The Real Bailout

Alan Greenspan has an editorial today in the Wall Street Journal which carefully explains that the Fed was no more responsible for watching the barn door than Fitch's, Moody's or Standard & Poor. Where Fitch points all ten fingers, Greenspan waves his arms and encourages us to look backwards:

The root of the current crisis, as I see it, lies back in the aftermath of the Cold War, when the economic ruin of the Soviet Bloc was exposed with the fall of the Berlin Wall. Following these world-shaking events, market capitalism quietly, but rapidly, displaced much of the discredited central planning that was so prevalent in the Third World.

It's all clear now. Banks were allowed to move liabilities "off the books" to SIVs because of the collapse of the Soviet Union. That certainly makes sense. Somewhere. Mr. Greenspan somehow fails to note that the shell game indulged in by the banks through the magic of black box algorithms which engendered "no loss" derivatives marketed by unregulated hedge funds has ended with no pea to be seen on the table. His only concession to the phenomenon is by mentioning that:

Arbitragable assets--equities, bonds and real estate, and the financial assets engendered by their intermediation--now swamp the resources of central banks. The market value of global long-term securities is approaching $100 trillion. Carry trade and foreign exchange markets have become huge.

I'm not as impressed as I had hoped to be.

Never fear. Today, Bernanke rides to the rescue. Since the credit markets are frozen because absolutely no one in the world has any remaining faith whatsoever in ratings issued by the "Who?" "Not me!!" credit rating crowd, the Fed is going to start shoveling money to - "All depository institutions that are judged to be in generally sound financial condition by their local Reserve Bank and that are eligible to borrow under the primary credit discount window program will be eligible to participate in TAF auctions."

Of course, that determination will be made based upon their rating by Fitch or Moody or Standard & Poor. What a relief.

I don't have any particular objection to special auctions to
inject liquidity. That's the purpose for the existence of central banks. It would be nice if the Fed made it clear that a depository institution had an either/or choice regarding off the books deals and remaining a depository. The mental picture of depository institutions gathered around a blanket, rolling dice on black box outcomes just doesn't inspire a great deal of confidence.

The Fed still has a lot more credibility (IMO) than the IMF or the World Bank or the Asian Development Bank. Those are the folks who have been touting the success of China in following the "third way". It is becoming increasingly clear that China's 'ascent' is chimerical. I've never heard of a 40% cut in a country's estimated GDP before. Except for that one time when the Communist mythos concerning the Soviet Union was completely demolished, of course. It's almost as if China and the former Soviet Union had something in common. Maybe the World Bank, the IMF and the ADP will be able to apply sophisticated analysis to determine whether a common element might exist?

Bernanke needs to clip and save Greenspan's editorial. When China collapses he'll be able to say that not even Greenspan saw it coming.

About Your Missing Horses....

One of the gnomes of Zurich woke up with a bad limp this morning. How in the world did a Swiss bank get clobbered with a $10 billion loss in subprime mortgages written in the US? A seriously misplaced trust in innovation firmly attached to "respected names" seems to be the main answer. Aside from greed, of course.

One of the "respected names" washes its hands of the matter thusly:

While we realize this was a very limited sample, Fitch believes that the findings are indicative of the types and magnitude of issues, such as poor underwriting and fraud, which are prevalent in the high delinquencies of recent subprime vintages. In addition, although the sample was adversely selected based on payment patterns and high risk factors, the files indicated that fraud was not only present, but, in most cases, could have been identified with adequate underwriting, quality control and fraud prevention tools prior to the loan funding. Fitch believes that this targeted sampling of files was sufficient to determine that inadequate underwriting controls and, therefore, fraud is a factor in the defaults and losses on recent vintage pools. Additionally, Fitch continues to attempt to expand its loan sample to provide further validation of its findings and will provide additional commentary as applicable.

See, it wasn't the credit rating company's fault, and, if you read very carefully and at length, it wasn't even the underwriter's (those folks who pay the credit raters) fault. It was the loan originator's fault and, in particular, the mortgage broker's fault. S & P, Moody's and Fitch were innocent bystanders who extended trust in good faith, although in retrospect, perhaps a tiny bit unwisely.

What utter hogwash.

The increase in default rates was traceable within months of the setup of each of the "deals". Each packaged mortgage "deal" is seasoned and the results are required to be reported monthly. The big banks set up indices to follow "valuation" of how creditworthy groups of deals are that allow one to follow a deal down to about the tranche level. ABX is one such index and Citigroup Mortgage Loan Trust 2007-AMC2 is a sample of a constituent element of the index. Go to the EDGAR CIK search engine, pop in "Citigroup Mortgage Loan Trust" and take a look at the list of deals, open 2007-AMC2 and take a look at the distribution reports. This is a $2 billion, ten thousand loan deal that was set up in February, 2007 and had over ten per cent of its loans at least 30 days past due by August. By December, twenty per cent were at least 30 days past due with half of them moving to the bankrupt, foreclosed or REO status group. My bet is that at least 500 loans out of the 1,000 that were sour in August were outright fraud of a sort that Fitch's report doesn't really identify. It doesn't take more than a shady realtor coupled with a soft appraiser and a "hot" mortgage broker to scam a sucker like Citi.

It might be cheaper for Citi in the future just to leave their vault doors open to the general public one day a year. Maybe they could get Fitch to pick up part of the tab? It couldn't hurt either of their current reputations very much. A sad part of this entire charade is that Citi wasn't anywhere near the worst player. The saddest part is that the reporting on the charade still doesn't identify the fact that the whole thing was driven by cost cutting at the origination level. The originators were driven by the underwriters into substituting simplistic (and easily scammed) FICO scores for "legwork" that really only entailed making a series of phone calls. The "savings" per app couldn't have been more than $200 - and it's not as if the borrower didn't pay for it in the first place.