WSJ is reporting that AIG which was destroyed and had to be bailed out by the Treasury because of the collateral it had to pay to counterparties to mark to market CDS contracts, is now in the position of reaping some of that collateral back.
http://finance.yahoo.com/insurance/article/108039/in-reversal-of-fortune-aig-recoups-collateral
This is very interesting turn of events as the article is stating that AIG got almost $1B back from Goldman Sachs.
This is certainly good news for AIG, as I am thinking not many analysts had this factored into their models. Estimates have got to go up for AIG as their derivatives trading unit could post up to $2.5B mark up gains for the quarter.
Which only means more bonus money to the blind squirrels at AIGFP.
AIG is set to report earnings on November 11Th.
Monday, November 2, 2009
Sunday, November 1, 2009
Tax Payers Take It On The Chin With CIT
CIT expected to file for a pre-packaged bankruptcy.
http://dealbook.blogs.nytimes.com/2009/11/01/cit-to-file-for-bankruptcy-soon/?hp
The $2.3B in government aid that was given to CIT in the form of preferred stock is worthless and is lost.
At least Goldman Sachs which is part of the government gets to preserve its $2.13B loan. So its not a total loss.
http://dealbook.blogs.nytimes.com/2009/11/01/cit-to-file-for-bankruptcy-soon/?hp
The $2.3B in government aid that was given to CIT in the form of preferred stock is worthless and is lost.
At least Goldman Sachs which is part of the government gets to preserve its $2.13B loan. So its not a total loss.
GOP Utterly Rudderless
Frank Rich with another great article in the NY Times.
http://www.nytimes.com/2009/11/01/opinion/01rich.html?ref=opinion
One would think that the way the Obama Administration has dealt with Wall Street would leave the Democrats in serious trouble, but the GOP most notably the radical right (Palin/Beck/Limbaugh) is so beyond self destructive, that the ultimate end game for politics is a race to the bottom of the barrel.
http://www.nytimes.com/2009/11/01/nyregion/01upstate.html?hp
http://www.nytimes.com/2009/11/01/opinion/01rich.html?ref=opinion
One would think that the way the Obama Administration has dealt with Wall Street would leave the Democrats in serious trouble, but the GOP most notably the radical right (Palin/Beck/Limbaugh) is so beyond self destructive, that the ultimate end game for politics is a race to the bottom of the barrel.
http://www.nytimes.com/2009/11/01/nyregion/01upstate.html?hp
McClatchy Does It Again.
Newspaper Organization McClatchy is running a series of stories on good old Goldman Sachs and their adventurers in AIG/SubPrime.
http://www.mcclatchydc.com/227/story/77791.html
No one in the media except for McClatchy and the blogesphere have taken on the fourth branch of government. Bloomberg to a lesser extent has taken on the government but has left GS alone for the most part.
Its not coincidence that the people at McClatchy were the first to call out the Bush/Cheney/Neocon Cabal and their fruitless exercise in Iraq. The above article even though is well known for the well read should get more everyday hardworking people to stand up against these type of practices.
McClatchy's inquiry found that Goldman Sachs:
•Bought and converted into high-yield bonds tens of thousands of mortgages from subprime lenders that became the subjects of FBI investigations into whether they'd misled borrowers or exaggerated applicants' incomes to justify making hefty loans.
•Used offshore tax havens to shuffle its mortgage-backed securities to institutions worldwide, including European and Asian banks, often in secret deals run through the Cayman Islands, a British territory in the Caribbean that companies use to bypass U.S. disclosure requirements.
•Has dispatched lawyers across the country to repossess homes from bankrupt or financially struggling individuals, many of whom lacked sufficient credit or income but got subprime mortgages anyway because Wall Street made it easy for them to qualify.
•Was buoyed last fall by key federal bailout decisions, at least two of which involved then-Treasury Secretary Henry Paulson, a former Goldman chief executive whose staff at Treasury included several other Goldman alumni.
There are other excellent pieces from McClatchy on GS:
http://www.mcclatchydc.com/homepage/story/77788.html
http://media.mcclatchydc.com/smedia/2009/10/29/12/20091028_Jobs_GOLDMAN.large.prod_affiliate.91.jpg
This is an another great piece on Moody's
http://www.mcclatchydc.com/homepage/story/77244.html
http://www.mcclatchydc.com/227/story/77791.html
No one in the media except for McClatchy and the blogesphere have taken on the fourth branch of government. Bloomberg to a lesser extent has taken on the government but has left GS alone for the most part.
Its not coincidence that the people at McClatchy were the first to call out the Bush/Cheney/Neocon Cabal and their fruitless exercise in Iraq. The above article even though is well known for the well read should get more everyday hardworking people to stand up against these type of practices.
McClatchy's inquiry found that Goldman Sachs:
•Bought and converted into high-yield bonds tens of thousands of mortgages from subprime lenders that became the subjects of FBI investigations into whether they'd misled borrowers or exaggerated applicants' incomes to justify making hefty loans.
•Used offshore tax havens to shuffle its mortgage-backed securities to institutions worldwide, including European and Asian banks, often in secret deals run through the Cayman Islands, a British territory in the Caribbean that companies use to bypass U.S. disclosure requirements.
•Has dispatched lawyers across the country to repossess homes from bankrupt or financially struggling individuals, many of whom lacked sufficient credit or income but got subprime mortgages anyway because Wall Street made it easy for them to qualify.
•Was buoyed last fall by key federal bailout decisions, at least two of which involved then-Treasury Secretary Henry Paulson, a former Goldman chief executive whose staff at Treasury included several other Goldman alumni.
There are other excellent pieces from McClatchy on GS:
http://www.mcclatchydc.com/homepage/story/77788.html
http://media.mcclatchydc.com/smedia/2009/10/29/12/20091028_Jobs_GOLDMAN.large.prod_affiliate.91.jpg
This is an another great piece on Moody's
http://www.mcclatchydc.com/homepage/story/77244.html
Mortgage Securitization - The Real Problem
This data is as of March 31, 2009. As we all know the government currently is the housing/mortgage market. Historically the split between GSE's and Private Bank Securitization has been in the area of 75% FNM/FRE and 25% Banks, that figure at the moment is 98% GSE's 2% Banks. There is absolutely no confidence in the private label lending market. From looking at the chart below, you will notice that most of the mortgages that are seriously delinquent are currently bundled.
Why are the banks in trouble if they have already off loaded mortgages off their books? A lot of the banks did their own securitizations and weren't able to sell them to investors, so they had to keep them on their own books. They had completed tens of billions in re tranching, resecuritizations, CDO & CDL tranching just before the secondary market blew up. All of those toxic assets had no place to go accept back on to balance sheets or SIVS.
From the above graphic, the delinquency rates are 35% for bank securitized mortgages and 42% from Private Mortgage backed investors.
This is the real problem that millions of home owners are facing with regards to mortgage modifications. The banks even though in bad shape are in no structural position to do these modifications. They don't have the horses to do so. Also a bigger problem, under The Making Homes Affordable Program, participating mortgage companies must modify loans for all qualified borrowers, the only exception is when a contract with investors prohibits the modification. Almost all of the private label mortgage contracts have prohibitions that prohibit modifications.
Most of these private label mortgages were ARM, Option ARM, Negative Amortization, and other dangerous types of hybrids. These mortgages were very profitable all the way of the supply chain. The banks knew they were selling products that home owner did not understand, but the fact remains that these were very profitable. You can assume that the main reason they are fighting the Plain Vanilla Mortgage standard offered by the consumer protection agency is to protect these type of actions. They continue to say it stifles innovation. INNOVATION! If Neg AM, Option ARM, Pick-A-Pay is innovation, please downgrade me to DOS on my PC! Furthermore, have you ever looked at a Hybrid Mortgage Tranche prospectus? It is nearly twice the size of a conventional 15/30 year prospectus.
Now we get to the way these mortgages are sliced and diced through the system. Where is Clyde when you need him the most?
After a typical mortgage is placed with a home owner, the bank that underwrote/originated the mortgage knowing that is crap, will attempt to sell this note to an investment bank, which in turn also knowing its crap, will bundle it up with other similar pieces of crap. This is how a MBS security is created. The investment bank will give it a fancy name. After the securitization has taken place, The syndicate department within the Structured area will peddle the crap to investors, who kinda know its crap, but need the extra yield. We live in an ALPHA WORLD. That's not the end of it. Someone has to manage the crap, so they hire another investment bank to that. Someone also has to service the crap make sure the payments are made, etc. Along along the chain, everyone is getting paid.
The buyers of MBS are not usually readily available, but its generally 401k's, Pension Plans, foreign governments, and college endowments. Sprinkle in some widows and orphans and you have an investor base. Now, you may ask how are 401k's and Pension Plans allowed to buy this crap? Are they not allowed to buy sub prime mortgages? Yes they are, but then again the banks had that covered as well. The Ratings Agency would always slap a AAA rating on them. Perfect for the pension fund manager.
Its this last area that banks are using as an excuse not to modify mortgages. They generally say that they are acting in the best interests of investors by not modifying these contracts as they hurt the overall MBS. They say that its the investors who are standing in the way of modifications. Firstly, legal experts say that investors have no say at all in mortgage mods. Secondly, this begs the question. Were the banks acting on investors best interest when they were placing crap disguised as Gold? Also the Obama Administration has amended many securitization rules that give the banks extreme latitude in doing modifications.
The reason they are not doing them is two fold:
1-They don't have the horses to do them. They are understaffed.
2-If they do modify mortgages, the underlying MBS gets repriced to a more reasonable true valuation. From this the banks would all have to take a haircut on the crap they currently own on their own books.
Needless to say Wells Fargo, BOFA, along with JP Morgan are the biggest suspects in these modification schemes.
The convenient excuse of blaming investors and contract rules don't jive with the facts. In reality the contracts themselves generally don’t limit modifications. Researchers at UC Berkeley’s law school looked at the contracts covering three-quarters of the subprime loans that were securitized in 2006. The researchers found that only 8% prohibited modifications outright. About a third of the loans were in contracts that said nothing about modification, and the rest set some limits but generally gave the servicers a lot to leeway to modify, particularly for homeowners that had defaulted or would likely default soon
Wells Fargo is the most egregious offender here, partly because they have the most to lose in a mortgage modification. That is because Wells currently is a giant Mortgage Hedging Company, disguised as a lender. IF they modify more loans, the value of their MSR hedges decline, because the mortgage servicing rights decline when a modifications takes place. As the MSR value goes down. We are not even going into the revaluation process of all of the mortgages on their books that would take place.
http://tradersutra.blogspot.com/2009/10/pure-simple-wells-fargo-is-disgrace.html
All of this has made modifications next to impossible. You can not take the banks seriously when they say they are trying to keep people in their homes. The only reason foreclosures slow down is that banks just don't want any more inventory on their books.
Why are the banks in trouble if they have already off loaded mortgages off their books? A lot of the banks did their own securitizations and weren't able to sell them to investors, so they had to keep them on their own books. They had completed tens of billions in re tranching, resecuritizations, CDO & CDL tranching just before the secondary market blew up. All of those toxic assets had no place to go accept back on to balance sheets or SIVS.
From the above graphic, the delinquency rates are 35% for bank securitized mortgages and 42% from Private Mortgage backed investors.
This is the real problem that millions of home owners are facing with regards to mortgage modifications. The banks even though in bad shape are in no structural position to do these modifications. They don't have the horses to do so. Also a bigger problem, under The Making Homes Affordable Program, participating mortgage companies must modify loans for all qualified borrowers, the only exception is when a contract with investors prohibits the modification. Almost all of the private label mortgage contracts have prohibitions that prohibit modifications.
Most of these private label mortgages were ARM, Option ARM, Negative Amortization, and other dangerous types of hybrids. These mortgages were very profitable all the way of the supply chain. The banks knew they were selling products that home owner did not understand, but the fact remains that these were very profitable. You can assume that the main reason they are fighting the Plain Vanilla Mortgage standard offered by the consumer protection agency is to protect these type of actions. They continue to say it stifles innovation. INNOVATION! If Neg AM, Option ARM, Pick-A-Pay is innovation, please downgrade me to DOS on my PC! Furthermore, have you ever looked at a Hybrid Mortgage Tranche prospectus? It is nearly twice the size of a conventional 15/30 year prospectus.
Now we get to the way these mortgages are sliced and diced through the system. Where is Clyde when you need him the most?
After a typical mortgage is placed with a home owner, the bank that underwrote/originated the mortgage knowing that is crap, will attempt to sell this note to an investment bank, which in turn also knowing its crap, will bundle it up with other similar pieces of crap. This is how a MBS security is created. The investment bank will give it a fancy name. After the securitization has taken place, The syndicate department within the Structured area will peddle the crap to investors, who kinda know its crap, but need the extra yield. We live in an ALPHA WORLD. That's not the end of it. Someone has to manage the crap, so they hire another investment bank to that. Someone also has to service the crap make sure the payments are made, etc. Along along the chain, everyone is getting paid.
The buyers of MBS are not usually readily available, but its generally 401k's, Pension Plans, foreign governments, and college endowments. Sprinkle in some widows and orphans and you have an investor base. Now, you may ask how are 401k's and Pension Plans allowed to buy this crap? Are they not allowed to buy sub prime mortgages? Yes they are, but then again the banks had that covered as well. The Ratings Agency would always slap a AAA rating on them. Perfect for the pension fund manager.
Its this last area that banks are using as an excuse not to modify mortgages. They generally say that they are acting in the best interests of investors by not modifying these contracts as they hurt the overall MBS. They say that its the investors who are standing in the way of modifications. Firstly, legal experts say that investors have no say at all in mortgage mods. Secondly, this begs the question. Were the banks acting on investors best interest when they were placing crap disguised as Gold? Also the Obama Administration has amended many securitization rules that give the banks extreme latitude in doing modifications.
The reason they are not doing them is two fold:
1-They don't have the horses to do them. They are understaffed.
2-If they do modify mortgages, the underlying MBS gets repriced to a more reasonable true valuation. From this the banks would all have to take a haircut on the crap they currently own on their own books.
Needless to say Wells Fargo, BOFA, along with JP Morgan are the biggest suspects in these modification schemes.
The convenient excuse of blaming investors and contract rules don't jive with the facts. In reality the contracts themselves generally don’t limit modifications. Researchers at UC Berkeley’s law school looked at the contracts covering three-quarters of the subprime loans that were securitized in 2006. The researchers found that only 8% prohibited modifications outright. About a third of the loans were in contracts that said nothing about modification, and the rest set some limits but generally gave the servicers a lot to leeway to modify, particularly for homeowners that had defaulted or would likely default soon
Wells Fargo is the most egregious offender here, partly because they have the most to lose in a mortgage modification. That is because Wells currently is a giant Mortgage Hedging Company, disguised as a lender. IF they modify more loans, the value of their MSR hedges decline, because the mortgage servicing rights decline when a modifications takes place. As the MSR value goes down. We are not even going into the revaluation process of all of the mortgages on their books that would take place.
http://tradersutra.blogspot.com/2009/10/pure-simple-wells-fargo-is-disgrace.html
All of this has made modifications next to impossible. You can not take the banks seriously when they say they are trying to keep people in their homes. The only reason foreclosures slow down is that banks just don't want any more inventory on their books.
The Problem With VAR & Risk Management
Economic and Financial Theories and Models have come under considerable criticism over the last 18 months, most of it well deserved. The primary targets have been Efficient Market Hypothesis, Free Market Capitalism, and most importantly Value At Risk Models. There has been many articles written on both sides of the pond in the area of EMH and the idea of free markets.
I posted a few days ago the duel over EMH.
http://tradersutra.blogspot.com/2009/10/emh-steel-cage-death-match.html
Also Free Markets Capitalism has been roasted by the Keynesian folks.
http://tradersutra.blogspot.com/2009/10/capitalism-has-failed.html
Back in September, there was a hearing on VAR Modeling held by the Subcommittee On Oversight And Investigations. This was a meeting to discuss how the role of risk models influenced the crisis and how they should be used going forward.
They call VAR the 1% Model, meaning that with certain confidence and all else being equal, a trader or desk can stand to lose a given amount on a given day. Simply if you have a VAR of $25M, that means that you on 99% of all days will lose less then $25MM. Sounds good. Control your VAR and you control your losses. Correct?
But the problem with VAR is much more complex, much more complex then the derivatives and assets it tries to model. VAR makes some assumptions that if you look back at is quite head scratching. Some if not all of these assumptions are clearly false.
1-Not all asset classes are included in the VAR calculation, because accurate pricing is not available. This was even before the crisis, where assets rarely traded and pricing was scarce. The VAR models that were used didn't take into account future toxic assets, most of which were off balance sheets and tied up in structured investment vehicles. Even today this is true.
2-Data used in VAR calculations are based on historical data. We live in a real time dynamic world yet we are using models that are static in nature. These results are unrepresentable of future results. This is what is also called "Future Blindness." People tend not to be able to anticipate a future they have never personally experienced.
3-VAR as well as Black Scholes and other risk measurements do not and can model the basic problem of liquidity. When markets are pressured the liquidity generally dries up. LTCM was brought down because the firm held hundreds of billions of assets that were not liquid. The VAR Model doesn't make the basic allowances for liquidity risk.
4-The most important assumption that VAR makes that is empirically and academically wrong is that asset prices follow a "normal" distribution or the classical bell curve. A lot of people tend to call these type of distributions "Gaussian."
I will go into why #4 is so wrong in a moment.
Lets get one thing straight. Risk Models work great and are designed to function properly in normal market conditions, but they should not be 100% relied upon in times of crisis. Too many bank executives relied on these models during times of crisis because they were seduced by the Nobel Prize winners that designed them. Both the strange thing is going back to LTCM, everyone knew you could not rely on these models when crap hot the fan. That they were completely worthless. This is the one remarkable thing that has so bewildered market thinkers. How in the world did the regulators allow the banks to use models that they knew were worthless in times of crisis, and those same models were telling the risk managers what level of capital requirements were needed in such times of crisis? In the end there was not enough cushion to soften the blow. I can only safely assume that bank executives who in the most part are not very mathematical left the heavy lifting to the model makers. There was so much competition in the financial alchemy world that economists and financial engineers were in the game of who can build a better mousetrap. These guys had their own incentives. The economic profession is all about giving more credence to mathematical models that can crunch the numbers faster and with the least bit of parameters. There was no room for common sense.
Most importantly the people behind the VAR Models knew of their shortcomings on almost every scale, but using those models brought results to the banking world. In the end VAR helped risk managers, traders, and high level executives rationalize bad trading bets. Traders used VAR to again rationalize a situation that defied even the basic common sense of risk management. The high level executives who have no clue of the shortcomings of VAR only cared to hear what they wanted to hear. In the end most financial models only work because they meet the basic need the human beings that use them. They needed VAR during the boom, and VAR need more traders to use them. When everyone is using the same road map, we all will drive off of a cliff.
Now lets go back to my 4Th point with regards to normal distributions. This is where I think VAR made the biggest wrong assumption. Its extremely dangerous to assume that risk are normally distributed. Of course on a day to day basis they tend not to move far away from the mean, but its a widely known fact that distribution of prices in financial markets are subject to something called "Fat Tails." Fat Tails alerts you that events far away from the mean are more likely to happen then a normal distribution would alert you to. These distributions are subject to "skewness", meaning they are not symmetrical around the mean.
Stocks and bonds are subject to negative skewness which mean longer tails of negative outcome. While commodities are subject to positive skewness. This is the reason, along with their low correlation with financial asset returns makes them a useful addition to a model portfolio.
Kurtosis is also known informally as “fat tails”. That means that events far away from the mean are more likely to happen that a normal distribution would suggest.
Now this one important finding has been researched and many papers have been written proving it, yet the math in which most risk management models including VAR and Black Scholes goes to bed at night assuming a normal distribution. The French Mathematician Benoit Mandelbrot observed that distributions of price changes in various markets were not normally distributed. The observed distributions of price changes had fatter tails than the normal distribution. From this we have Nassim Nicolas Taleb, author of The Black Swan and Fooled by Randomness, who has dubbed significantly larger extreme price moves than those predicted by a normal distribution as “Black Swans.” Taleb has linked Black Swan price change events to the recent financial crisis, suggesting in effect that we all collectively misunderstood on which side of the distribution of possible risk outcomes we stood.
This is where VAR fails. It misrepresents and underestimates the nature of risk.
So the argument can be made like this:
Current risk management and derivative pricing regimes are based upon normal distributions. Price movements in the recent financial crises were unpredictable or low probability events that were also greater than predicted by normal distribution models. Hence the collective failure to anticipate Black Swan events is “responsible” for the recent crises as mis-specified risk management models failed due to fatter than normal tails.
So the argument cam also go this way. Was housing and sub prime a Black Swan event or a failure of the stated objectives of risk management and oversight?
We all know that risk management systems based solely on analysis of past price moves will at some point fail if financial markets continue to change. The problem with current risk management systems cannot be fixed by simply changing VAR parameters or other statical models. Risk management regimes must incorporate judgments about the evolution of the underlying markets, distribution of possible price changes and other dynamic sources of risk.
I can only say that risk was so badly miss priced that a black swan event was going to happen sooner or latter because of the simple fact that too many complex derivatives were created with far too much leverage, and that no model was ever created or will be subsequently created to manage this.
I posted a few days ago the duel over EMH.
http://tradersutra.blogspot.com/2009/10/emh-steel-cage-death-match.html
Also Free Markets Capitalism has been roasted by the Keynesian folks.
http://tradersutra.blogspot.com/2009/10/capitalism-has-failed.html
Back in September, there was a hearing on VAR Modeling held by the Subcommittee On Oversight And Investigations. This was a meeting to discuss how the role of risk models influenced the crisis and how they should be used going forward.
They call VAR the 1% Model, meaning that with certain confidence and all else being equal, a trader or desk can stand to lose a given amount on a given day. Simply if you have a VAR of $25M, that means that you on 99% of all days will lose less then $25MM. Sounds good. Control your VAR and you control your losses. Correct?
But the problem with VAR is much more complex, much more complex then the derivatives and assets it tries to model. VAR makes some assumptions that if you look back at is quite head scratching. Some if not all of these assumptions are clearly false.
1-Not all asset classes are included in the VAR calculation, because accurate pricing is not available. This was even before the crisis, where assets rarely traded and pricing was scarce. The VAR models that were used didn't take into account future toxic assets, most of which were off balance sheets and tied up in structured investment vehicles. Even today this is true.
2-Data used in VAR calculations are based on historical data. We live in a real time dynamic world yet we are using models that are static in nature. These results are unrepresentable of future results. This is what is also called "Future Blindness." People tend not to be able to anticipate a future they have never personally experienced.
3-VAR as well as Black Scholes and other risk measurements do not and can model the basic problem of liquidity. When markets are pressured the liquidity generally dries up. LTCM was brought down because the firm held hundreds of billions of assets that were not liquid. The VAR Model doesn't make the basic allowances for liquidity risk.
4-The most important assumption that VAR makes that is empirically and academically wrong is that asset prices follow a "normal" distribution or the classical bell curve. A lot of people tend to call these type of distributions "Gaussian."
I will go into why #4 is so wrong in a moment.
Lets get one thing straight. Risk Models work great and are designed to function properly in normal market conditions, but they should not be 100% relied upon in times of crisis. Too many bank executives relied on these models during times of crisis because they were seduced by the Nobel Prize winners that designed them. Both the strange thing is going back to LTCM, everyone knew you could not rely on these models when crap hot the fan. That they were completely worthless. This is the one remarkable thing that has so bewildered market thinkers. How in the world did the regulators allow the banks to use models that they knew were worthless in times of crisis, and those same models were telling the risk managers what level of capital requirements were needed in such times of crisis? In the end there was not enough cushion to soften the blow. I can only safely assume that bank executives who in the most part are not very mathematical left the heavy lifting to the model makers. There was so much competition in the financial alchemy world that economists and financial engineers were in the game of who can build a better mousetrap. These guys had their own incentives. The economic profession is all about giving more credence to mathematical models that can crunch the numbers faster and with the least bit of parameters. There was no room for common sense.
Most importantly the people behind the VAR Models knew of their shortcomings on almost every scale, but using those models brought results to the banking world. In the end VAR helped risk managers, traders, and high level executives rationalize bad trading bets. Traders used VAR to again rationalize a situation that defied even the basic common sense of risk management. The high level executives who have no clue of the shortcomings of VAR only cared to hear what they wanted to hear. In the end most financial models only work because they meet the basic need the human beings that use them. They needed VAR during the boom, and VAR need more traders to use them. When everyone is using the same road map, we all will drive off of a cliff.
Now lets go back to my 4Th point with regards to normal distributions. This is where I think VAR made the biggest wrong assumption. Its extremely dangerous to assume that risk are normally distributed. Of course on a day to day basis they tend not to move far away from the mean, but its a widely known fact that distribution of prices in financial markets are subject to something called "Fat Tails." Fat Tails alerts you that events far away from the mean are more likely to happen then a normal distribution would alert you to. These distributions are subject to "skewness", meaning they are not symmetrical around the mean.
Stocks and bonds are subject to negative skewness which mean longer tails of negative outcome. While commodities are subject to positive skewness. This is the reason, along with their low correlation with financial asset returns makes them a useful addition to a model portfolio.
Kurtosis is also known informally as “fat tails”. That means that events far away from the mean are more likely to happen that a normal distribution would suggest.
Now this one important finding has been researched and many papers have been written proving it, yet the math in which most risk management models including VAR and Black Scholes goes to bed at night assuming a normal distribution. The French Mathematician Benoit Mandelbrot observed that distributions of price changes in various markets were not normally distributed. The observed distributions of price changes had fatter tails than the normal distribution. From this we have Nassim Nicolas Taleb, author of The Black Swan and Fooled by Randomness, who has dubbed significantly larger extreme price moves than those predicted by a normal distribution as “Black Swans.” Taleb has linked Black Swan price change events to the recent financial crisis, suggesting in effect that we all collectively misunderstood on which side of the distribution of possible risk outcomes we stood.
This is where VAR fails. It misrepresents and underestimates the nature of risk.
So the argument can be made like this:
Current risk management and derivative pricing regimes are based upon normal distributions. Price movements in the recent financial crises were unpredictable or low probability events that were also greater than predicted by normal distribution models. Hence the collective failure to anticipate Black Swan events is “responsible” for the recent crises as mis-specified risk management models failed due to fatter than normal tails.
So the argument cam also go this way. Was housing and sub prime a Black Swan event or a failure of the stated objectives of risk management and oversight?
We all know that risk management systems based solely on analysis of past price moves will at some point fail if financial markets continue to change. The problem with current risk management systems cannot be fixed by simply changing VAR parameters or other statical models. Risk management regimes must incorporate judgments about the evolution of the underlying markets, distribution of possible price changes and other dynamic sources of risk.
I can only say that risk was so badly miss priced that a black swan event was going to happen sooner or latter because of the simple fact that too many complex derivatives were created with far too much leverage, and that no model was ever created or will be subsequently created to manage this.
Saturday, October 31, 2009
Bank Crash Coming.....
I don't know if anyone saw this, but its extremely unnerving for the banks I am sure.
http://www.federalreserve.gov/newsevents/press/bcreg/20091030a.htm
This is the FRB telling the banks you are on your own when it comes to CRE. That the FED is encouraging active loan workouts as an official policy. Also Banks with significant CRE exposure are on their own. It seems to me that the FED is now acknowledging the major CRE problems. The biggest risk here are the banks who have not used the rally to offload exposure.
"Financial institutions that implement prudent loan workout arrangements after performing comprehensive reviews of borrowers' financial conditions will not be subject to criticism for engaging in these efforts, even if the restructured loans have weaknesses that result in adverse credit classifications. In addition, performing loans, including those renewed or restructured on reasonable modified terms, made to creditworthy borrowers, will not be subject to adverse classification solely because the value of the underlying collateral declined."
The Fed created QE for residential real estate, they have gotten hammered for it. They do not want the backlash of QE for CRE. Another reason why the markets got blitzed Friday.
I would not be surprised to see some CRE related downgrades in the financial sector Monday Morning. The same analysts who though the banks can go back to business as usual will do a complete turn around.
http://www.federalreserve.gov/newsevents/press/bcreg/20091030a.htm
This is the FRB telling the banks you are on your own when it comes to CRE. That the FED is encouraging active loan workouts as an official policy. Also Banks with significant CRE exposure are on their own. It seems to me that the FED is now acknowledging the major CRE problems. The biggest risk here are the banks who have not used the rally to offload exposure.
"Financial institutions that implement prudent loan workout arrangements after performing comprehensive reviews of borrowers' financial conditions will not be subject to criticism for engaging in these efforts, even if the restructured loans have weaknesses that result in adverse credit classifications. In addition, performing loans, including those renewed or restructured on reasonable modified terms, made to creditworthy borrowers, will not be subject to adverse classification solely because the value of the underlying collateral declined."
The Fed created QE for residential real estate, they have gotten hammered for it. They do not want the backlash of QE for CRE. Another reason why the markets got blitzed Friday.
I would not be surprised to see some CRE related downgrades in the financial sector Monday Morning. The same analysts who though the banks can go back to business as usual will do a complete turn around.
What Geithner Really Means.....
Treasury Secretary Tim Geithner was speaking to Congress this week trying to convince one set of crooks that the FSA plan cooked up by another set of crooks was a beneficial plan.
Also this:
http://www.nytimes.com/2009/10/30/business/30regulate.html?_r=1&scp=1&sq=Tim%20Geithner&st=cse
http://dealbook.blogs.nytimes.com/2009/10/29/geithner-recommends-stripping-fed-of-some-bailout-powers/?scp=2&sq=Tim%20Geithner&st=cse
But what does he really mean?
I stated before that he talks the talk but rarely walks the walk.
http://tradersutra.blogspot.com/2009/10/financial-stability-act-i-would-like-to.html
What he really means is although the Tax Payer really shouldn't have to fund another bank bailout, there is not going to be a resolution facility that would make future bank bailouts obsolete. No such measures are going to be implemented to make sure banks are not gambling with customer deposits. No such measures will be implemented to make sure the banks don't use their infinite subsidy against the taxpayer. What Geithner is really proposing is to let the Banks continue to steal all of the money, let them continue to loot the country. Only after they have done so in completely leeching the tax payer, and the entire system is on life support, the ones that survive, which will be the JP Morgans and GS of the world should be the first to bailout the country, not the taxpayer. Wonderful idea. Lets not fix TBTF. We are beyond that. Here we have the Treasury Secretary, the one that is responsible for being the custodian of our countries wealth for future generations basically telling you that TBTF institutions are an official policy going forward. That we should not draft any resolution that would restrict the TBTF ability to take risks with customer deposits. Simply create a penalty(To be levied by the Executive Branch of course)for them after they screw it all up again in the great casino we call financial markets.
What a wonderful depiction of equal representation under the Constitution by Mr. Geithner.
The question to ask is this?
Why is it legal for the Banks to continue to gamble with Tax Payer Money? The answer is THE BANKS RUN THE PLACE!
The banks are using the crisis that they created to liberalize the Casino to scam and loot the tax payer of even more funds.
We need more Elizabeth Warren's, more Neil Berofsky's, and even more Shiela Bair's in this world. I know Bair has her opponents, at least she pretends to be on our side.
Also this:
http://www.nytimes.com/2009/10/30/business/30regulate.html?_r=1&scp=1&sq=Tim%20Geithner&st=cse
http://dealbook.blogs.nytimes.com/2009/10/29/geithner-recommends-stripping-fed-of-some-bailout-powers/?scp=2&sq=Tim%20Geithner&st=cse
But what does he really mean?
I stated before that he talks the talk but rarely walks the walk.
http://tradersutra.blogspot.com/2009/10/financial-stability-act-i-would-like-to.html
What he really means is although the Tax Payer really shouldn't have to fund another bank bailout, there is not going to be a resolution facility that would make future bank bailouts obsolete. No such measures are going to be implemented to make sure banks are not gambling with customer deposits. No such measures will be implemented to make sure the banks don't use their infinite subsidy against the taxpayer. What Geithner is really proposing is to let the Banks continue to steal all of the money, let them continue to loot the country. Only after they have done so in completely leeching the tax payer, and the entire system is on life support, the ones that survive, which will be the JP Morgans and GS of the world should be the first to bailout the country, not the taxpayer. Wonderful idea. Lets not fix TBTF. We are beyond that. Here we have the Treasury Secretary, the one that is responsible for being the custodian of our countries wealth for future generations basically telling you that TBTF institutions are an official policy going forward. That we should not draft any resolution that would restrict the TBTF ability to take risks with customer deposits. Simply create a penalty(To be levied by the Executive Branch of course)for them after they screw it all up again in the great casino we call financial markets.
What a wonderful depiction of equal representation under the Constitution by Mr. Geithner.
The question to ask is this?
Why is it legal for the Banks to continue to gamble with Tax Payer Money? The answer is THE BANKS RUN THE PLACE!
The banks are using the crisis that they created to liberalize the Casino to scam and loot the tax payer of even more funds.
We need more Elizabeth Warren's, more Neil Berofsky's, and even more Shiela Bair's in this world. I know Bair has her opponents, at least she pretends to be on our side.
Shams, Scams, Schemes & One Big Clunker.
The computer traded stock market rallied Thursday on better then expected GDP results. All I heard from the fraudsters on CNBC, was what are the naysayers going to do now? The economy is back! The shorts are finished! I knew that CNBC was in the business of fraud, but what struck me was the Bloomberg News was also waving the pom poms. It seems that the media is finally getting tipsy drinking the cool aid. The market rallied furiously Thursday. Even though my shorts were hedged going into the GDP report, I just knew that Part 9 of The "Great Sham" was taking hold. If you want to know:
Part 1 = Fannie, Freddie, Citigroup, & AIG backstops
Part 2 = TARP
Part 3 = TLGP & the roughly 13 other Government liquidity programs.
Part 4 = Permanent Open Market Operations or POMO
Part 5 = Stress Tests
Part 6 = Cash For Clunkers
Part 7 = FHA Rouse
Part 8 = Housing Tax Credit
Part 9 starts out with the much better then expected 3rd Quarter GDP figures.
From USA Today:
"Gross domestic product expanded at a 3.5% seasonally adjusted annual rate in the quarter ended in September, a rise that leaned heavily on government spending. Some of the largest components of growth came from spending on cars and house building -- two areas propped up by federal programs."
"Without stimulus programs such as "cash for clunkers" and a first-time home buyer's credit, "real GDP would have risen little, if at all, this past quarter," Christina Romer, president of the White House Council of Economic Advisers, said in a statement."
What I want to know is how in the world the market being up some 200 points on Thursday is helping the fortunes of the nation's 15.1 million unemployed?
Many smart bloggers are correctly saying that the 3.5% growth, about 1% point came from sales of motor vehicles and parts which directly benefited from cash for clunkers. Another 1/2% of GDP growth came from private residential investment, of which home building is a big component. If you are thinking $8000 Tax Credit you are correct.
Take out 0.5% for Housing which is 100% government run, 0.9% from inventories, and 1% from Cash For Clunkers, and what do you have? You have a Clunker of an Economy!
Now many people in the media would like you to believe that TARP has been successful as some financial institutions have made headlines for paying back TARP funds, the vast majority still owe the government billions. TARP lent $238 billion to more than 680 banks, only 44 banks have repaid the funds, for a total of $71 billion. That in itself is an outrage, but the bigger outrage and real bailout wasn't TARP.
It was lending and guarantee programs from the Federal Reserve, FDIC, and ultimately the Treasury. The Fed had a three borrowing programs before the crisis started in the summer of 2007, when two Bear Stearn's hedge funds failed. At the height of the bailout, there were 13 programs.
These programs enabled Wall Street firms to borrow money at historically cheap rates. At such levels, it isn’t hard to turn a profit from the spreads between borrowing and lending. Much of the money that taxpayers have pumped into the financial system has ended up at banks that are lending it back to the government by buying Treasury securities. What a wonderful concept! The FED makes money available to the banks at 0%, The banks lend it to back to Treasury/Fed at a markup of course, and the banks make money off our tax dollars. All along paying millions to lobbyists so they can continue to do so.
How can we forget the famous bailout of AIG? Unlike TARP, AIG doesn’t need to pay back the $85 billion that the FRBNY provided to pay off the insurer’s credit default swap trades at 100 cents on the dollar. Why you say they don't need to pay it back? Because they cant. They just tapped the government for billions more, right in time for bonus season.
Bloomberg ran this piece on Tuesday:
http://www.bloomberg.com/apps/news?pid=20601109&sid=a7T5HaOgYHpE
Goldman received $14 billion when AIG canceled its trades. Then Goldman was paid an additional $5.6B for selling the underlying investments behind its swaps to a government created toxic asset fund, called Maiden Lane III.
I have written about Maiden Lane here:
http://tradersutra.blogspot.com/2009/07/maidon-lane-llc-ulimate-siv-ponzy.html
http://tradersutra.blogspot.com/2009/08/frb-balance-sheet-and-credit-crisis-2.html
What worse is why are we paying Society General $16.5B and Deutsche Bank $8.5B to settle CDS at 100% when Citigroup was settling them for less then 40%?
http://tradersutra.blogspot.com/2009/06/more-on-gs-and-boys-at-aig.html
So the market was up Thursday. All was good. But Friday was another day. This was the day when the U. Of Michigan Sentiment Data came in line but the market really took it on the chin when distressed securities investor Wilbur Ross warned of massive commercial real estate losses. I have also written about this very frequently.
http://tradersutra.blogspot.com/2009/04/cre-get-ready-for-next-down-leg.html
http://tradersutra.blogspot.com/2009/02/commercial-real-estateanother-time-bomb.html
http://tradersutra.blogspot.com/2009/06/commercial-real-estate-defaults-rising.html
http://tradersutra.blogspot.com/2009/07/next-wave-of-failures.html
I have roughly 20 more posts on the next leg of defaults most notably CRE.
But, does Wall Street care? Nope. They just keep the shenanigans going.
http://tradersutra.blogspot.com/2009/08/return-of-king.html
Its the ultimate game of Extend and Pretend.
The Sham Banks have been swimming in losses since the collapse of the credit markets in mid-2007.
Real estate research firm Foresight Analytics estimates banks should have booked losses on around $110B of defaulted commercial real estate and construction loans. But so far they have taken their medicine in only about 1/3 of those cases. That means the banks could face a backlog of $70B or so defaulted but unreserved loans as we head into the teeth of down cycle in CRE where the bulk of bubble era loans are due to be repaid or refinanced between 2010 and 2012. Regional and community banks, rather than the giant TARP-taking entities, will bear the brunt of this onslaught. Banks with between $100MM and $10B in assets have almost $900B of commercial real estate exposure. That's three times their capital. We are at the beginning of this problem not the end.
Then we have non performing assets. Nonperforming asset levels were 17% higher in regulatory filings than in public statements, suggesting that some big banks are understating problem loans as they go through the restructuring process. Troubled debt restructurings have doubled over the past year, as banks extend loan maturities and cut interest rates or loan balances, particularly on troubled residential loans.
What about FASB and repatriation of OBS/SIVS? Did anyone notice when BOFA CEO/Born Thief Ken Lewis alerted the street that the bank would have to bring back some $125B in OBS assets/crap back onto BOFA's balance sheet? Is it not funny or coincidental that BOFA has not caught a bid since that statement?
Then we come to Wells.
Wells Fargo is a giant Mortgage Hedging operation disguised as a lending and deposit institution.
http://tradersutra.blogspot.com/2009/10/pure-simple-wells-fargo-is-disgrace.html
Add in Congress, K-Street, The Treasury, FRB, and the Media we have a powerful cocktail to get the masses drunk, while Wall Street continues to loot the country.
Part 1 = Fannie, Freddie, Citigroup, & AIG backstops
Part 2 = TARP
Part 3 = TLGP & the roughly 13 other Government liquidity programs.
Part 4 = Permanent Open Market Operations or POMO
Part 5 = Stress Tests
Part 6 = Cash For Clunkers
Part 7 = FHA Rouse
Part 8 = Housing Tax Credit
Part 9 starts out with the much better then expected 3rd Quarter GDP figures.
From USA Today:
"Gross domestic product expanded at a 3.5% seasonally adjusted annual rate in the quarter ended in September, a rise that leaned heavily on government spending. Some of the largest components of growth came from spending on cars and house building -- two areas propped up by federal programs."
"Without stimulus programs such as "cash for clunkers" and a first-time home buyer's credit, "real GDP would have risen little, if at all, this past quarter," Christina Romer, president of the White House Council of Economic Advisers, said in a statement."
What I want to know is how in the world the market being up some 200 points on Thursday is helping the fortunes of the nation's 15.1 million unemployed?
Many smart bloggers are correctly saying that the 3.5% growth, about 1% point came from sales of motor vehicles and parts which directly benefited from cash for clunkers. Another 1/2% of GDP growth came from private residential investment, of which home building is a big component. If you are thinking $8000 Tax Credit you are correct.
Take out 0.5% for Housing which is 100% government run, 0.9% from inventories, and 1% from Cash For Clunkers, and what do you have? You have a Clunker of an Economy!
Now many people in the media would like you to believe that TARP has been successful as some financial institutions have made headlines for paying back TARP funds, the vast majority still owe the government billions. TARP lent $238 billion to more than 680 banks, only 44 banks have repaid the funds, for a total of $71 billion. That in itself is an outrage, but the bigger outrage and real bailout wasn't TARP.
It was lending and guarantee programs from the Federal Reserve, FDIC, and ultimately the Treasury. The Fed had a three borrowing programs before the crisis started in the summer of 2007, when two Bear Stearn's hedge funds failed. At the height of the bailout, there were 13 programs.
These programs enabled Wall Street firms to borrow money at historically cheap rates. At such levels, it isn’t hard to turn a profit from the spreads between borrowing and lending. Much of the money that taxpayers have pumped into the financial system has ended up at banks that are lending it back to the government by buying Treasury securities. What a wonderful concept! The FED makes money available to the banks at 0%, The banks lend it to back to Treasury/Fed at a markup of course, and the banks make money off our tax dollars. All along paying millions to lobbyists so they can continue to do so.
How can we forget the famous bailout of AIG? Unlike TARP, AIG doesn’t need to pay back the $85 billion that the FRBNY provided to pay off the insurer’s credit default swap trades at 100 cents on the dollar. Why you say they don't need to pay it back? Because they cant. They just tapped the government for billions more, right in time for bonus season.
Bloomberg ran this piece on Tuesday:
http://www.bloomberg.com/apps/news?pid=20601109&sid=a7T5HaOgYHpE
Goldman received $14 billion when AIG canceled its trades. Then Goldman was paid an additional $5.6B for selling the underlying investments behind its swaps to a government created toxic asset fund, called Maiden Lane III.
I have written about Maiden Lane here:
http://tradersutra.blogspot.com/2009/07/maidon-lane-llc-ulimate-siv-ponzy.html
http://tradersutra.blogspot.com/2009/08/frb-balance-sheet-and-credit-crisis-2.html
What worse is why are we paying Society General $16.5B and Deutsche Bank $8.5B to settle CDS at 100% when Citigroup was settling them for less then 40%?
http://tradersutra.blogspot.com/2009/06/more-on-gs-and-boys-at-aig.html
So the market was up Thursday. All was good. But Friday was another day. This was the day when the U. Of Michigan Sentiment Data came in line but the market really took it on the chin when distressed securities investor Wilbur Ross warned of massive commercial real estate losses. I have also written about this very frequently.
http://tradersutra.blogspot.com/2009/04/cre-get-ready-for-next-down-leg.html
http://tradersutra.blogspot.com/2009/02/commercial-real-estateanother-time-bomb.html
http://tradersutra.blogspot.com/2009/06/commercial-real-estate-defaults-rising.html
http://tradersutra.blogspot.com/2009/07/next-wave-of-failures.html
I have roughly 20 more posts on the next leg of defaults most notably CRE.
But, does Wall Street care? Nope. They just keep the shenanigans going.
http://tradersutra.blogspot.com/2009/08/return-of-king.html
Its the ultimate game of Extend and Pretend.
The Sham Banks have been swimming in losses since the collapse of the credit markets in mid-2007.
Real estate research firm Foresight Analytics estimates banks should have booked losses on around $110B of defaulted commercial real estate and construction loans. But so far they have taken their medicine in only about 1/3 of those cases. That means the banks could face a backlog of $70B or so defaulted but unreserved loans as we head into the teeth of down cycle in CRE where the bulk of bubble era loans are due to be repaid or refinanced between 2010 and 2012. Regional and community banks, rather than the giant TARP-taking entities, will bear the brunt of this onslaught. Banks with between $100MM and $10B in assets have almost $900B of commercial real estate exposure. That's three times their capital. We are at the beginning of this problem not the end.
Then we have non performing assets. Nonperforming asset levels were 17% higher in regulatory filings than in public statements, suggesting that some big banks are understating problem loans as they go through the restructuring process. Troubled debt restructurings have doubled over the past year, as banks extend loan maturities and cut interest rates or loan balances, particularly on troubled residential loans.
What about FASB and repatriation of OBS/SIVS? Did anyone notice when BOFA CEO/Born Thief Ken Lewis alerted the street that the bank would have to bring back some $125B in OBS assets/crap back onto BOFA's balance sheet? Is it not funny or coincidental that BOFA has not caught a bid since that statement?
Then we come to Wells.
Wells Fargo is a giant Mortgage Hedging operation disguised as a lending and deposit institution.
http://tradersutra.blogspot.com/2009/10/pure-simple-wells-fargo-is-disgrace.html
Add in Congress, K-Street, The Treasury, FRB, and the Media we have a powerful cocktail to get the masses drunk, while Wall Street continues to loot the country.
European Bank Smack Down
First it was ING.
http://www.ft.com/cms/s/0/681ffe72-c200-11de-be3a-00144feab49a.html
Now Brussels has its targets on RBS.
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/6470180/EU-competition-commission-foists-draconian-remedies-on-RBS.html
ING will be scaling back its balance sheet 30%. RBS, Lloyd's, and Northern Rock equally quaking in their boots.
Blackrock CEO Larry Fink thinks that downsizing US Financial Institutions (TBTF)will make it far more difficult to compete with European Banks. He should start reading European Financial newspapers.
http://www.ft.com/cms/s/0/681ffe72-c200-11de-be3a-00144feab49a.html
Now Brussels has its targets on RBS.
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/6470180/EU-competition-commission-foists-draconian-remedies-on-RBS.html
ING will be scaling back its balance sheet 30%. RBS, Lloyd's, and Northern Rock equally quaking in their boots.
Blackrock CEO Larry Fink thinks that downsizing US Financial Institutions (TBTF)will make it far more difficult to compete with European Banks. He should start reading European Financial newspapers.
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