kent nickell
Well-known member
I think it's useful to review the subject of just what a CDO is and what makes it toxic. A CDO (collateralized debt obligation) is a security made up of various loans backed by collateral such as homes, commercial property and cars. This security generates money as people pay on the loans. Similar securities were formed by lumping together other types of loans such as credit card and student loans. These securities go bad essentially when people stop paying back these loans and thus the security stops generating income and becomes toxic. At least with the collateral backed securities there is some recourse to reclaiming the homes and cars although at much reduced values. The credit cards and student loans become almost complete write-offs with the only recourse being to stop repeating the practices of the past which means cutting off credit to the tune of hundreds of billions of dollars...
Many of these toxic assets are being carried 'off the balance sheet' strangely enough so it's hard to determine the actual solvency of these banks. By trying to get these toxic assets into the light of day they are being offered to private investors with fed backing. This brings up how these CDOs should be valued such as 'mark to market', 'mark to maturity' and 'mark to myth'. The old way of doing business definitely had a lot of myth. Valuing these at current 'market' conditions could lead to significant write-downs putting these institutions into possible insolvency. Mark to maturity is the hope that holding onto these assets such as residential and commercial property will bring higher prices in the future. Banks and private investors will try and work out a price with the FDIC taking an active role in trying to see that these assets get back on the balance sheets so that markets have some transparency.....
http://themoderatevoice.com/politics/economy/24738/say-goodbye-to-plastic/
Say Goodbye To Plastic
December 1st, 2008
By MIKKEL FISHMAN
Nouriel Roubini has been the most prominent Cassandra for the financial crisis, especially when it comes to his understanding of the fundamental drivers. In the 90s he studied banking and deficit induced international economic crises and then used his understanding to predict that the United States was most likely the next victim. Of course no one listened to him as it was right smack in the middle of the real estate bubble and as Keynes famously noted: "The market can stay irrational longer than you can stay solvent." While I agree fully with Roubini's prescription of the problem, I have always felt that he was a bit blithe about the extent of damage that would ensue if his predictions came to fruition. Even now his policy proscriptions don't really seem to mesh well with his writings on the root causes, but at least he is getting play in mainstream discourse.
The person that has been the best at detailing and predicting the financial sector in particular has been Meredith Whitney. She has nearly been a crystal ball when it comes to reading balance sheets and macro-economic reports and then predicting exactly what banks would do. It is with that in mind that I introduce her newest prediction: the severe curtailing of credit card lines. It would definitely make sense as banks haven't been keeping credit card debt on their books, but instead turning them into securities to sell off (the modern bank really is little more than a massive hedge fund) and now the demand for those has dried up. This is why the government has committed to buying several hundred billion of credit card securities. As Roubini and others have consistently pointed out, the consumers that actively use credit lines are tapped out, and with rising unemployment banks are going to be looking to reduce exposure?so I think Meredith has a good chance of being correct on this as well.
The sum is staggering though and I don't think people appreciate how much deflation will be caused by reducing consumer credit $2 trillion. I would recommend taking an honest assessment of finances and job security, and if you have little debt and are even slightly worried about your job, then I would start carrying a balance to preserve cash. The Age of Plastic has ended.
Update: Yves Smith, as always, provides an insightful view into how credit card reductions will affect small businesses.
Per Michael's post below, the problem is that the government has focused on trying to prevent the economy from tanking by focusing on long term consumption and asset value. What they are calling the "credit crunch" isn't a credit crunch at all, it's a solvency problem where there are too many bad loans.
The real "credit crunch" is when small businesses can't get easy credit to use for temporary needs, or when consumers can't buy large ticket items that they plan on paying off over the course of only a few months. That crunch is going to be what kills deserving and nimble businesses, even as trillions flow to banks and other businesses that made awful decisions
Many of these toxic assets are being carried 'off the balance sheet' strangely enough so it's hard to determine the actual solvency of these banks. By trying to get these toxic assets into the light of day they are being offered to private investors with fed backing. This brings up how these CDOs should be valued such as 'mark to market', 'mark to maturity' and 'mark to myth'. The old way of doing business definitely had a lot of myth. Valuing these at current 'market' conditions could lead to significant write-downs putting these institutions into possible insolvency. Mark to maturity is the hope that holding onto these assets such as residential and commercial property will bring higher prices in the future. Banks and private investors will try and work out a price with the FDIC taking an active role in trying to see that these assets get back on the balance sheets so that markets have some transparency.....
http://themoderatevoice.com/politics/economy/24738/say-goodbye-to-plastic/
Say Goodbye To Plastic
December 1st, 2008
By MIKKEL FISHMAN
Nouriel Roubini has been the most prominent Cassandra for the financial crisis, especially when it comes to his understanding of the fundamental drivers. In the 90s he studied banking and deficit induced international economic crises and then used his understanding to predict that the United States was most likely the next victim. Of course no one listened to him as it was right smack in the middle of the real estate bubble and as Keynes famously noted: "The market can stay irrational longer than you can stay solvent." While I agree fully with Roubini's prescription of the problem, I have always felt that he was a bit blithe about the extent of damage that would ensue if his predictions came to fruition. Even now his policy proscriptions don't really seem to mesh well with his writings on the root causes, but at least he is getting play in mainstream discourse.
The person that has been the best at detailing and predicting the financial sector in particular has been Meredith Whitney. She has nearly been a crystal ball when it comes to reading balance sheets and macro-economic reports and then predicting exactly what banks would do. It is with that in mind that I introduce her newest prediction: the severe curtailing of credit card lines. It would definitely make sense as banks haven't been keeping credit card debt on their books, but instead turning them into securities to sell off (the modern bank really is little more than a massive hedge fund) and now the demand for those has dried up. This is why the government has committed to buying several hundred billion of credit card securities. As Roubini and others have consistently pointed out, the consumers that actively use credit lines are tapped out, and with rising unemployment banks are going to be looking to reduce exposure?so I think Meredith has a good chance of being correct on this as well.
The sum is staggering though and I don't think people appreciate how much deflation will be caused by reducing consumer credit $2 trillion. I would recommend taking an honest assessment of finances and job security, and if you have little debt and are even slightly worried about your job, then I would start carrying a balance to preserve cash. The Age of Plastic has ended.
Update: Yves Smith, as always, provides an insightful view into how credit card reductions will affect small businesses.
Per Michael's post below, the problem is that the government has focused on trying to prevent the economy from tanking by focusing on long term consumption and asset value. What they are calling the "credit crunch" isn't a credit crunch at all, it's a solvency problem where there are too many bad loans.
The real "credit crunch" is when small businesses can't get easy credit to use for temporary needs, or when consumers can't buy large ticket items that they plan on paying off over the course of only a few months. That crunch is going to be what kills deserving and nimble businesses, even as trillions flow to banks and other businesses that made awful decisions