The Great Depression between 2007 and 2011 was created by a single word, "DEBT". The origins of this depression date not to the Lehman September 2008 bankruptcy, but to the failed bank debt offering against Boots Alliance and Chrysler in July 2007. When that transaction failed, the securitision markets and overall debt markets failed. The West was headed for a second Great Depression...A true shift of power from West to East.
This article explores four key factors that lead to this catastrophe.
The banks and insurance companies manufactured credit default swaps (CDS). These first two points on CDS are well connected. The old fashion commercial bank would make a loan and hold that loan on its balance sheet. The loan officer would come around to your house and kick the tyres on your car. Then, a great merger took place between an Investment Bank and a Commercial Bank in the early 2000 period. That was a defining moment to this story. That old commercial bank kept its loans on the balance sheet but the investment banks saw ways to profit by trading those loans. The new Goliath would simply buy insurance from it cousin Giant Insurance Company GIA. So we begin the story.
1.) Credit Default Swaps were created to insure against a default. They were manufactured against the underlying bonds of the company it would insure. As the credit rating of a company declined, the premium for that insurance increased. Everyone (the banks) bought that sweet candy insurance. However, it was not common sense. Simply, you sell your house to 100 people and they all show up at high noon to claim that house, but there is only one house. This was the problem with the bilateral CDS market. The warning was the default by Delphi, a former division of General Motors. The banks came together and put together an auction plan. They all received less that USD 1 in insurance and came to a much lower price on the default. They never thought that this could happen at a massive scale. Those days were boom! boom! in the early 2000 period. The perfect storm was brewing, as simply no central clearing system for CDS existed.
2.) The second point is that the CDS maturity did not match the bank's loan maturity. Goliath bank wrote down its balance sheet against the purchase of CDS. Goliath bought a five year CDS in 2003 against a loan maturity of 10 years. Then, after mid 2007, the price of CDS increased. Goliath decided not to reinsure in 2008 due to the increased premium, but we all know that there is no free lunch. Now, that loan came back to Goliath's balance sheet...and loan after loan came back to that balance sheet. The balance sheet soared and the music no longer played and no one danced.
3.) The securitisation markets failed. Securitisation is a great concept and one day it should be restored. An entity has cash flows (annuity) and you simply bundle those flows. Everyone became a hunter and there was no game keeper in the park. You simply went down to your local realestate agency in the UK. They gave you this low mortgage interest. They turned around and sold your mortgage to a High Street local bank. The local bank sold it to Goliath. Goliath called his cousin Giant Insurance Company...and presto, a triple AAA securitised bond was created. That bond was then sold to Ms. X's pension fund. Ms. X worked for 30 years as a school teacher and looked forward to her nice retirement in a humble bungalow house with her husband Y. However, couple Z her neighbour did not keep up with the mortgage payments and defaulted. If we multiply that by millions, "Houston, we have a problem!"
4.) Arbitrage by the banks came into play. Like Cain and Able, there were two Goliaths. The one brother put his syndication loans into held for investment (HFI) where he simply looked at Financial Accounting Standard (FAS) methodology and won by keeping it all at simple book value. But, the other brother Goliath kept those loans hoping that he could sell them. Every month, Goliath would market to market those loans. One day, a small guy named David brought Goliath down.
If you never know the cause of a disease you can never cure it.
1.) We need a central clearing system on CDS.
2.) We need independent risk and independent audit to ensure that we all understand Finance 101.
3.) We require accountability and responsibility to monitor our actions, especially what we secure.
4.) We require uniform accounting rules, even if that protects Goliath. Arbitrage builds nothing!
Copy Right July 23, 2011. All Rights Reserved.
Saturday 23 July 2011
Tuesday 12 July 2011
The Euro?
Many publications have been written about the Euro that focus on economics. If we take two steps back, we need to focus on four strategic elements; culture, society, politics and economics. First, we must look at the culture and society within Europe.
Europe ignores that the United States of America has a history. That history is embedded in its Civil War that cost more lives than all the other U.S. wars put together. It was a war about Federalism versus States rights. It was a war not only about slavery but a war about culture and society. It was a war about the Northern banks having mortgages on the Southern plantations. That was a horrible war. For good or bad, a true Union has emerged today in the United States of America. It took great leaders like Lee from the South and Grant from the North to mend those deep wounds. Enemies sometimes were, are and become best friends.
The most important fact from U.S. history is that the European Union is a Confederation, not a true Union. The cultures and societies within Europe are very different. The labour force is not mobile. A person with German culture and living in a German society will most likely not immigrate to Spain. The Spanish will also not go to Greece. In the United States, the labour force is mobile and this is a difference between a Union and a Confederation. So, the starting point is that the European Union is not a Union but indeed a Confederation.
Second, we must look at the politics. The states dictate the Confederation. The rich countries within the Confederation will support a Euro because that increases their exports to the Confederation. An Audi will cost the same in Portugal than it does in Germany. That creates jobs for the wealthy North, but what about the South? Do their politicians have the same clout?
Finally, the economic factors come into play. The Confederation has lost its monetary and fisical policy to a Union that does not exist. Sun and tourism are exports, but Portugal, Greece, Spain and Italy have surrendered this to the clouds of the North. Without these tools, the South will default. The South needs to devalue its currency. The South needs lower interest rates to stimulate its economy at a time when the North needs to raise interest rates in order to fight inflation and defend its economic growth. The South needs to regain its fisical policy...but now it is trapped. The only way out for Greece is to leave the Euro. It needs to attract tourism like its arch rival neighbour Turkey...that I am sure each will come to peace with each other as they are Southern neighbors. However, success in Europe must be determined by economic empowerment within the European Confederation.
The Euro can not survive in its current form.
The Euro?.....
THE END
Copy right July 12, 2011. All rights reserved.
Europe ignores that the United States of America has a history. That history is embedded in its Civil War that cost more lives than all the other U.S. wars put together. It was a war about Federalism versus States rights. It was a war not only about slavery but a war about culture and society. It was a war about the Northern banks having mortgages on the Southern plantations. That was a horrible war. For good or bad, a true Union has emerged today in the United States of America. It took great leaders like Lee from the South and Grant from the North to mend those deep wounds. Enemies sometimes were, are and become best friends.
The most important fact from U.S. history is that the European Union is a Confederation, not a true Union. The cultures and societies within Europe are very different. The labour force is not mobile. A person with German culture and living in a German society will most likely not immigrate to Spain. The Spanish will also not go to Greece. In the United States, the labour force is mobile and this is a difference between a Union and a Confederation. So, the starting point is that the European Union is not a Union but indeed a Confederation.
Second, we must look at the politics. The states dictate the Confederation. The rich countries within the Confederation will support a Euro because that increases their exports to the Confederation. An Audi will cost the same in Portugal than it does in Germany. That creates jobs for the wealthy North, but what about the South? Do their politicians have the same clout?
Finally, the economic factors come into play. The Confederation has lost its monetary and fisical policy to a Union that does not exist. Sun and tourism are exports, but Portugal, Greece, Spain and Italy have surrendered this to the clouds of the North. Without these tools, the South will default. The South needs to devalue its currency. The South needs lower interest rates to stimulate its economy at a time when the North needs to raise interest rates in order to fight inflation and defend its economic growth. The South needs to regain its fisical policy...but now it is trapped. The only way out for Greece is to leave the Euro. It needs to attract tourism like its arch rival neighbour Turkey...that I am sure each will come to peace with each other as they are Southern neighbors. However, success in Europe must be determined by economic empowerment within the European Confederation.
The Euro can not survive in its current form.
The Euro?.....
THE END
Copy right July 12, 2011. All rights reserved.
Monday 11 July 2011
Welcome to BAM (Bhushan, Alda & Moore)
Description:
BAM was formed on July 12, 2011 as a private fund. BAM is not regulated by the SEC, FSA or any other government regulatory institution. All opinions provided on this web page are private. Please consult professional advice; including but not limited to legal, accounting and investments. The opinions provided on this page are from BAM and do not represent professional advice. All articles are copy righted and require direct permission from BAM to reprint. The use of any intellectual material provided in the BAM web publications is prohibited.
Kind regards,
Jonathan J. Bhushan
Partner
Bhushan, Alda & Moore (BAM)
BAM was formed on July 12, 2011 as a private fund. BAM is not regulated by the SEC, FSA or any other government regulatory institution. All opinions provided on this web page are private. Please consult professional advice; including but not limited to legal, accounting and investments. The opinions provided on this page are from BAM and do not represent professional advice. All articles are copy righted and require direct permission from BAM to reprint. The use of any intellectual material provided in the BAM web publications is prohibited.
Kind regards,
Jonathan J. Bhushan
Partner
Bhushan, Alda & Moore (BAM)
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