That personal essay thing
Back in 1995 at a press conference Then Colorado Governor Roy Romer tried to explain derivatives trading and what his son was employed at doing.
“It sounds too complicated to me as a way to make a living,†the governor joked.
Well, Romer must have had ESP, because as we have all learned, the derivatives markets, the hedge funds that manage them and especially the complicated and toxic Credit Default Swaps and Credit Default Assurance markets have collapsed – and experts from all over the land are at a loss at how to explain how they collapsed, how they work are what actually happened.
I am a financial neophyte – that said, here in a nutshell is what I have been able to gather about this mess (this is written at the 30,000 foot level. I am certain there are details missing but the point is still made) :
Subprime mortgages were bundled together into one investment then split again into tiny chunks as lower risk investment vehicles. Then those investors. (usually banks) bought an assurance bond (insurance) from the investment banks. These bonds – another derivative, were call CDAs. And then to complicated it again, those CDAs were insured through another assurance bond called CDS – swap the value between many different merchants.
Then something bad happened. Folks making 50 or 60 grand a year were no longer able to make the Adjustable Rate Mortgage payments on their $450,000 homes. (For some unforeseen reason, it thought a good idea to loan a couple making $60,000 a year a mortgage loan for $450,000 despite bad credit. It was also thought a good idea to give that loan at 6 or 7 percent interest – what could have gone wrong.)
Soon, banks began calling in their CDAs to cover their bad investments. And the CDS market collapsed trying to save the CDA market. Soon banks were no longer able to collect on their unregulated insurance investments. Banks began failing in late 2007 and first quarter 2008. The bleeding was bad but not concentrated in any particular market so it wasn’t news or headlines.
Then Bear Stearns fell. A big investment bank that was up to its ears in these CDS and CDA products (it is credited as a leading founder of the securitization and asset-backed securities market, read: CDA/CDS derivatives) . Lehman Brothers fell next. And all sites were now on AIG. AIG is the king/big brother/master of this toxic CDS/CDA bond market. As explained in this week’s Time Magazine – AIG was running a tremendous unregulated hedge fund under the guise of their Financial Products division – an the US bail money has essentially kept them afloat as they give out the money from the government to cover their bad bets.
I am a small town boy. That is where my instincts and nuances (if any) come from. And my boyhood town’s economy is fueled by just two major industries. Coal and Cattle. Both are pretty simple — Dig/Produce Product > Sell at market to ensure a profit. My father worked for the post office – a more complicated business but I understand it a bit as well. The post office is a nationalized industry held in public trust and self financed and managed by a government appointed board.
Economists and politicians are all over the place on how to solved the crisis. My gut reaction is to let them fall. They created a monster with these unregulated securitization and asset-backed securities markets. Let the chips fall.
But because the breadth and depth of these derivative funds touches so many industries and so many companies, if AIG falls, the recession may very just get worse. GM and auto industries had lots of money in these funds. Sprint dabbled in this market. Intel and Microsoft dipped their toes in these investments. Small town banks, retirement funds – the list goes on and on as to who will be hit, who may very well fall if AIG falls and many economists believe this house of cards must be protected because the rest of the economy is so perilously poised we cannot afford NOT to prop it up.
Monday, Treasury Secretary Geithner proposed a very complex, very detailed plan to shore up AIGs bad debt by buying it from them and partnering with other investors, liquidating the debt to make a profit.
Again, if it is so complicated it can’t be explained, it is probably not the right solution.
The US is now an 80 percent stock holder in AIG. We should move in, take it over, nationalize it – file for bankruptcy, let a judge dismiss the bad CDA/CDS debt and then place AIG in a public trust and using a board of governors, oversee its use of federal funds and its efficient and prudent use of funds.
