said.

Kansas City, Missouri-based George K. Baum & Co. will manage the bond sale for Ohio's finance agency. The bonds will taxable because the U.S. tax code prohibits states and local governments from using proceeds of tax-exempt bonds to refinance existing mortgages, Connell said.

The survey by the Mortgage Bankers Association found that Ohio's foreclosure rate across all loan types was 3.38 percent. Indiana was second among U.S. states with 2.97 percent and Michigan was 2.39 percent. Ohio also led the nation will 11.32 percent of subprime loans in foreclosure.

To say, as the mainstream analysts were, that the housing crisis can be weathered and a rebound is just around the corner is crazy, unless some other bubble can be created. Michael Hudson pointed out that the total value of all New York real estate is greater than the total value of all plants and machinerty in the United States. What this means, according to Stef Zucconi is that,

Hudson’s point is that the US stopped being an industrial economy long ago and the US economy is now based on property ownership, rent and usury rather than actually making things.

Which is, of course, a throw back to the good old days of feudalism.

Which is nice if you either own lots of property, happen to be a money lender, or are an environmentalist who wants everyone to return to a ‘simpler’ way of life, but not so crash hot for the rest of us.

Zucconi points out the way a new bubble is created in order to avoid the consequences of the bursting of the existing bubble:

For example, when faced with the news that house prices in London have risen by 22% over the last year and the average price of a home in London now stands at £366,302 (sorry, that was yesterday, it must be topping £380,000 by now) the delusional conspiracy theorist will blame the eye-watering price rises on cynical manipulation of the money supply by scheming bankers.

Whereas the clued-in people, the rationalists who really know how the world works, will know that high levels of property inflation are due to non-conspiratorial factors such as...

"Wealthy City financiers, foreign buyers and big income earners are driving the demand in London and with quality stock at an all-time low, there is an exacerbated effect on prices"

All very sane and rational.

Only a couple of problems though.

First off, it's a matter of record that people are borrowing shit loads of money to buy property - not 'wealthy city financiers' or mysterious 'foreign buyers' but ordinary people being obliged to saddle themselves with buttock-clenching levels of debt to buy a home.

Second off, there's the small matter of the former Governor of the Bank of England openly 'fessing up and admitting that, yes, he and his buddies had deliberately stoked up personal debt and inflation to unsustainable levels...

"In the environment of global economic weakness at the beginning of this decade ... external demand was declining and related to that business investment was declining.

"We only had two alternative ways of sustaining demand and keeping the economy moving forward: One was public spending and the other was consumption.

"Now of course it's true that taxation and public spending may influence the economic climate, may influence consumer spending.

"But we knew that we were having to stimulate consumer spending; we knew we had pushed it up to levels which couldn't possibly be sustained into the medium and long term.

"But for the time being, if we had not done that the UK economy would have gone into recession just as has the United States.

"That pushed up house prices, it increased household debt ... my legacy to the MPC if you like has been 'sort that out'."

Or put another way 'Why have a recession in 2001 when you can have a full-blown depression a few years later?'

Or put another way 'We could have stimulated the economy by building infrastructure that would have served the nation for generations but decided to encourage everyone to go out and buy shit instead'

Or put another way 'Me and my mates decide the price of your house, your monthly outgoings, how much you earn, and even whether you have a job or not. And there's f*** all you can do about it'

And because ordinary people don't understand, haven't been educated to understand, how money works, bankers can pull shit like this again and again without ever being strung up from the nearest lamp post. Hats off to whoever figured this money-lending game out in the first place. He was a clever dude. Destined to burn in Hades for all Eternity, sure enough, but definitely clever.

But all this seems absurd only if you assume that the governments and those who control them actually care for the welfare of their citizens. Most likely, the anglo countries have been racking up unsustainable levels of debt in order to finance their once-and-for-all power grab, although sometimes it’s hard to tell if the Military Industrial Complex was created to enable to takeover of total power in the world or if the goal of seizing total power was set forth to justify the Military Industrial Complex:

In Soviet America, the military beggars YOU!

Over half of all federal discretionary spending goes to the Pentagon. In non-Soviet Russia, the people beggar the military, which has to beg even for enough money to feed its troops and keep the power hooked up at its falling down bases. In Soviet America, the military beggars YOU.

So where is the money going? Well, bunches of it are going to contractors who provide truck drivers making $150K+/year to take the place of GI's making $20K/year, who provide cooks making $150K+/year to take the place of GI's making $20K/year, etc. Because of course it's cheaper to hire someone for $150K/year than to hire someone for $20K/year (snark!). Funny, most of these contractors also seem to be Bush administration cronies. Odd how that works out, eh?

Other money is going to weapons we don't need. The F-16 and the F/A 18 Super Hornet will be the best fighter jets in the world for the next 20+ years. Past a certain point you hit fundamental laws of physics, past which it is impossible to improve beyond what an airframe has already achieved. Consider this: The F-16 first flew over 30 years ago, yet even today, there is not a single jet fighter in the world that can out-dogfight it. None. Zero. Zilch. The only improvements there have been in the past thirty years have been in engines and avionics. Airframes? Not so much. We've hit fundamental laws of physics there. Yet we are spending hundreds of billions of dollars on F-22 and F-35 fighter jets that don't work any better for 99% of tasks than what we have yet are five times more expensive because, well, Pentagon cronies need money, I guess.

Then there is the enormous sum of money spent maintaining legions around the world -- Germany, South Korea, Iraq, Afghanistan, and hundreds of military bases all over the globe. Democracies don't need that. But empires do. And, in the end, that is what causes the collapse of empires. The Roman Empire collapsed because it ran out of money to pay its soldiers and they decided to sack Rome (repeatedly) and install one of their own as Emperor (repeatedly) to take by force what was due them, until there was nothing left to take and the barbarians came in and took over the pitiable remnants. In a democracy, there is little need for a large military because democracies do not attack other nations and defense can be handled by a part-time National Guard like in Switzerland. In a democracy, the people beggar the military because there just isn't much need for one. In an empire like Soviet America, on the other hand, the military beggars you.

Signs of the Economic Apocalypse, 3-19-07

From Signs of the Times:

Gold closed at 653.90 dollars an ounce Friday, up 0.6% from $650.10 at the close of the previous Friday. The dollar closed at 0.7509 euros Friday, down 1.5% from 0.7625 at the previous week’s close. That put the euro at 1.3318 dollars compared to 1.3115 at the end of the week before. Gold in euros would be 490.99 euros an ounce, down 1.0% from 495.69 for the week. Oil closed at 57.11 dollars a barrel, down 5.1% from $60.05 at the end of the week before. Oil in euros would be 42.88 euros a barrel, down 6.8% from 45.79 for the week. The gold/oil ratio closed at 11.45, up 5.7% from 10.83 at the close of the previous Friday. In U.S. stocks, the Dow Jones Industrial Average closed at 12,110.41, down 1.4% from 12,276.32 for the week. The NASDAQ closed at 2,372.66, down 0.6% from 2,387.55 at the close of the previous Friday. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.54%, down four basis points from 4.58 for the week.

Fears of a serious recession sparked by the bursting of the housing bubble drove down the dollar, oil and stocks last week. The problems of the sub-prime mortgage market were all over the news. For oil prices to drop so sharply, over 5% last week, in the face of extreme instability in the Middle East, it must mean that the housing problem in the United States is even worse then they are letting on.

Foreclosures May Hit 1.5 Million in U.S. Housing Bust

By Bob Ivry

March 12 (Bloomberg) -- Hold on to your assets. The deepest housing decline in 16 years is about to get worse.

As many as 1.5 million more Americans may lose their homes, another 100,000 people in housing-related industries could be fired, and an estimated 100 additional subprime mortgage companies that lend money to people with bad or limited credit may go under, according to realtors, economists, analysts and a Federal Reserve governor. Financial stocks also could extend their declines over mortgage default worries.

The spring buying season, when more than half of all U.S. home sales are made, has been so disappointing that the National Association of Home Builders in Washington now expects purchases to fall for the sixth consecutive quarter after it predicted a gain just last month.

“The correction will last another year,” said Mark Zandi, chief economist for Moody's Economy.com in West Chester, Pennsylvania. “Fewer people qualifying for mortgages means there will be less borrowers, and that will weigh on demand.”

A five-year housing boom that ended in 2006 expanded home- ownership to a record number of U.S. households. Now it has given way to mounting defaults, failing subprime mortgage companies and an increasing number of unsold homes.

Last Housing Slump

If this slump follows the same pattern as the last one, in 1991, it will persist for at least another year and may fuel a recession. New-home sales declined 45 percent from July 1989 to January 1991 and about 1 percent of all U.S. jobs, or 1.1 million, were lost in that recession, said Robert Kleinhenz, deputy chief economist of the California Association of Realtors.

This time around, new-home sales have declined 28 percent since September 2005, hitting a low in January, the last month for which data is available. And though the national jobless rate is near a five-year low this month, mortgage-related jobs fell by almost 2,000 in January alone. At least two dozen of the more than 8,000 mortgage lenders have been forced to close or sell operations since the start of 2006.

Subprime lenders Ameriquest Mortgage Co. in Irvine, California; Ownit Mortgage Solutions LLC and WMC Mortgage Corp., a subsidiary of General Electric Co., in Woodland Hills, California; Mortgage Lenders Network USA Inc. in Middletown, Connecticut and Fremont General Corp. together have fired more than 5,600 workers in the past year.

New Century

New Century Financial Corp., the second-largest subprime lender, said today it ran out of cash to pay back creditors who are demanding their money now. The Irvine, California-based company has lost 90 percent of its market value this year and stopped making new subprime loans, prompting speculation it will seek bankruptcy protection. New Century already has cut 300 jobs and its 7,000 remaining employees are waiting to see if the company will survive.

Fremont General, the Brea, California-based lender that is trying to sell its residential-mortgage unit, was ordered to stop making subprime loans by the U.S. Federal Deposit Insurance Corp. last week. Fremont was marketing and extending loans “in a way that substantially increased the likelihood of borrower default or other loss to the bank,” the FDIC said last week.

Doug Duncan, chief economist of the Washington-based Mortgage Bankers Association, predicted in January that more than 100 home lenders may fail this year.

The subprime crisis “has taken the fuel out of the real estate market,” said Edward Leamer, director of the UCLA Anderson Forecast in Los Angeles. “The market needs new money in order to appreciate, and all of that money is gone for a very long time. The regulators are not going to allow it to happen again.”

Higher Rates

Subprime mortgages are given to people who wouldn't qualify for standard home loans and typically have rates at least 2 or 3 percentage points above safer prime loans. The portion of subprime loans that financed new mortgages rose to 20 percent last year from 5 percent in 2001, according to the Mortgage Bankers Association.

Subprime loans contributed to a home-ownership rate that reached a record 69.3 percent of U.S. households in the second quarter of 2004, up 5.4 percentage points from the same period in 1991, according to the U.S. Census Bureau.

“Probably the gain in home ownership over the last four, five years, is almost entirely due to looser lending standards,” said James Fielding, a homebuilding credit analyst at Standard & Poor's in New York.

Refinancing Option

As home prices steadily gained from 2001 to 2006, homeowners who fell behind on mortgage payments could sell their homes and pay off their loans or get better refinancing terms based on the higher value of their property. Now that home values are declining, many borrowers won't be able to refinance because they would have to come up with the difference between their new mortgage and what their home is now worth.

Defaults may dump more than 500,000 homes on a housing market already saturated with leftover inventory built during boom times, New York-based bond research firm CreditSights Inc. said in a March 1 report.

Mortgage defaults may climb to $225 billion over the next two years, compared with about $40 billion annually in 2005 and 2006, according to debt strategists at Lehman Brothers Holdings Inc.

Seven-Year High

The portion of subprime loans more than 60 days delinquent or in foreclosure rose to 10 percent as of Dec. 31, from 5.4 percent in May 2005, the highest in seven years, according to data compiled by Friedman Billings Ramsey Group Inc. of Arlington, Virginia.

Many of the delinquencies came from loans where borrowers didn't have to provide tax returns or other evidence of income, or where they financed 100 percent or more of the home's value, CreditSights analyst David Hendler wrote in a March 5 report. Other defaults came on adjustable-rate mortgages with artificially low introductory “teaser” rates, sometimes with “option” payment plans that allowed borrowers to defer interest.

Banks ought to be concerned about such loans and are likely to see more missed payments and foreclosures as consumers with weak credit histories begin to face higher monthly mortgage payments, Federal Reserve Governor Susan Bies said last week.

“What we're seeing in this narrow segment is the beginning of the wave,” Bies said. “This is not the end, this is the beginning.”

About 1.5 million U.S. homeowners out of a total of 80 million will lose their homes through foreclosure, University of California-Berkeley economist Ken Rosen said last week.

“The subprime borrowers paid too much for their homes, and all of a sudden, they'll see their house value drop by 10 to 15 percent,” Rosen said.

Borrowers at Risk

The Center for Responsible Lending in Durham, North Carolina, said in a December study that as many as 2.2 million borrowers are at risk of losing their homes, at a potential cost of $164 billion, from subprime mortgages originated from 1998 through 2006.

The number of U.S. foreclosures rose 42 percent to 1.2 million last year from 2005, according to Irvine, California-based RealtyTrac, while delinquencies in the last three months of 2006 rose to the highest level in four years, the Federal Reserve said.

Housing and related industries, which account for about 23 percent of the U.S. economy -- including makers of everything from copper pipes to kitchen cabinets -- fired about 100,000 workers last year. The total will be higher this year, according to Amal Bendimerad of the Joint Center for Housing Studies at Harvard University in Cambridge, Massachusetts.

Job Cuts

By the end of this year, job cuts at companies including Benton Harbor, Michigan-based Whirlpool Corp., Masco Corp. of Taylor, Michigan, and St. Louis-based Emerson Electric Co. may exceed the fallout from the 1991 housing slump, said Paul Puryear, managing director at St. Petersburg, Florida-based Raymond James & Associates. The Bureau of Labor Statistics doesn't give data for housing-related job losses.

“The fallout in the early 1990s was much worse than what we've seen so far, but this downturn is not over,” Puryear said. “The full impact hasn't hit yet.”

U.S. House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, said he may propose legislation to reign in “inappropriate” lending, and a House subcommittee is scheduled to consider subprime lending and foreclosures March 27.

“The standards got loosened so much, and there's always the pressure to make money that there was pressure to maybe make the questionable loans that shouldn't have been made,” said Ohio Representative Paul Gillmor, the subcommittee's top Republican, in a March 9 interview. “The major problem has been the overall deterioration in credit standards by lenders that's exacerbated by those who are unscrupulous.”

Fraud ‘Pervasive and Growing'

The Federal Bureau of Investigation says mortgage fraud is “pervasive and growing” and the incidence of such fraud has almost doubled in the past three years.

“There has been an increase in unscrupulous individuals in the market,” said Arthur Prieston, chairman of the Prieston Group, a San Francisco-based company that investigates mortgage fraud. “There's an unfair assumption of a connection between subprime failure and fraud. But there is a connection between early default and fraud.”

Mortgage fraud is committed when a borrower misrepresents himself or his finances to a lender. Some of that fraud involved speculators. They drove up prices during the boom by ordering new homes with the intent of selling them immediately after taking possession.

That “flipping” inflated demand and put the speculators in competition with the homebuilders, propelling the median U.S. home price to $276,000 last June from $177,000 in February 2001.

Housing Bubble

“A lot of the housing bubble was speculation,” said Mike Inselmann of the Houston-based research firm Metrostudy.

When home prices got so high that speculators could no longer turn a profit, they canceled their contracts and walked away from their down payments.

Cancellation rates for new homes have surged to almost 40 percent of home contracts, Margaret Whelan, a New York-based analyst at UBS AG, said in a report on March 2.

That forced the top five U.S. homebuilders -- D.R. Horton Inc., Pulte Homes Inc., Lennar Corp., Centex Corp. and Toll Brothers Inc. -- to write off a combined $1.47 billion on abandoned land in the fourth quarter of 2006.

On top of that, new home sales plunged 17 percent last year from 2005, the biggest decline since 1990, according to the Chicago-based National Association of Home Builders. Existing home sales fell 8.4 percent in 2006 from a record in 2005, according to the National Association of Realtors…

The problem is so important, yet more than a little complicated, so it’s worth reading different attempts to explain it, even though it’s ground we have covered extensively. Most people can understand mortgages and risky mortgages. But bring in securitized mortage pools and then derivatives and it becomes increasingly hard for the layperson to keep up. The following is one of the better explanations of derivatives:

"Well, What Do You Want It To Be?"

Thursday, March 15, 2007

Today I will follow a debt trail, from loan origination all the way to its ultimate existence as part of a credit derivative product. I will use a sup-prime mortgage loan as an example, but any debt obligation will do. Keep the question of the title in mind, it will make sense in the end.

Let's start two years ago with Ron and Ronda White, a couple in their early 30's with a combined income of $60.000 who have their eyes set on a $300.000 house to call home. They have saved only $5.000 to put down, which barely covers the closing costs. Their mortgage broker talks them into a $250.000 first mortgage ARM with an initial 2-year teaser rate of 2% rising to prime+1% thereafter and a $50.000 second, 30-year fixed at a whopping 10.5%. Despite the obvious problems apparent right from the start, such loans were made to hundreds of thousands of people. But no matter...

The two loans were immediately sold to investment bank XYZ who pooled them with other loans (creating Residential Mortgage Backed Security, or RMBS) and placed them inside a CDO. Using recent default data, the financial engineer employed by XYZ took 90% of the White's outstanding mortgage amount and placed it in CDO Tranch A, the supposedly safest portion rated AAA and paying 0.10% more than other AAA straight corporate bonds. The rest was apportioned 7% to Tranch B rated BBB, paying 1.5% more than equivalent bonds and the remaining 3% to Tranche C, also known as the "equity" tranche, which was unrated and paying 10% above Treasury bonds. In case of default, Tranche C gets hit first until it is exhausted, then Tranche B and, finally, Tranche A. This is a "cascade" or "waterfall" pattern, common to all such collateralized products.

Notice how 100% of a loan package that could be described as CCC has been turned into 90% AAA, 7% BBB and 3% NR. In plain terms, the "engineer" is betting that no more than ~3% of the total principal and interest will be lost, including recoveries from selling foreclosed real estate.

Call this the First Derivative - depending on conditions, the market prices of the CDO Tranches will vary significantly more than straight corporate or government bonds.Those CDO Tranches are then sold as follows, typically:

· Tranche A to a pension fund attracted by the slight yield premium on a AAA bond.

· Tranche B to a fixed income mutual fund.

· Tranche C to a hedge fund attracted by the high yield - or is retained by XYZ.

So far this has been a plain vanilla process, the only question mark being how high or low the "engineer" places the assumptions for defaults and recoveries.

The next step in debt "derivativization" is the issuance and trading of Credit Default Swaps on the first two Tranches of the CDO. It can be done by XYZ, another bank, a hedge fund or all of them - there is no limit. These swaps guarantee payment in case of default events by the CDO, itself a conduit for Mr. and Mrs. Smith's mortgages. These CDS's require an up front payment and subsequent semi-annual ones, usually for up to five years. One can think of them as tradeable insurance policies. Naturally, Tranche A carries a much smaller insurance premium than Tranche B, given the respective AAA and BBB ratings.

Call this the Second Derivative - the prices of CDS's will certainly vary more than the prices of the underlying Tranches and much more than straight bonds.These CDS's generate income to the seller, who assumes the risk of making the buyer whole if the CDO Tranches experiences payment shortages. Who sells this insurance?

· CDS on Tranche A may generate 0.15% annually and is typically sold by a bank or a pension fund attracted by the income generated by insuring a AAA credit.

· CDS on Tranche B may generate 1.30% annually, commonly sold by hedge funds.

Who buys the stuff? It would seem pointless for the CDO owner to buy protection for the bonds he already owns, but it does happen for portfolio hedging purposes or even as a way to "trade" the underlying CDO's without actually selling or buying the actual bonds.

But there are more buyers than just hedgers, as we shall see below.

Another investment bank, it could even be XYZ itself, buys a bunch of such CDS's and creates another CDO, also with tranches, ratings, etc. Remember, all you need for a CDO is a stream of regular payments to slice and dice into tranches.

We have now reached the Third Derivative stage: the potential volatility of such a product can be orders of magnitude greater than a simple bond. This is a CDO made up of CDS on another CDO made up of RMBS's - the alphabet soup is thickening fast. The credit leverage, i.e. what happens to the price of this type of product for a given rise in loan defaults in the, by now very distant, mortgage is very, very high.

Should an "investor" actually provide cash to purchase the above Third Derivative CDO we have what is known as a "funded" CDO. But this is becoming increasingly uncommon, because there is yet another derivation that can be performed on Mr. and Mrs. White's nortgage.

Another investment bank (or the original XYZ) can construct an "unfunded" CDO from the CDS's in step three, an instrument that just pays out or demands payment from its owners on a quarterly basis, depending on the shrinking or widening of the CDS spreads. This "synthetic" CDO owns nothing - not even the CDS; it just uses them to mark to market the said CDS spreads and to thus calculate the quarterly payments.

We are up to the Fourth Derivative. Sorry, but I have run out of superlatives to describe the leverage, volatility and credit risk sensitivity of these constructs. And yet, les apprentices sorciers who cook them up think it "innovative financial engineering". Like any fourth derivation, the price of such instruments is completely unrecognizable versus the original mortgage.

Thus the title of today's post, explained best by an anecdote:

Bank XYZ is looking for a dealer for its derivatives desk. Candidate A walks in the door and the desk manager asks, "What is 2 and 2?" --- "Four, sir" answers the job candidate. "Next", says the manager.

Candidate B is asked the same question: "Depends on if you mean 2 plus 2, or 2 minus 2", answers B ..."Next"...

Candidate C comes in and before he answers the question he looks at the manager and asks: "I just want to be absolutely sure - the job is for the credit derivatives desk, right?"

"Certainly", answers the desk manager.

"In that case, 2 and 2 is whatever YOU want it to be", says C.

"Hired, when can you start?"

P.S. Now, let's say that Mr. and Mrs. White default on their loan and, along with them, another 6% of the mortgages default, too - way above what the "engineer" had assumed. What will happen to the prices of the above RMBS, CDO, CDS, Synthetic CDO's? Aren't we lucky we have trader C to tell us - or aren't we?

P.P.S. If it was not made clear, unlimited CDS's can be written on a particular debt obligation, including the CDO in step one. Say a "first derivative" CDO has $100 million outstanding. The CDS's issued against, however, may amount to many times that - as I said, there is no limit. Therefore, there is no limit to the third or fourth derivative CDO's that may be issued, themselves backed by those multiple CDS's. This situation can easily create a viral contagion negative effect, as one "sick" original CDO can infect many others through the CDS market. Ouch.

Here’s this from the Washington Post (no longer is it just crazy bloggers writing about this stuff!)

'No Money Down' Falls Flat

By Steven Pearlstein
Wednesday, March 14, 2007

Today's pop quiz involves some potentially exciting new products that mortgage bankers have come up with to make homeownership a reality for cash-strapped first-time buyers.

Here goes: Which of these products do you think makes sense?

(a) The "balloon mortgage," in which the borrower pays only interest for 10 years before a big lump-sum payment is due.
(b) The "liar loan," in which the borrower is asked merely to state his annual income, without presenting any documentation.
(c) The "option ARM" loan, in which the borrower can pay less than the agreed-upon interest and principal payment, simply by adding to the outstanding balance of the loan.
(d) The "piggyback loan," in which a combination of a first and second mortgage eliminates the need for any down payment.
(e) The "teaser loan," which qualifies a borrower for a loan based on an artificially low initial interest rate, even though he or she doesn't have sufficient income to make the monthly payments when the interest rate is reset in two years.
(f) The "stretch loan," in which the borrower has to commit more than 50 percent of gross income to make the monthly payments.
(g) All of the above.

If you answered (g), congratulations! Not only do you qualify for a job as a mortgage banker, but you may also have a future as a Wall Street investment banker and a bank regulator.

No, folks, I'm not making this up. Not only has the industry embraced these "innovations," but it has also begun to combine various features into a single loan and offer it to high-risk borrowers. One cheeky lender went so far as to advertise what it dubbed its "NINJA" loan -- NINJA standing for "No Income, No Job and No Assets."

In fact, these innovative products are now so commonplace, they have been the driving force in the boom in the housing industry at least since 2005. They are a big reason why homeownership has increased from 65 percent of households to a record 69 percent. They help explain why outstanding mortgage debt has increased by $9.5 trillion in the past four years. And they are, unquestionably, a big factor behind the incredible run-up in home prices.

Now they are also a major reason the subprime mortgage market is melting down, why 1.5 million Americans may lose their homes to foreclosure and why hundreds of thousands of homes could be dumped on an already glutted market. They also represent a huge cloud hanging over Wall Street investment houses, which packaged and sold these mortgages to investors around the world.

How did we get to this point?

It began years ago when Lewis Ranieri, an investment banker at the old Salomon Brothers, dreamed up the idea of buying mortgages from bank lenders, bundling them and issuing bonds with the bundles as collateral. The monthly payments from homeowners were used to pay interest on the bonds, and principal was repaid once all the mortgages had been paid down or refinanced.

Thanks to Ranieri and his successors, almost anyone can originate a mortgage loan -- not just banks and big mortgage lenders, but any mortgage broker with a Web site and a phone. Some banks still keep the mortgages they write. But most other originators sell them to investment banks that package and "securitize" them. And because the originators make their money from fees and from selling the loans, they don't have much at risk if borrowers can't keep up with their payments.

And therein lies the problem: an incentive structure that encourages originators to write risky loans, collect the big fees and let someone else suffer the consequences.

This "moral hazard," as economists call it, has been magnified by another innovation in the capital markets. Instead of packaging entire mortgages, Wall Street came up with the idea of dividing them into "tranches." The safest tranche, which offers investors a relatively low interest rate, will be the first to be paid off if too many borrowers default and their houses are sold at foreclosure auction. The owners of the riskiest tranche, in contrast, will be the last to be paid, and thus have the biggest risk if too many houses are auctioned for less than the value of their loans. In return for this risk, their bonds offer the highest yield.

It was this ability to chop packages of mortgages into different risk tranches that really enabled the mortgage industry to rush headlong into all those new products and new markets -- in particular, the subprime market for borrowers with sketchy credit histories. Selling the safe tranches was easy, while the riskiest tranches appealed to the booming hedge-fund industry and other investors like pension funds desperate for anything offering a higher yield. So eager were global investors for these securities that when the housing market began to slow, they practically invited the mortgage bankers to keep generating new loans even if it meant they were riskier. The mortgage bankers were only too happy to oblige.

By the spring of 2005, the deterioration of lending standards was pretty clear. They were the subject of numerous eye-popping articles in The Post by my colleague Kirstin Downey. Regulators began to warn publicly of the problem, among them Fed Chairman Alan Greenspan. Several members of Congress called for a clampdown. Mortgage insurers and numerous independent analysts warned of a gathering crisis.

But it wasn't until December 2005 that the four bank regulatory agencies were able to hash out their differences and offer for public comment some "guidance" for what they politely called "nontraditional mortgages." Months ensued as the mortgage bankers fought the proposed rules with all the usual bogus arguments, accusing the agencies of "regulatory overreach," "stifling innovation" and substituting the judgment of bureaucrats for the collective wisdom of thousands of experienced lenders and millions of sophisticated investors. And they warned that any tightening of standards would trigger a credit crunch and burst the housing bubble that their loosey-goosey lending had helped spawn.

The industry campaign didn't sway the regulators, but it did delay final implementation of the guidance until September 2006, both by federal and many state regulators. And even now, with the market for subprime mortgages collapsing around them, the mortgage bankers and their highly paid enablers on Wall Street continue to deny there is a serious problem, or that they have any responsibility for it. In substance and tone, they sound almost exactly like the accounting firms and investment banks back when Enron and WorldCom were crashing around them.

What we have here is a failure of common sense. With occasional exceptions, bankers shouldn't make -- or be allowed to make -- mortgage loans that require no money down and no documentation of income to people who won't be able to afford the monthly payments if interest rates rise, house prices fall or the roof springs a leak. It's not a whole lot more complicated than that.

Although the mainstream media is now covering the issue, rarely have they pointed out one obvious fact. The reason they had to extend credit to such poor risks is that there was no other way to keep the market afloat while they were, in effect, cutting the pay of the vast majority of people in the United States. The results are completely predictable and have been predicted for years, so that can only mean that the whole cycle, from bubble creation to bubble popping, has been intentional, has been part of a long process of funneling the wealth up to a small elite. Those in the know could make out like bandits as long as they know when to pull out. When the crash happens, we may go from being debt- and wage-slaves to real slaves.

Another thing the mainstream media ignores in all of this talk about the housing market is how this crash coincides with disastrous foreign-policy mistaked by the United States. That is the elephant in the room. Many financial journalists are comparing this housing bust with the one in 1990-91. The difference here couldn’t be clearer. In 1991, the United States was a triumpant winner of both the Cold War and the Gulf War. In 2007, the United States is in the process of losing everything.

Signs of the Economic Apocalypse, 3-12-07

From Signs of the Times:


Gold closed at 650.10 dollars an ounce Friday, up 0.7% from $645.90 at the close of the previous Friday. The dollar closed at 0.7625 euros Friday, up 0.6% from 0.7580 at the previous week’s close. That put the euro at 1.3115 dollars compared to 1.3193 at the end of the week before. Gold in euros would be 495.69 euros an ounce, up 1.2% from 489.58 euros for the week. Oil closed at 60.05 dollars a barrel Friday, down 2.4% from $61.47 at the end of the week before. Oil in euros would be 45.79 euros a barrel, down 1.7% from 46.59 for the week. The gold/oil ratio closed at 10.83, up 3% from 10.51 at the close of the previous Friday. In U.S. stocks, the Dow closed at 12,276.32, up 1.1% from 12,138.77 for the week. The NASDAQ closed at 2,387.55 up 0.6% from 2,374.12 at the close of the Friday before. In U.S. interest rates the yield on the ten-year U.S. Treasury note closed at 4.58%, down seven basis points from 4.51 for the week

The stabilizing of stock markets, caused by halfway decent U.S. employment numbers last month (97,000 jobs added) or by the Plunge Protection Team, take your pick, calmed a lot of nerves. I guess last week wasn’t the time the Plunge Protection Team either couldn’t or wouldn’t stop the plunge. Here is Mike Whitney on the PPT:

Juicing the Stock Market
The secret maneuverings of the Plunge Protection Team

By Mike Whitney03/07/07

The Working Group on Financial Markets, also known as the Plunge Protection Team, was created by Ronald Reagan to prevent a repeat of the Wall Street meltdown of October 1987. Its members include the Secretary of the Treasury, the Chairman of the Federal Reserve, the Chairman of the SEC and the Chairman of the Commodity Futures Trading Commission. Recently, the team has been on high-alert given the increased volatility of the markets and, what Hank Paulson calls, "the systemic risk posed by hedge funds and derivatives.”

Last Tuesday’s 416 point drop in the stock market has sent tremors through global system. An 8% freefall on the Chinese stock exchange triggered a massive equities sell-off which continued sporadically throughout the week. The sudden shift in sentiment, from Bull to Bear, has drawn more attention to deeply rooted “systemic” problems in the US economy. US manufacturing is already in recession, the dollar continues to weaken, consumer spending is flat, and the sub-prime market in real estate has begun to nosedive. These have all contributed to the markets’ erratic behavior and created the likelihood that the Plunge Protection Team may be stealthily intervening behind the scenes.

According to John Crudele of the New York Post, the Plunge Protection Team’s (PPT) modus operandi was revealed by a former member of the Federal Reserve Board, Robert Heller. Heller said that disasters could be mitigated by “buying market averages in the futures market, thus stabilizing the market as a whole.” This appears to be the strategy that has been used…

In fact, as Ambrose Evans-Pritchard of the U.K. Telegraph notes, Secretary of the Treasury, Hank Paulson has called for the PPT to meet with greater frequency and set up “a command centre at the US Treasury that will track global markets and serve as an operations base in the next crisis. The top brass will meet every six weeks, combining the heads of Treasury, Federal Reserve, Securities and Exchange Commission (SEC), and key exchanges”.

This suggests that the PPT may have been deeply involved in last Wednesday’s “miraculous” stock market rebound from Tuesday’s losses. There was no apparent reason for the market to suddenly “go positive” following a ruinous day that shook investor confidence around the world. The editors of the New York Times summarized the feelings of many market-watchers who were baffled by this odd recovery:

“The torrent of bad news on housing is only worsening, with a report yesterday that new home sales for January had their steepest slide in 13 years...Manufacturing has already slipped into a recession, with activity contracting in two of the last three months. How is it then that investors took Mr. Bernanke’s words as a “buy” signal?”

How indeed; unless other forces were operating secretly behind the scenes?

Market Rigging

“Gaming” the system may be easier than many people believe. Robert McHugh, Ph.D. has provided a description of how it works which seems consistent with the comments of Robert Heller. McHugh lays it out like this:

“The PPT decides markets need intervention, a decline needs to be stopped, or the risks associated with political events that could be perceived by markets as highly negative and cause a decline; need to be prevented by a rally already in flight. To get that rally, the PPT’s key component — the Fed — lends money to surrogates who will take that fresh electronically printed cash and buy markets through some large unknown buyer’s account. That buying comes out of the blue at a time when short interest is high. The unexpected rally strikes blood, and fear overcomes those who were betting the market would drop. These shorts need to cover, need to buy the very stocks they had agreed to sell (without owning them) at today’s prices in anticipation they could buy them in the future at much lower prices and pocket the difference. Seeing those stocks rally above their committed selling price, the shorts are forced to buy — and buy they do. Thus, those most pessimistic about the equity market end up buying equities like mad, fueling the rally that the PPT started. Bingo, a huge turnaround rally is well underway, and sidelines money from Hedge Funds, Mutual funds and individuals’ rushes in to join in the buying madness for several days and weeks as the rally gathers a life of its own.” (Robert McHugh, Ph.D., “The Plunge Protection Team Indicator”)

If a secret team is interfering in the stock market, it presents serious practical and moral issues. For one thing, it disrupts natural “corrections” which are a normal part of the business cycle and which help to maintain a healthy and competitive slate of equities.

More importantly, outside intervention punishes the people who see the weaknesses in the stock market and have invested accordingly. Clearly, these people are being ripped off by the PPT’s back-channel manipulations. They deserve to be fairly compensated for the risks they have taken.

Moreover, artificially propping up the market only encourages over-leveraged speculators and smiley-face Pollyanna’s who continue to believe that the grossly-inflated market will continue to rise. Rewarding foolishness only stimulates greater speculation.

The tinkering of the PPT is sure to erode confidence in the unimpeded activity of capital markets. It’s astonishing to think that, after years of singing the praises of the “free market” as the ultimate expression of God’s divine plan; these same conservative ideologues and “market purists” favor a strategy for direct intrusion. The actions of the Plunge Protection Team prove that it’s all baloney. The “free market” is merely a public relations myth with no basis in reality. Saving the system will always take precedent over ideology; just as the “invisible hand” will always be overpowered by the manicured and mettlesome fingers of banking elites and Wall Street big wigs. It’s their system and they’re not going to let it get wiped out by some silly commitment to principle.

The free market system is supposed to be “self cleansing” through cyclical purges of over-inflated equities and over-extended speculators. Do we really want “central planning” from an unelected, Market-Nanny that re-jiggers the system according to its own economic interests?

The Plunge Protection Team may wrap itself in pompous rhetoric, but it operates like a Fiscal Politburo inserting itself into the market in way that promotes the narrow interests of its own constituents. It’s an outrage.

Besides, the market is so fragile it trembles every time someone halfway around the world sells a fistful of equities. It needs a good shakedown.

The years of deregulation have taken their toll. The market is resting on a foundation of pure quicksand. Collateralized debt, rickety hedge funds, shaky sub-prime equities, and an ocean of margin debt are just a few examples of deregulation’s excesses. These untested debt-instruments are presently bearing down on Wall Street like a laser-guided missile. It’ll take more than Hank Paulson and his PPT “plumber’s unit” to prevent the implosion…

The upshot is a one-sided bet for investors. They have explicit assurances from regulators and policy makers that almost anything goes when the markets are hot, and implicit assurances — based on past experience — that the Fed would lower interest rates to contain a financial crisis should one erupt. Unfortunately, there is no guarantee that easing up on rates would have the same powerful effect in a future crisis as it had in the past.

The next crisis appears to be building around weakness in the United States, not in Russia or Asia or South America. That means money could flow out of the country if markets were rattled. That would weaken the dollar and require speedy and complex remedial action by the world’s central banks — not just a rate cut by the Fed.” (NY Time)

...This is the biggest equity bubble in history. Neither increasing the money supply nor lowering interest rates will fend off the impending catastrophe. We need to address the mushrooming risk that has arisen from lending hundreds of billions in sub-prime loans, and from overexposure in the hedge funds and derivatives markets. These things need to be confronted immediately as they pose a “clear and present danger” which could set off a chain reaction of defaults and bankruptcies.

The world’s markets are facing a global liquidity crisis which will become more evident as the real estate sub-prime market continues to deteriorate. This will undoubtedly be accompanied by larger and more ferocious gyrations in the stock market.

Does “Hans Brinker” Paulson really believe he can stop the flood by sticking his well-burnished finger in the dike?

It’s All Uphill from Here on Out

The U.S. economy faces daunting challenges in the near-future; a steadily shrinking manufacturing sector, increasing job losses in housing, a nascent currency crisis, and a real estate market that is in full retreat. Additionally, the “always dependable” American consumer is showing signs of fatigue which is pushing investors towards foreign markets.

This explains why “the SEC said it aims to slash margin requirements for institutions and hedge funds on stocks, options, and futures to as low as 15pc, down from a range of 25pc to 50pc.The ostensible reason is to lure back hedge funds from London, but it is odd policy to license extra leverage just as the Dow hits an all-time high and the VIX 'fear' index nears an all-time low – signaling a worrying level of risk appetite. The normal practice across the world is to tighten margins to cool over-heated asset markets.” (Ambrose Evans-Pritchard, “Monday View: Paulson Reactivates Secretive support team to prevent markets meltdown” UK Telegraph)

This is yet another red flag. The stewards of the system are actively seeking larger infusions of marginal debt just to keep the faltering market on its last legs.

That’s not reassuring and it is clearly a step in the wrong direction. It further illustrates the worrisome level of recklessness at the top rungs of the decision-making apparatus…

The precariousness of our present economic situation has caused these dramatic changes and strengthened the conjugal relationship between the privately-owned Central Bank, major corporations and the state. The market is more vulnerable now than anytime since the late 1920s, a fact that was emphasized in a statement by the IMF just 2 months ago:

“Financial markets have failed to price in the risk that any one of a host of threats to economic security could materialize and deliver a massive shock to the world economy. It is clear that risks are on the downside of a sharper than expected slowdown in house prices that would produce weaker-than-expected growth that would have implications for global growth and financial markets.” (“IMF: Risk of global crash is increasing” UK Independent)

Risk, over-exposure, cheap money, shaky loans, a falling dollar, low reserves and a confidence deficit; these are the crumbling cinder-blocks upon which America’s Empire of Debt currently rests. The possibility of a major disruption grows more likely by the day. Consider the world's 8,000 unregulated hedge funds with $1.3trillion at their disposal or the wobbly derivatives market and the effects that a sudden downturn might have. Kenneth J. Gerbino put it like this in his recent article “The Big Sell Off” on kitco.com:

“With a global market panic starting in a low interest rate and, so far, low inflation environment, one has to be wonder about the real reason for (Tuesday’s) sell-off. Easy money almost everywhere leads to leverage and speculation. No where is this more prevalent than in the global derivatives market. It is not out of the question that third party defaults and risk aversion designed instruments that collapse and go sour may someday overwhelm the financial markets. Latest figures from the Bank of International Settlements: $8.3 trillion of real money is controlling $313 trillion in derivatives. That’s 38 to 1 leverage. These figures are just for the over - the - counter derivatives and do not include the global exchange traded derivatives in currencies, stocks and commodities which are another $75 trillion.”

“$8.3 trillion of real money is controlling $313 trillion in derivatives!”

This illustrates the sheer magnitude of the problem and the economy-busting potential of a miscalculation. That’s why Warren Buffett calls derivatives “weapons of mass destruction”. If there’s a fire-sale in hedge funds or derivatives, there’s nothing the Plunge Protection Team or the Federal Reserve will be able to do to stop a meltdown. The market will crash leaving nothing behind.

We are reaping the rewards of a lawless, deregulated system which has removed all the safeguards for protecting the small investor. There is no government oversight; it’s a joke. The stock market is a crap-shoot that serves the sole interests of establishment elites, corporate plutocrats, and banking giants. The small investor is trapped beneath the wheel and getting squeezed more and more every day. He has no way to fix the markets like the big guys and no lobby to promote his interests. He must arrive at his decisions by researching publicly available information and then plunking down his money. That’s it. He’d be better off in a casino; the odds are about the same.

Whitney has a point. Why did the market rally when all week the news on the subprime mortgage front was grim? As we discussed last week, defaults in the mortgage market in the United States will have effects going beyond financial corporations and far beyond the borders of the United States:

GM May Take Almost $1 Billion Charge for Mortgages

By Greg Bensinger

March 6 (Bloomberg) -- General Motors Corp., the world’s largest automaker, may take a charge of almost $1 billion to cover bad mortgage loans made by its former home-lending unit, according to a Lehman Brothers Holdings Inc. analyst.

Residential Capital LLC relies on loans to people with poor or limited credit records or high debt burdens, for more than three-quarters, or $57 billion, of its loan portfolio, Lehman analyst Brian Johnson wrote in a research report. Delinquency rates on such subprime loans made last year are at a record high.

Detroit-based GM, struggling to reverse more than $13 billion in losses over the last seven quarters through Sept. 30, delayed filing its fourth-quarter and full-year earnings to as late as March 16 in order to restate results. The company in November sold a 51 percent stake in General Motors Acceptance Corp. for $14.4 billion to a group led by Cerberus Capital Management LP. Residential Capital, or ResCap, is part of GMAC.

The subprime market is “a key factor to see what the earnings power of GM’s remaining interest in GMAC is going to be,’’ Johnson said in an interview.
GM may have to spend as much as $950 million to make up the difference between the original value of the finance unit and any losses for subprime loans made by ResCap, he said last month.

Rising Delinquencies

About 13 percent of the subprime loans backing bonds issued in 2006 and rated by S&P are delinquent, with 6.65 percent of the loans behind in payments by 90 days or more, according to Standard & Poor’s. More than 20 lenders have closed or are seeking buyers since the beginning of 2006. Subprime mortgages typically have rates at least two or three percentage points above safer prime loans.

“Some traders are expressing their view that we’re a pure mortgage market play, whether that’s appropriate or not,” Louise Herrle, ResCap’s treasurer, said in an interview last week.

ResCap may have lost $160 million to $520 million in the fourth quarter because of subprime mortgages, Citigroup Inc. analyst Jon Rogers in New York said on Feb. 28…

The news last week that Barclays Bank revealed $1 billion in exposure to the sub-prime lender New Century Financial Corporation shows that it will not only be imprudent United States people who will pay for this, but also the thrifty Europeans.

The whole world feels American subprime pain

Andrew Leonard
Salon

When How the World Works first began checking in on the state of the U.S. housing market, the rationale for including such a topic in a blog ostensibly about globalization was straightforward:

American consumers are the locomotive pulling the global economy forward. The rapid appreciation of home prices in the great housing boom of the early 21st century gave those consumers access to a seemingly unlimited ATM of home equity financing. If the housing bust turned off that spigot, then the global economy might go off the tracks.

A year ago, HTWW had little clue that the subprime mortgage lending market would be the first great casualty of a popped housing bubble (although as far back as last April, I did note that some Wall Street hedge funds had begun to bet on a bust). But a separate fixation of this space has always been the exotic world of derivatives trading, and it has been enlightening to watch how the housing bust has become a narrative about derivatives. The repackaging of subprime mortgage bonds into "collateralized debt obligations" -- a derivative instrument that has boomed in popularity over the past decade -- is the stuff of daily coverage in the financial pages today, with no one particularly sure whether what we are seeing is the Achilles' heel of the global economy finally exposed or proof that modern financial systems are sophisticated and resilient enough to survive any shock.

Whatever the case is, the narrative provides another angle on globalization. As the Wall Street Journal reports today, European investors are discovering that they unwittingly exposed themselves to the U.S. housing bust by buying collateralized debt obligations that included repackaged American subprime mortgage loans.

Investors are realizing they may own more exposure to subprime-mortgage-loan pools than they thought.

That exposure is surfacing because of the way fixed-income investments can be layered. Banks sell asset-backed securities, known as ABS, backed by mortgages to investors. The ABS can ultimately end up in complex structures called collateralized debt obligations, or CDOs. Institutional investors invest in CDOs, sometimes not realizing they have subprime mortgages in them.

"There are European investors who until a few weeks ago did not know an awful lot about what subprime was who are realizing that they actually have exposure through some of their CDOs," said Citigroup credit strategist Hans Lorenzen. "I've spoken to one investor who said that their portfolio had exposure to subprime and they just knew that it had some American ABS exposure. They hadn't gone through enough detail" of their investment to realize they owned loans to Americans with spotty credit records.

Because derivatives trading is relatively unregulated and exceedingly complex, no one really knows how exposed European investors (or big American players like Goldman Sachs or Citigroup) are to the subprime mess. It's also true, as the New York Times reports today, that if you were smart enough to bet on a housing bust coming true, you are making good money now off of subprime misfortune. Maybe risk has been sufficiently spread around and hedged in so many different directions that for every loser there will be a winner and it will all balance out in the end. That would be nice, for the global economy.

But the deeper story is that the evolution of derivatives trading, in which ever-more-complex securities that are created by repackaging underlying assets (home loans, car loans, stocks and bonds and futures options and so on) in ever more innovative ways, is resulting in a global economy where investors all over the world, whether they know it or not, have a finger sticking in everyone else's pie. So the risk for a home loan made to a Californian with bad credit may end up partially borne by a hedge fund in Latvia. And a meltdown anywhere ripples into everywhere.

But, thanks to the Plunge Protection Team, we can relax for a little while (weeks? days?).

Irresponsible bubble creation, lack of real political alternatives, and general political and economic idiocy is unfortunately not exclusive to the United States. Here is Stef Zucconi on future U.K. prime minister and current Chancellor of the Exchequer, Gordon Brown:

Gordon Brown, Chancellor of the Exchequer and Prime Minister in waiting, came out with a blinder yesterday and announced that health and other public sector workers were going to receive a below inflation pay rise this year.In the words of good old Gordie..."The overall awards come within the inflation target at 1.9% demonstrating our total determination to maintain discipline and stability and continue with an 11th year of sustained economic growth."
Gordon neglected to mention that, whatever La La Land inflation targets the government may set, the real rate of inflation for ordinary people is something like 4 to 9% which means nurses will be receiving an effective pay cut of as much as 5% in real terms.
He also neglected to mention that giving lower paid staff an effective pay cut will have virtually f*** all impact on the rate of inflation.

Inflation has a LOT more to do with the 800 billion pounds of personal debt (all paying a lovely rate of interest to the banks) that's been whisked out of thin air and pumped into the country since he took charge and nothing to do with whether a nurse can pay her electricity bill next month or not.Could that staunch socialist Gordon be making low paid workers scapegoats for the excesses of the financial services industry (it's been a cracking year for bonuses BTW)?Perish the thoughtThat 800 billion pound increase in personal debt and all the lovely shopping that went with it has also been the major contributory factor to those 11 years of sustained 'growth'. The only problem being that people are starting to have trouble servicing it.
F*** it, I'll write it out in full

800,000,000,000 ... pounds
that's on top of the

600,000,000,000 ... pounds
that was there before Brown took over. Making a total of, give or take the GDP of a few small countries

1,400,000,000,000 ... poundsof personal debt which was sp***** away on over-priced housing and tat that's mostly in a landfill by now and which people will be obliged to pay off, with interest, at some point

Hmmmm, lots of lovely debt and lots of lovely pay cuts for low-waged people who can't keep up with the price rises facilitated by that debt.

And there's no way Gordon doesn't know all this. Only he's not owning up to it.

Naughty Gordon

My money's on him hoping to distract everyone with a spot of Terror and some Enviro-twaddle. Tony's been doing a pretty decent warm-up act

Media pundits are predicting that Gordon is going to take over as leader of the Labour Party and consequently become Prime Minister in a few months' time because there are no other Labour MPs who are strong enough candidates to oppose him, and even if there were they wouldn't muster enough support from their fellow MPs to be nominated.

Which says a lot for just how terminally f***** the Labour Party is

And the really hysterical thing is that they're running the place

And it gets even funnier

The only viable alternative is to vote the Conservatives in

My, how we laughed

Everyone is going to have to download twice as many ringtones to straighten this particular mess out

... and remember, in times of economic uncertainty gold is always a safe investment…

Clearly the political and economic elite don’t have our best interests at heart. But how do they think what they are doing will benefit them? Someone who wrote into George Ure’s website sketched out a plausible scenario:

Suppose you are a member of TPTB. You see the coming of Peak Oil, and your advisors tell you its real. You are aware of upcoming climate changes (Not the warming part, but the subsequent and rapid arrival of continental glaciation). You are managing your family's fortune for future generations. How to prepare for the coming chaos and die off?

You look to the traditional source of your wealth - cities. That's where business banking really takes place. And cities have long been centers of manufacturing, etc, in a low fungibility energy status (which we are not right now, but are headed towards.) Big problem, you see. Since the second world war, formerly vibrant cities have become shells: donuts, if you will. Empty centers, with the value around them. Good paradigm for making money growing into those green fields, and you've made bundles doing so. But hard to secure, hard to protect, and not very energy efficient. What you want in the future is an updated version of the medieval walled cities - cosy inside, with nice tough security and minimal energy needs to sustain a quality life style for your heirs. You want cities to be Danish pastries, with nice juicy, rich fillings, and a uniform layer of housing supporting it all. But you have a few too many undesirables living in those hollow centers. How to recreate your cities in the most profitable manner?

You create the conditions for maximal subprime lending. Drop the rates. Set up special subprime lending institutions - they will ultimately be the fall guys and sit thru the Congressional testimonies, but for now they are necessary. You begin by having them lend further and further down the food chain. Then come the ARMs. Then the zero down, interest only notes. On it goes. Until it ends.

Then the interest rates come up - not too much; just enough. The notes come due; the chickens come home to roost. The subprime lending institutions take the hits. Your mega banks come in and secure the loans and their collateral (the housing areas you wanted all along). There is some friction - squatting, etc. You call in the authorities. Clashes. Fires. But the squatters move on. You now have untenable former housing. Bummer, it seems.

Except that you now sort the portfolios. What will be inside the city walls gets bulldozed, and rebuilt - upscale. Very upscale. Unaffordable except to those you want living inside the walls when the walls go up. The properties outside the walls either become purpose built (i.e. "throwaway") low income housing, or get bulldozed and turned back into greenbelt, with a special nod to the environmentalists.

Within a decade, you have rebuilt significant portions of formerly blighted urban areas. The gentry come back. Mixed use returns. Cities blossom. Property values inside the walls skyrocket. And you and your family control it all. Things in the former suburbs get gritty. Violence rises there, while falling in the city center. A reason for management of access to your now nice urban areas? You betcha. The walls go up.

Twenty years on, you are set, living the good life inside restored, safe, controlled, vibrant, urban areas, served by farmers markets as well as the remaining industrial farming. There's a green belt around the walls of truck farms, and then, outside that, the rather dangerous exurbs and crumbling former fringe suburbs. But you have little reason to ever go there, except to fly over them on your way to another of the nice oasis lily pads you have built over the first two decades of the 21st century…

The scenario leaves out one important part: depopulation. The wealthy in the urban cores won’t be needed 7 billion people to work for them. What is interesting about that scenario, though, is that it fits the way cities were for most of history and still are in most places: the rich in the inner city and the poor and lawless in the suburbs. It was only in the United States that the equation was reversed.

In any case, the past week gave a chilling reminder of how much the Powers That Be care about us or “the children” in New Bedford, Massachusetts:

More than 300 seized in Massachusetts immigration raid

Kate Randall
9 March 2007

Federal immigration authorities carried out a massive raid on a New Bedford, Massachusetts, plant Tuesday morning, detaining 300 to 350 immigrant workers and charging the company’s owner and three managers with knowingly hiring undocumented workers. The company holds a multimillion-dollar contract with the Defense Department producing supplies for the US military and runs a poverty-wage operation employing mostly Central American labor.

The sweep at Michael Bianco Inc. (MBI) began shortly after 8 a.m., as about 300 agents of the US Immigration and Customs Enforcement (ICE) and New Bedford police converged on the three-story building. Police surrounded the plant, and a Coast Guard helicopter hovered overhead to prevent the workers—mainly women with young children—from escaping. Buses lined up outside waiting to haul workers away.

Witnesses inside the plant described a horrifying scene of one the largest immigration raids ever conducted in the area. The workers—most of them Guatemalans and Salvadorans, working as seamstresses—were ordered to remain at their sewing machines as authorities reviewed their immigration status. Mayhem ensued as some attempted to flee, only to be turned back by police and the bitter winter cold outside the factory.

Tina Pacheco, a supervisor with 14 years at MBI, described the situation to the Boston Globe. “When we realized what was going on, a lot of people were screaming and crying. They told American citizens to stand in one area and the people without papers to stand in another area. It was terrible, they were crying and didn’t know what was going to happen.”

Police guarded the exits while other officers grabbed workers attempting to flee and ordered them to lie on the ground. Some agents brandished handguns. Workers were handcuffed behind their backs with plastic ties and were instructed not to use their cell phones.

Viviana Luis Hernandes, 25, a stitcher whose husband also worked at MBI, said she was forced to wait in the factory for nine hours, handcuffed, while authorities reviewed her case. Like many of the workers, she feared for the welfare of her young child if she were taken away. “When this first happened, all I thought about was my baby,” she said. Her husband was also arrested, and she was eventually released because there would be no one to care for her one-year-old.

About 320 undocumented workers were detained. The ICE said 45 workers were released following the raid because of pregnancy or other medical issues, or family and childcare concerns. The remaining 275 were eventually driven by bus about an hour and a half away to Fort Devens, a former military base now used by the Army Reserve, for questioning. About 300 government officials were involved in processing those detained.

An additional 15 women were released from Fort Devens. All those determined by authorities to have no documentation—including those released—will be required to appear in immigration court to determine their status. The majority reportedly will be flown outside the state—some as far away as Texas—to appear before an immigration court judge for deportation proceedings.

The workers include immigrants from Mexico, El Salvador, Honduras, Guatemala, Cape Verde, Portugal and Brazil. Many have lived and worked in New Bedford for years. If deported, they will be returned to lives of poverty and possible political repression in their native countries. During a press conference following the raid, Rev. Marc Fallon of Catholic Social Services described many of the detained workers as “refugees of civil war” who suffer from post-traumatic stress disorder.

Many of those detained are frantic because young children have been left on their own as a result of the raid. Immigration advocates estimate that as many as 200 children are missing a parent caught up in the sweep. Many were left at babysitters and daycare centers for hours following the raid, with caregivers receiving no word from their mothers or fathers. Corinn Williams, director of the Community Economic Development Center of Southeastern Massachusetts, commented: “It’s been a widespread humanitarian crisis here in New Bedford.”

As details became known following Tuesday’s raid, a picture emerged of virtual slave-labor conditions at Michael Bianco Inc., with workers toiling long hours for minimal pay and subjected to brutal reprisals at the hands of management. The vast majority of workers employed by MBI had no documentation. A government investigation revealed that company management steered workers to a source to obtain phony work papers—at $120 apiece—and then preyed on their fear of deportation to exploit them.

MBI, once a small operation manufacturing high-end handbags and other leather goods, won Defense Department contracts between 2001 and 2003 worth $10 million to produce two types of airmen’s survival vests. In 2004, the company won another $82 million to make lightweight backpacks for the military. The workforce at the plant skyrocketed from 85 employees in 2001 to more than 500 by 2005, and the owner was granted $57,000 in tax breaks by the city.

Company owner Francesco Insolia, 50, along with payroll manager Ana Figueroa, plant manager Dilia Costa and office manager Gloria Melo, are charged by federal authorities with “conspiring to encourage or induce illegal aliens to reside in the United States, and conspiring to hire illegal aliens.”

US Attorney Michael J. Sullivan commented on the charges: “It is alleged that MBI, Insolia and others knowingly and intentionally exploited the government by recruiting and hiring illegal aliens without authorization to work, exploited the workforce with low-paying jobs and horrible working conditions, and exploited the taxpayers by securing lucrative contracts funded by our legal workforce.”

The government’s allegations are small comfort to the hundreds of immigrants who will most likely be deported back to their home countries. In many cases, they will also be forced to make the wrenching decision to either leave behind their young children—many of them US citizens—or take them to a country where they have never set foot.

A three-year ICE investigation of MBI found that Insolia ran “a sweatshop” where workers earned only $7.00 to 7.50 an hour, received no benefits, and were paid no overtime. In reality, wages were far lower after deductions for violations of draconian company policy.

Workers were docked 15 minutes’ pay for every minute they were late for work. They were fined $20 for spending more than two minutes in the restroom, with second violations resulting in dismissal. They were also fined $20 for leaving work before the break bell sounded or for talking during work. The company provided only one roll of toilet paper per stall in the restroom, which ran out in less than an hour.

With the fear of deportation constantly hanging over them, workers were afraid to speak out against the deplorable conditions, as better jobs are virtually nonexistent. With 9.4 percent unemployment, Greater New Bedford has the highest jobless rate in the state of Massachusetts.

Many of the area’s small manufacturing plants have shut down. Just this week, Revere Copper Products, founded by American revolutionary Paul Revere in 1801, announced that it will close the plant within the next six months. Presently employing 85, the company had 1,200 workers at its peak.

For centuries, immigrants have formed the backbone of this coastal New England city and the surrounding area, manning whaling fleets, working in seafood processing and working in textile and other small mills. Today, those without documentation live in constant fear of being rounded up. In a number of families, one parent has residence status while the other has navigated the immigration system for years in attempts to gain it, to no avail.

An estimated 3,000 Central Americans—mostly young men from Guatemala—currently work in New Bedford’s fish-processing industry. In December 2005, an early-morning sweep by the US Coast Guard and immigration authorities resulted in the arrest of 13 men at the AML International and other fish processing plants on New Bedford’s waterfront. Those picked up in the raid included seven men from Guatemala, three from El Salvador, two from Mexico and one from Honduras.

As word of the raid spread by cell phone, plants emptied out across the city. Frank Ferreira, plant manager at AML, told the Globe, “People were just leaving because they didn’t want to get in trouble. Even the legal ones left. Nobody knew what was going on. It looked like an invasion.”

Signs of the Economic Apocalypse, 3-5-07

From Signs of the Times:

Gold closed at 645.90 dollars an ounce Friday, down 6.2% from $685.70 at the close of the previous Friday. The dollar closed at 0.7580 euros Friday, down 0.2% from 0.7595 at the previous week’s close. That put the euro at 1.3193 dollars compared to 1.3167 at the end of the week before. Gold in euros would be 489.58 euros an ounce, down 6.4% from 520.77 for the week. Oil closed at 61.47 dollars a barrel, up 0.5% from $61.14 at the close of the previous week. Oil in euros would be 46.59 euros a barrel, up 0.3% from 46.43 euros at the end of the week before. The gold/oil ratio closed at 10.51 Friday, down 6.8% from 11.22 for the week. In U.S. stocks, the Dow Jones Industrial Average closed at 12,138.77, down 4.2% from 12,647.48 at the close of the previous Friday’s trading. The NASDAQ closed at 2,374.12 Friday, down 5.9% from 2,515.10 at the close of the Friday before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.51% down 16 basis points from 4.67 for the week.

The big story last week was the fall in stock markets across the world on Tuesday. In the United States the Dow had it’s biggest one-day drop since September 2001 while the housing market continued its slide and signs of recession mounted.

U.S. Economy: Home Sales Tumble, Growth Revised Lower

By Courtney Schlisserman and Joe Richter

Feb. 28 (Bloomberg) -- New-home sales in the U.S. tumbled last month by the most in 13 years and fourth-quarter economic growth was less than previously estimated, dousing speculation that the worst of the slowdown is over.

January new-home purchases fell 16.6 percent, the most since 1994, the Commerce Department said today in Washington. The department in a separate report said gross domestic product, the sum of all goods and services produced, grew at an annual rate of 2.2 percent, compared with the 3.5 percent reported on Jan. 31, and the 2 percent the previous quarter.

Federal Reserve Chairman Ben S. Bernanke played down the figures, saying the growth revision is in line with his estimates and predicting a rebound later this year. His remarks helped lift stocks after the biggest slide in four years.

“One by one, various growth indicators for the U.S. economy are tipping to the downside,” said Avery Shenfeld, a senior economist at CIBC World Markets Inc. in Toronto. “The housing market still looks decidedly in a downtrend. The Fed appears to be somewhat late in adjusting its views.”

A separate report showed a national business activity index unexpectedly dropped this month. The National Association of Purchasing Management-Chicago said its business barometer fell to 47.9 this month, the lowest since October 2002, from 48.8 in January. A reading lower than 50 signals contraction.

For all of last year, the economy grew 3.3 percent, compared with 3.2 percent in 2005…

Gold prices fell sharply as well last week, even more sharply than stocks did, dropping 6.2%. The drop in gold prices seemed to follow the logic of the stock market drop, a correction after a period of steady price increases.

Gold battered by stock market worries

By Daniel Magnowski
Fri Mar 2, 10:52 AM ET

LONDON (Reuters) - The global flight from risk knocked precious metals again on Friday, with gold falling below $650 an ounce for the first time in three weeks as shaky global stock markets prompted investors to reduce positions in commodities.

Investors often buy gold as a safe bet when financial markets look unstable, but investors are keen to unload the metal after plunges in global equity markets this week, analysts said.

Many investment funds were seen to have bought commodities, including gold, over the past month with the proceeds from stocks as Wall Street reached record highs last month.

"Gold is not glittering any longer as a safe haven," Dresdner Kleinwort analysts said in a market report.

"Commodities in general are perceived as risky assets...This asset class is just sold to reduce portfolio risk and to take profits in order to compensate losses suffered in other assets like equities," the bank said.

"Thus, as long as unwinding of yen carry trades continues and equity prices head south, gold and silver remain in the wake of bear markets."

As of 1537 GMT spot gold was at $651.50/651.95 per ounce, down sharply from $662.60/663.30 in New York on Thursday. It fell as low as $649.25 on Friday, the lowest since February 8 and down almost 6 percent from the nine-month high touched on Monday.

The pan-European FTSEurofirst 300 index was down 0.35 percent by 1536 GMT after losing 5 percent in the past three sessions, while in the United States the Dow Jones industrial average was down 0.22 percent.

A 9 percent fall in the Shanghai stock market on Tuesday triggered a global flight away from stocks into less risky assets.

Technical sentiment in gold deteriorated after the price went below several near- and medium-term moving averages.

Cash gold broke below its seven-day moving average of $674 and its 30-day average around $660.

However, traders said gold might receive support from firm energy prices.
U.S. crude oil futures hit a 2007 high on Thursday on tightening fuel supplies in the United States.

On Friday, U.S. crude traded firmly above $62. It was quoted at $62.15 at 1540 GMT, up 15 cents from Thursday’s close. On Thursday it hit $62.40, its highest since December 26.

Gold hit a nine-month high of $689 on Monday as firm crude oil and tensions between Iran and the United States raised the metal’s appeal as a haven and a hedge against inflation.

Traders were watching whether gold could hold above $655.40 -- a low reached on February 20.

The so-called flight to safety was a flight to bonds (bond prices increased sending yields down sharply) not a flight to precious metals. As the above article put it, “Many investment funds were seen to have bought commodities, including gold, over the past month with the proceeds from stocks as Wall Street reached record highs last month.” Meaning that, as George Ure observed, the drop in gold came from investors selling gold to cover other positions. Like Ure, I can’t help but think that the storm clouds hanging over the stock market and the larger economy will be good for gold.

As for the continuing problems in housing, these will have more effects on stock prices than some might think, due to the massive amounts of bad paper being held (usually as funds holding securitized debt and derivatives connected to those markets) as assets by most all of the top financial institutions:

General Motors and the housing bust

Back at the dawn of the automobile era, banks generally refused to loan money for such things as buying a car. It wasn’t considered prudent. This was frustrating to companies such as General Motors, which naturally wanted as many people as possible to have the wherewithal to purchase Cadillacs and Oldsmobiles and Pontiacs and Chevrolets. So GM decided to solve the problem by, in effect, becoming its own bank. In 1919 GM created the General Motors Acceptance Corp., a financial arm of GM that specialized in offering credit to car buyers and allowing them to buy on installment plans.

GMAC was a huge success. So much so that, over the years, it gradually expanded its operations, becoming a significant bottom-line contributor to GM’s profits. In 1985, GM’s execs decided, hey, if we’re loaning money to our customers to buy cars, why not go ahead and loan them money to buy homes as well? GM promptly purchased two large mortgage lenders and instantly became the second largest mortgage bank in the U.S.

Along the way GMAC also became an early player in the world of "structured finance" or derivatives, by taking the income streams generated by all those car and mortgage payments and turning them into bonds, through the process known as "securitization," which it then sold off to investors. All very state-of-the-art, all very emblematic of the career arc of the modern American corporation.

Why should we care about all this history? Well, with the Dow just finishing its worst week in four years, down another 120 points on Friday, it would behoove us to look for explanations as to what is continuing to spook investors. To wit: On Thursday, GM shook up Wall Street by announced that it was delaying filing its 2006 Annual Report by a couple of weeks. The reason, said analysts, had to do with GMAC’s significant exposure to the ever-popular subprime lending debacle. Like so many other players in the mortgage business in the last few years, GMAC’s home lending subsidiary, ResCap, apparently got pretty deep into making risky loans to homeowners with bad credit, and now is paying the price.

How bad is it? According to the Houston Chronicle, "At the end of the third quarter, ResCap, long viewed as the crown jewel in GMAC’s businesses, held $57 billion of subprime mortgages for investment, or 77 percent of its total loans held for investment. Its exposure to ‘residual interest’ in mortgage securities -- the high-yielding slices that suffer some of the first losses if loan defaults are higher than expected -- was $1.4 billion as of Sept. 30."

There are two primary schools of thought on how the subprime lending saga will play out. One side says that financial woes are limited to just that segment of the mortgage industry that dealt with the riskiest loans, and the problems will spread no further. But the other side contends that we’re only at the beginning of a chain reaction that could end up causing serious damage to some of Wall Street’s biggest players.

GM, the largest car maker in the world, is a pretty big institution, and GMAC is a pretty big financial player. But due to the opaque nature of the derivatives trading business, no one, not even, apparently, GM itself, is clear on exactly what ResCap’s subprime woes might mean for the larger picture. But it can’t be good.

From the Chronicle:

ResCap said in January it will eliminate 1,000 positions by October to reduce costs as the mortgage lender grapples with the continued deterioration in the subprime mortgage sector. The company now has 14,000 employees worldwide. In a filing with the SEC, ResCap estimated that it would incur about $10 million in severance and related costs associated with the work-force reduction.

"We continue to believe GM equity is complacent about the potential impact of such subprime exposure," Bear Stearns auto analyst Peter Nesvold wrote in a note. He said the weakness at GMAC due to subprime problems is one of the key risks facing GM.

Last fall, GM sold 51 percent of GMAC to Cerberus Capital Management, in a cash-raising effort aimed at bolstering the company’s shaky finances. But the two parties have since been squabbling over the fine print. There now appear to be some questions as to whether GMAC was properly valued at the time of the deal.

All in all, not a good week for Wall Street. Monday morning should be interesting.

Indeed, the exposure to severe risk is unprecendented throughout the top levels of the corporate system:

Goldman, Merrill Almost ‘Junk,’ Their Own Traders Say

By Shannon D. Harrington

March 2 (Bloomberg) -- Goldman Sachs Group Inc., Merrill Lynch & Co. and Morgan Stanley, which earned a record $24.5 billion in 2006, suddenly have become so speculative that their own traders are valuing the three biggest securities firms as barely more creditworthy than junk bonds.

Prices for credit-default swaps linked to the bonds of the New York investment banks this week traded at levels that equate to debt ratings of Baa2, according to Moody’s Investors Service. For Goldman, Morgan Stanley and Merrill that’s five levels below the actual Aa3 rating on their senior unsecured notes and two steps above non-investment grade, or junk.

Traders of credit derivatives are more alarmed than stock and bond investors that a slowdown in housing and the global equity market rout have hurt the firms. Merrill since 2005 has financed two mortgage lenders that subsequently failed and bought a third, First Franklin Financial Corp., for $1.3 billion.

“These guys have made a lot of money securitizing mortgages over the years in a mortgage boom time,” said Richard Hofmann, an analyst at bond research firm CreditSights Inc. in New York. “The question now is what is the exposure to credit risk and what are the potential revenue headwinds if they’re not able to keep that securitization machine humming along.”

Credit-default swaps on the debt of Goldman, the world’s biggest securities firm, have risen to $32,775 per $10 million in bonds, up from $21,500 at the start of the year, according to prices compiled by London-based CMA Datavision. The price touched $35,000 on Feb. 28, the highest since June 2005.

Spokesmen and spokeswomen for Goldman, Lehman, Merrill and Morgan Stanley declined to comment. A spokeswoman for Bear Stearns didn’t immediately return calls for comment.

Conceived to Protect

Morgan Stanley and Goldman were among the top five traders of credit-default swaps in 2005, a group that represented 86 percent of the market, according to a September Fitch Ratings report. Lehman, Merrill and Bear Stearns were among the top 12.

Credit-default swaps that trade at such wide gaps below actual ratings tend to rally, said David Munves, director of Moody’s credit strategy research group.

The contracts were conceived by Wall Street to protect bondholders against default and pay the buyer face value in exchange for the underlying securities should the company fail to adhere to debt agreements. An increase in price indicates a decline in the perception of creditworthiness; a drop means the opposite.

Contracts tied to Morgan Stanley, Merrill, Lehman Brothers Holdings Inc. and Bear Stearns Cos. also are at 19-month highs.

Rising Prices

Morgan Stanley credit swaps have risen $10,000 to $32,775 this year, CMA data show. Contracts on Merrill jumped $16,500 to $33,000. For Lehman, they are up $12,440 to $34,440, and the swaps on Bear Stearns have climbed $12,080 to $33,830.

By contrast, Deutsche Bank AG in Frankfurt, Germany, is trading near a record low at 9,800 euros, according to data compiled by Bloomberg. And, a Standard & Poor’s index of investment bank stocks has fallen 6.29 percent this year.

The increases were larger than an index that measures credit risk for investment-grade companies in North America. The cost of protecting $10 million in debt included in the Dow Jones CDX North America Investment Grade Index has risen $1,250 to $34,750 this year, according to Deutsche Bank prices.

Lehman and Bear Stearns credit swaps traded as if their debt were rated four levels lower than their A1 rankings. High-yield, high-risk notes, or junk bonds, are rated below Baa3 at Moody’s and lower than BBB- at S&P.

More Bearish

Credit-default swap investors are more bearish than bondholders, data from Moody’s Market Implied Ratings service shows. As of Feb. 28, the bonds of Goldman and Morgan Stanley were trading as if the debt were rated a step below Moody’s official rating. Goldman has $171.6 billion in bonds outstanding, according to data compiled by Bloomberg. Morgan Stanley has $168.5 billion.

Last year was the best ever for the five biggest Wall Street firms, whose combined profit rose 33 percent to $132.5 billion.

Subprime mortgages, loans taken out by homebuyers with poor or limited credit histories, typically charge rates at least two or three percentage points above safer, so-called prime loans. They made up about a fifth of all new mortgages last year, according to the Washington-based Mortgage Bankers Association.

Subprime Turmoil

At least 20 lenders have shut down, scaled back or been sold this year. Countrywide Financial Corp., the biggest U.S. mortgage lender, yesterday said borrowers were at least 30 days past due at the end of last year on almost a fifth of the subprime loans that it serviced for others.

“There’s been a little bit of a reappraisal of the financial sector, with a strong desire to get away from subprime exposure,” said Scott MacDonald, director of research at Aladdin Capital Management LLC in Stamford, Connecticut, which manages $16.5 billion in assets.

What they are telling us here is that the signal has been given to start a severe recession. If the “financial sector” stops lending massive amounts of money to everyone (that’s what they mean by ‘getting away from subprime exposure’), the whole system will crash.

The web bot linguistic analysis folks at http://www.halfpasthuman.com/ deserve credit for predicting the exact date of the correction, February 27th. I also like their “rolling iceberg” metaphor:

Markets - Iceberg Rolls Over, Gold Floats on Debt

The [illusion] of (prosperity) that has propped up the Bush administration these last 6/six years is breaking up. Unlike previous market situations, our data suggests that no mere correction is underway, rather what is happening is akin to the [economic] and [financial] iceberg of the USofA rolling over. The vastly disparate ratio of wealth transfer these last few decades, which accelerated to gigantic proportions under the Bush decider-ship, and which has resulted in the top 1/one percentile of the populace controlling 99/ninety-nine percent of the wealth, is about to [flip] or roll over. As with real icebergs, the process is observable only at the point rolling begins, and by then it is way too late to react. As with real icebergs, it is entirely unequal distribution of ‘mass’ which results in the flip. As with really big icebergs, the actual flipping can take minutes.

The data suggests that the economy of the USofA based markets, and specifically all forms of [usofa dollar] associated debts are rolling over, and the actual visible signs of the roll will be apparent on February 27, 2007… The coming period of 8/eight days leading up to the Ides of March release period will also be presenting more [visible] (manifestations) of financial crumbling, but by that time, it is far too late to react to stem the process. In fact, as of this interpretation, ...alea jacta est/the die is cast. Start running now, just guess correctly as to which way the iceberg will roll.

As part of the [economic] degradation, soon to be exacerbated by political degradation, the populace of the USofA is going to have to endure a Spring of [employment] (crashes). The data sets are quite clear about the projection, and it is very dire. The data being interpreted has been showing up for over the last 6/six months and has been posted in previous ALTA report series.

The fundamental core of our modelspace is the replacement of words. These words are showing up in basically the same sorts of conversations about the same kinds of things, but the nature of the words used to discuss all this same-old at the same-old, is different. So as an instance, since early July (2006) the Markets entity has been moved through modelspace by the replacement values associated with words used to describe 2/two very large {linguistically, that is lots of verbiage’s on the internet} general areas. The dominant of these has been [housing], with the subordinate element being [instruments, paper/debt]. In this last area there are all the references to such things as stocks, bonds, derivatives, notes, et al. Further the lexicon for this group naturally contains references back to the other element [housing] just as within the [housing] lexical structure are supporting aspect/attributes which include [paper debt] and [note] references. This brief description is to provide a certain sense of the muddy nature of our interpretations. That is to say, the data sets are not usually very cleanly separated, and thus a certain amount of bleed-through on the interpretation will occur.

At this time the Markets entity is exhibiting what we have termed in the past "splitting behavior". We have seen this most frequently within the Bushista entity as the various layers of support feel away from the BushCo entity and subsequently the linguistic descriptor set was split or pared down to its current shape. Within the Markets entity, and specifically within the [usofa] sub set, a split of direction is becoming visible as the [housing] lexical element is now dropping below the neutral line. This occurs as a result of the summation of the emotional values associated with the words now linked to this [housing] aspect. As the summation drops past 0/zero and into the negative range, it has a tendency to drag down the entity as a whole by lowering the many related summations which compose an entities movement through modelspace. All that just as clear as crystal at the bottom of a lake on a cloudy day?

Well, here is the developing issue within the Markets entity. The [housing] sub set, a large sub set, is now dropping into negative territory, and this is JUST as the [paper debt] sub set is roaring along on a [stressed] (run up/climb). Further, the [housing] section of the data set is larger than the total [paper debt] sub set in several key ways within our modelspace. The data sets and processing that we use tend to put humans first over information. So the emotional component of [housing] in the real world will be several orders of magnitude more impacting than that of [stocks/bonds/et al] since more humans have houses than ‘own’ paper debt…

None of what’s happening should come as any surprise. Now we at least have a date for when it all happened.