Banking/Wall Street/Financial Experts?

[OldCatFan]

I am curious if there is anyone on here in the financial markets/wall street etc? I would like your thoughts on the current financial situation. I will admit to being a novice where this is concerned and would think that WCN has some folks as smart about this as the talking heads on TV.

I tend to believe that this crisis started in the early 90's. Seems like about that time that money got very easy to get, not only home loans but business loans as well. People went crazy borrowing money for all sorts of things, especially flaky business ventures such as some of the dot.coms. Later, home loans were being handed out with very few checks and balances on anyone. Credit card debt is about as high as it has ever been. Seems like as a country, we have been living and expanding the economy using credit for the last 15 years or so.

I am sure there are lots of other causes which someone on the inside could expand on.

Please let this be an information thread and not a "blame someone" thread. I am not trying to assign blame, just gather information from our WCN experts.

[TransientAlum]

Not involved in the markets, just digging through the AIG thing to understand who they are and what happened, if there is anything there. Link to SEC filings below:

http://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=0000005272&type=&dateb=&owner=include&start=0&count=40

Something gave recently on their financials. In the latest 10-Q, they reported huge losses in capital asset holdings and credit swaps over the prior year. They did discuss downgrading their rating in 05 and continued concerns over availability to credit and liquidity in prior 10-Ks.

Possibly, more importantly, this was disclosed in their latest 10-K:

During the evaluation of disclosure controls and procedures as of December 31, 2007 conducted during the preparation of AIG’s financial statements to be included in this Annual Report on Form 10-K, a material weakness in internal control over financial reporting relating to the fair value valuation of the AIGFP super senior credit default swap portfolio was identified. As a result of this material weakness, described more fully below, AIG’s Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2007, AIG’s disclosure controls and procedures were ineffective.


PriceWaterhouseCoopers stated:


Also in our opinion, AIG did not maintain, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) because a material weakness in internal control over financial reporting related to the AIGFP super senior credit default swap portfolio valuation process and oversight thereof existed as of that date. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.

The credit swaps in question are measured as such:

AIGFP employs a modified version of the Binomial Expansion Technique (BET) model to value its super senior credit default swap portfolio, including maturity-shortening puts that allow the holders of the notes issued by certain multi-sector CDOs to treat the notes as short-term eligible 2a-7 investments under the Investment Company Act of 1940 (2a-7 Puts). The BET model utilizes default probabilities derived from credit spreads implied from market prices for the individual securities included in the underlying collateral pools securing the CDOs, as well as diversity scores, weighted average lives, recovery rates and discount rates. The determination of some of these inputs requires the use of judgment and estimates, particularly in the absence of market observable data. AIGFP also employs a Monte Carlo simulation to assist in quantifying the effect on the valuation of the CDOs of the unique aspects of the CDO’s structure such as triggers that divert cash flows to the most senior part of the capital structure. In the final determination of fair value, AIGFP also considers the price estimates for the super senior CDO notes provided by third parties, including counterparties to these transactions, and makes adjustments when deemed necessary. See also Risk Management, Segment Risk Management, Financial Services — Capital Markets Derivative Transactions and Note 8 to Consolidated Financial Statements.

Now, when I combine all of that with the latest revenue info:

Three Months Six Months
Ended June 30, Ended June 30,
2008 2007 2008 2007
Revenues:
Premiums and other considerations $21,735 $19,533 $42,407 $39,175
Net investment income 6,728 7,853 11,682 14,977
Net realized capital losses (6,081) (28) (12,170) (98)
Unrealized market valuation losses on AIGFP super senior credit default swap portfolio (5,565) — (14,672) —
Other income 3,116 3,792 6,717 7,741
Total revenues 19,933 31,150 33,964 61,795


That is more than a little error in internal control considering net income in recent prior years.

It would seem as though someone was choosing not to report something in prior periods.

For the past few years, AIG has reported earnings and positive cash flow. Pretty credit worthy, unless something even bigger and more recent that has remained undisclosed occurred.

All of this is just speculation, I am really rusty, and have little to no clue on credit swaps.

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Sorry, tried to get the revenue to space out correctly but it wont work.

[sardiscat]

There was a lot of crazy investing going on in the '90s, but it was primarily investment bankers funding dot.com's that did not have any earnings whatsoever. The "new paradigm" then was that the number of hits on the website was what counted, not earnings. They found out they were wrong, but the money lost was money the investment bankers had available to lose. The problem in recent years was that the banks and brokers persuaded the SEC and Federal Reserve to waive the normal capital reserve ratios for some of the new mortgage-backed investments in favor of new age modeling developed by all the young hotshots fresh out of business schools. Well, that and the fact that the mortgages being bundled and swapped were full of false information about the borrowers' incomes, information that those purchasing the mortgages believed was true without being able to verify it for themselves. Well, that and the fact that all the grownups at the firms buying the investments left the room leaving nobody to say, "This all sounds too good to be true." My big question for the current situation is, who made the money on it? When we know who profited from the situation, we'll know who to blame. Borrowers are losing their homes. Banks have lost their shirts. The hedge funds and brokerages that bought the mortgages are in bankruptcy or bordering on it. Somebody has to have made money on these things, but nobody is claiming to. Hedge funds and other investors who shorted the stock of the firms that got in trouble have made money on the stock market, but who has made money on the mortgages themselves? I've never before heard of an investment where the buyers, sellers, and middlemen all lost their money.

[TransientAlum]

In Enron and Worldcom it was the heads that made all the money. If I am right about AIG having, essentially, lied about its FMV losses until caught, we are looking at the same thing again.

Guess one should look into Fannie, Freddie, and Lehman too huh?

Just a guess but AIG's issue is partly the CEO, CFO, and Chairman and part the auditor's.

[oruacat2]

Check this out (http://www.nysun.com/business/ex-sec-official-blames-agency-for-blow-up/86130/)

The Securities and Exchange Commission can blame itself for the current crisis. That is the allegation being made by a former SEC official, Lee Pickard, who says a rule change in 2004 led to the failure of Lehman Brothers, Bear Stearns, and Merrill Lynch.

The SEC allowed five firms — the three that have collapsed plus Goldman Sachs and Morgan Stanley — to more than double the leverage they were allowed to keep on their balance sheets and remove discounts that had been applied to the assets they had been required to keep to protect them from defaults.

KD

[TransientAlum]

Check this out (http://www.nysun.com/business/ex-sec-official-blames-agency-for-blow-up/86130/)

The Securities and Exchange Commission can blame itself for the current crisis. That is the allegation being made by a former SEC official, Lee Pickard, who says a rule change in 2004 led to the failure of Lehman Brothers, Bear Stearns, and Merrill Lynch.

The SEC allowed five firms — the three that have collapsed plus Goldman Sachs and Morgan Stanley — to more than double the leverage they were allowed to keep on their balance sheets and remove discounts that had been applied to the assets they had been required to keep to protect them from defaults.

KD


"An important component of the CSE program is the regular interaction of Commission staff with senior managers in the firm's own control functions, including risk management, treasury, financial controllers, and the internal auditor, as well as onsite testing to determine whether the firms are implementing robustly their documented controls," SEC chairman Christopher Cox (http://www.nysun.com/related_results.php?term=Christopher+Cox) testified in a hearing of the House Committee on Financial Services in July.

So, when AIG was found to have not had good internal controls over a huge revenue item on it's income statement in February, what did the SEC do?

[oruacat2]

Here's what I want to know (and I've asked this on the political board too, so excuse the redundancy):

If the taxpayers are buying these debts, who exactly are we buying them from? If we're buying them from the banks, doesn't that mean that they now get their money AND get to keep all this foreclosed property?

Wouldn't a better solution be to "buy" the debt from the debtors themselves? That is, pay-off the mortgages and allow the homeowner to keep the home? The bank would still get their money.

I don't like the idea either, but if we're buying them anyway, and by all accounts we are, wouldn't this be a way to help the lenders AND the debtors rather than just helping the lenders alone?

Simple example: suppose all of us here own homes financed through WCN Bank, but we're all about to have them foreclosed, threatening WCN Bank's very existence. Now, under the current bailout plan, taxpayers will give WCN Bank money to take care of those debts, and WCN Banks also keeps the foreclosed properties to do with as they wish. Meanwhile, all of us former homeowners are now in financial ruin.
Wouldn't a better solution, since the taxpayers are getting screwed anyway, be to pay those mortgages for us struggling homeowners? That way, the Bank still gets its money AND we avoid being left homeless and in financial dire straits.

I don't want the debtors to be rewarded for not paying their bills, but I also don't want the lenders to be rewarded for their idiotic practices.....but if given the choice, I'd prefer we help both, or neither....but NOT just the banks alone. See what I mean?



KD

[Dawood Khan]

I agree with Kenny.

I thought the whole thing was idiotic. It seems a simple matter of not adjusting the mortgage rate would have sufficed to solve all of this. As I understand it,this mess all started because a huge number of folks signed mortgages with ARMS.

When the rates went up, the payments went from 600 bucks a month to 1200 bucks and in some cases more.

To prevent all of these foreclosures and banks from going under, why didn't the Fed Gov step in and artificially suppress the rate. Keep the payments low and payable. Why didn't the banks call these folks in and re-work these loans so that these morons who signed the ARMs could still make payment.

Greed did lots of folks in. I don't understand how people could be so stupid.

[Blue Heaven]

I agree with Kenny.

I thought the whole thing was idiotic. It seems a simple matter of not adjusting the mortgage rate would have sufficed to solve all of this. As I understand it,this mess all started because a huge number of folks signed mortgages with ARMS.

When the rates went up, the payments went from 600 bucks a month to 1200 bucks and in some cases more.

To prevent all of these foreclosures and banks from going under, why didn't the Fed Gov step in and artificially suppress the rate. Keep the payments low and payable. Why didn't the banks call these folks in and re-work these loans so that these morons who signed the ARMs could still make payment.

Greed did lots of folks in. I don't understand how people could be so stupid.
Just another example of how not reading the fine print or asking questions at closing can be a killer. All folks were seeing was that they could get a lot of house for not much of a monthly payment, all in the name of impressing folks. We are a stupid lot, for the most part, and I don't know if I feel sorry for either side. I come from a backround that you gotta pick yourself up and live to fight another day. What is there to learn if someone is always there to bail you out? It's socialism at its best and I hate it.

[surveyor]

WRT specifically to ARMs, I'd have to think the folks who took ARMs knew exactly what they were getting in to.

I recall when we bought our house 14 years ago, lenders would tout that ARMs are perfect for people who aren't going to stay in a house longer than 4 or 5 years, as the balloon isn't due (in most cases) until year 6 or so.
In addition, many ARMs had limits regarding how much the interest rate could "adjust" over a given period.

Most folks who took ARMs probably had borderline credit, OR had questionable spending/saving habits which made ARMs and low monthly payments attractive.
Rather than judiciously budgeting spending, many spent further beyond their means to the extent of damaging their credit enough to make a standard fixed mortgage financially unattainable.
WRT to ARMs, I blame the borrower moreso than the lender.

WRT sub-primes it's probably an even split, and 125% loan to house value, moreso the blame is on the lender. Lending 125% above the value of a home was a risk the lender took and should eat, IMO.

[JohnJ]

Agree about the greed. Congress failed in its oversight responsibilities - big time - and the tens of millions of dollars that the banks gave to Congress in the last 10 years to buy influence and changes in the laws probably had a lot to do with that.

[gerntz]

JMO, but these low ARM/teaaser rates, fueled by low Fed funds rates, together fueled excessive increases in home prices that never could be sustained. The objective, supposedly, was to get more people owning homes.

Read somewhere months back that historically home price gains have barely outpaced inflation gains, by <1% annually. With current price drops, we're getting back to historical prices. I think in the long run that's good, but a mess today.

[The Old School JPS]

Agree about the greed. Congress failed in its oversight responsibilities - big time - and the tens of millions of dollars that the banks gave to Congress in the last 10 years to buy influence and changes in the laws probably had a lot to do with that.

The lobbying and campaign contributions got them what they wanted for far more than just the past 10 years, and it was more than just banks that got more than they deserved, to everyone else's eventual expense. The repeal of the Glass-Steagall Act, among other things, was foolish. Fannie Mae and Freddie Mac threw a lot of influence around too, unfortunately. The SEC and Fed failed pretty badly as well in their duties.

[WildcatDan]

Laws which led to banks having to worry about meeting quotas of minorities and low income borrowers is what started the mess. Lax lending practices, greedy brokers, lack of checks and balances internally within banks when BUYING groups of loans, dishonest or uneducated borrowers, plus bank policy makers turning a blind eye to the fact that the "bubble" would eventually burst, is what caused the SCOPE of the mess. There are so many factors at play that you cannot point the finger in any one direction. The whole thing is crazy. Some of the people involved SHOULD have known better, some should have taken the time to do their research.

Lending more than 100% on any property value is just stupid, but especially in what is obviously an inflated market. Conservative banks did NOT engage in this practice and that is why not all banks are struggling right now.

A.R.M. loans are only a part of the problem. There are so many things that you sign when you get an adjustable rate that there is no way that people did not know what they were getting. When I was a loan officer I always presented them as an option for those who knew beyond a shadow of a doubt that they would be leaving the home either before the rate adjusted or very shortly thereafter. Fixed rates were so low during that time that the arm loans did not do you that much of a favor.

When it comes to this bail out package there is no way that they could bail out the homeowners who are in default. How could they possible do that in a fair manner? What about those of us who have been faithfully making our mortgage payments? Would they pay ours off? Aren't we the ones who really deserve the help? Are they just going to pay the past due amounts owed to the banks to bring the mortgages current? If that is the case we would find ourselves in the same situation again in a few months.

Save the banks, save the economy, help everyone out. Let me go ahead and say I am not 100% sure I agree with the bailout since we are not sure what final form it is going to take. However, the housing market is not the only one suffering here. If the banks do not get a bailout then a lot of folks would end up losing their retirement, their savings, their total means of survival. It would be a great depression all over again.

[Blue Heaven]

^ excellent post:thumbup:

[Matt Dillon]

^ excellent post:thumbup:

Indeed it is.