Lipstick on Pigs

Building up to the election, it is hard to find news.

I am not talking about CNN and MSNBC. You can watch both all day long. Unless something horrific, such as monster hurricanes and train wrecks (no, really), all I hear are opinions, on the viewpoints, of what the existential meaning is of an utterance by a tired politician on the campaign trail.

I believe a direct conversation of the economy, more specifically banks and the taxpayer money being used to replace their bad bets, is in order. Is it right to use taxpayer money to cover the bad bets of Wall Street and Main Street Bankers?

From CNBC.com;

The end result of the global economic slowdown may be the U.S. announcing national bankruptcy as the government cannot afford the bailouts that it promised and the market will not bail out the government, Martin Hennecke, senior manager of private clients at Tyche, told CNBC on Thursday.

"We expect a depression in the United States. We expect a depression, very possibly, also in Europe," Hennecke said on "Worldwide Exchange."

The estimated $300 billion cost of the Fannie/Freddie bailout will probably be considered as a loss that the government will have to take, therefore passing it on to taxpayers, he explained.

"We already have $3 trillion of debt, as far as the U.S. government is concerned. These debt figures across the U.S. economy are rising very sharply."

When the government can no longer pass the United States' "immense debt" on to taxpayers, it will turn to the holders of U.S. dollars, leading to the eventual downfall of the currency, Hennecke said.

"Definitely, it (the dollar) is not a safe place to be invested in, as real inflation is closer to 10 or 11 percent than the actual inflation numbers given by the U.S. government," Hennecke said on "Worldwide Exchange".

Investors should avoid exposure to debt and stay away from leveraging on any investment or asset, including property, Hennecke advised, adding that "banks have been too highly leveraged in the past, private households, everybody."

Following is one of the issues the candidates are desperate to avoid. They know the less people realize, the fewer tough questions they are forced to answer. It is a complicated issue, but is the most important issue right now, just edging out Iraq;

MBS and the derivatives built on them
There are somewhere around $700+ Trillion in derivatives, globally. Most are built on the backs of US Mortgage Backed Securities and other debt such as credit card debt, auto loans, and even student loans.
MBS are derivatives of the first order. The issuer of the MBS gathers multlple mortgages, usually similar in nature (ie. Nov. 2006 first lien ARMs) and bundles them together. The bundles can represent $20 million, $100 million or more in mortgages. This is called securitizing, and creates a bond for the issuer to sell. This new bond of MBS actually owns the underlying mortgages. Should a mortgage contained within an MBS go into default, and subsequently be liquidated, through short sale or foreclosure sale, the MBS is first in line to get the money from those proceeds.
CDO's, CLO's, CMO's, SIV's and the like are derivatives of the second order. A CDO is usually made up of several MBS issues (and may include other forms of debt that have been securitized), each portion called a tranche. Each tranche is calculated to offer a certain rate of return. Most often, a few of the tranches in a CDO have very risky MBS, such as subprime mortgages, which have a higher rate of return, thus raising the overall rate of return of the CDO. CDO's squared, and all things similar, are derivatives of the third order. CDO's squared contain two or more CDO's put together.

All derivatives of the second order are bets on the performance of the underlying MBS or whatever debt is contained in the original securitization. 

All derivatives of the third order are bets on the performance of derivatives of the second order.

Almost all derivatives of the second and third order are owned by commercial banks, investment banks and central banks. Why? In creating the underlying MBS, they withheld portions of the subprime rate of return, which, if they owned that portion, would make them more profit. They then assigned that portion to the CDO's and other derivatives. They then sold these to other banks, and themselves. 

MBS and CDO’s are distinctly different. 

I hear many people tell me they "know" what a derivative is. I know they have no idea what a derivative is. How do I know? They keep buying financial stocks, just before they tumble.
$13 Trillion MBS. 

$700 Trillion Derivatives. 

$600+ Trillion in bets on the performance of the $13 Trillion.

Is it sinking in yet?

Most of the twenty-five largest banks have exposure to derivatives and blown MBS representing 300%, 400% and some many more times, their hard assets. Chase is the single largest holder of derivatives in the world. There are somewhere around $700 Trillion in derivatives, globally. Most are built on the backs of US MBS and other debt. In Sept 2007, Chase had $92 Trillion in derivative holdings, almost 1/7 of all derivatives. Their hard assets in Sept 2007 were $ 1.3 trillion. Bank of America, before Countrywide, had $42 Trillion in derivative holdings with hard assets a little over $1 Trillion. After Countrywide, that spread widened considerably.

Theoretically, even with only a haircut of 5%, on paper, they are insolvent. The losses on derivatives, as a whole, will be no less than 50% across the board. They are bets on the performance of MBS. The derivatives of the second or third order do not own the mortgages, they are only bets on the performance of those mortgages contained in the original MBS. The MBS is still there, intact, and it owns those mortgages. The owner of a CDO cannot assume the property of a foreclosure represented within one of its tranches, because the CDO is only a bet on whether that mortgage would perform and reach maturity.

Already proven in court in Cleveland, CDO's have no claim to the underlying mortgages. The owners of over $1 billion in CDO’s issued by Deutschebank tried to get the foreclosed properties represented in the issues they bought. The judge, once it was explained to him what the CDO’s were, laughed and tossed their case out. The attorneys could not produce any documents to show the owners of the CDO’s held the notes to those properties, because they don’t. The holders of the underlying MBS to those CDO’s hold the notes, and they aren’t giving them to the buyers of CDO’s.

The ability of mainstream media to tell us about lipstick is amazing. Hats off to Matthews, I would never have guessed that was important. I would have thought the loss of the commodities markets, the loss of AAA rating on US treasury notes and the bankruptcy of America were more important.