book recommendation

[socca]

Amazon.com: The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash: Charles R. Morris: Books

Mr. Morris finished writing his book in late 2007; it was published March 2008. In his book, he predicted a meltdown in "mid 2008" - who can fault him for a being a few months early? What is less important than his remarkably prescient prediction (someone somewhere is always predicting a meltdown ) is his accurate description of the root causes behind the meltdown.

He compares the current crisis to previous crises, and describes the financial instruments and practices that have gotten us into this mess. Quite fascinating, really, in a morbid sort of way. If I had read this book in March 2008 and acted upon it, I could have saved a bundle. Unfortunately, at that time I would have dismissed the book based on its title as alarmist pap.

The last two chapters, describing the post-crash world and how to recover, are by far the weakest. Now that the "Great Unwinding" (chapter 6) he predicted has actually come to pass, I'm sure that he could write far more focused and relevant chapters 7 and 8.

Happy Reading!

 

[socca]

some quotes from the book...

The importance of [synthetic collateralized debt obligations] is that their issuance volume is not constrained by the volume of underlying reference securities. In other words, the sum of subprime mortgages in both cash-flow and synthetic CDOs could easily be larger than the volume in the real world, but investors reap exactly the same gains and suffer exactly the same losses from the synthetics as from the real ones.

Gotta hand it to the financial engineers - this is damn clever! Essentially, they created 'virtual subprime mortgages', and then packaged these into CDOs and sold them. Momma mia - amazing.

In addition to the multitrillion CDO and synthetic CDO market, it emerged there is a new kind of shadow CDO world called SIVs, or structured investment vehicles, run within - but legally separate from - the major money center banks. SIVs are typically Caymen Island limited partnerships that collect bundles of bank loans or other securities. They are especially convenient for moving assets off a bank's balance sheet and apparently have substantial holdings of commercial and residential mortgages and mortgage-backed securities.

Shades of Andrew Fastow and Enron??

As the CMO crash of 1994 illustrated, the limiting factor on CDO-type securities is finding a buyer for the toxic waste, the bottom tranches, or the equity that absorbs all of a CDO's first losses. The buyers for CDO toxic waste serve as a kind of global securitization risk sink, the foundation that keeps the huge, wobbly structure still standing. Who can absorb that much risk?

Well, they must be investors willing to take on tremendous risk to earn superior returns. And they must have considerable freedom to invest as they choose. Ideally, they wouldn't have to disclose the details of their positions to nervous shareholders or trustees. They would need access to huge amounts of investable funds and must be free to leverage up their positions to enhance returns. Yes, as the reader has already guessed, it's the hedge funds. And the entire industry is dancing to their tune.

Banks...are deeply in bed with their hedge fund clients, with massive amounts of money at risk. The temptation not to trigger value hits, and to let unsound positions build, is very strong. But substantial reversals in any important asset class leave no place to hide. Sooner or later, the banks will have no choice but to start seizing assets, even at the risk of opening the gates to unshirted hell.

The stage is set for a true shock-and-awe surge of asset writedowns through most of 2008. Widespread collateral defaults, particularly at the credit hedge funds, will trigger forced selling from margin accounts. Rolling downgrades will require divestitures by pensions funds and insurance companies that find themselves in violation of rules on holding investment-grade paper. Holders of senior CDO tranches will liquidate their holdings as credit protection dissolves, as they have the right to do. Add in even mildly bad outcomes for the monolines and in the credit insurance markets, and the global financial system will be in catastrophe.

Remember - he was writing in late 2007!!

How could leverage get so high? In the class of instruments we've been talking about, there are relatively few "names," or underlying companies, that are deeply traded, several hundred at most. And a relatively small number of institutions, basically the global banks, investment banks, and credit hedge funds, do most of the trading. In effect, they've built a huge ... unstable tower of debt by selling it back and forth among themselves, booking profits all along the way. That is the definition of a Ponzi game. So long as a free-money regime forestalled defaults, the tower might wobble, but stayed erect. But small disturbances in any part of the structure can bring the whole tower down, and the seismic rumblings already in evidence portend disturbances that are very large.

The question is whether the Countrywides of the world are risk-taking enterprises or public utilities. You can't be both. If the government is going to be on the hook, by means of deposit insurance, the various federal borrowing windows, or implicit federal insurance for "too important to fail" institutions, bank risk-taking has to be tightly controlled. Cautious, risk-adverse public utility-style banks need intelligent credit and balance-sheet managers, not envelope-pushing high-rollers with eight-figure paychecks.

This quote is highly relevant to Paulson's latest plan for the $700B bailout money. Having taxpayers purchase equity in commercial, for-profit, risk-taking banking institutions doesn't answer the question: is the financial institution being operated for public or private good?

 

[Andy R]

Interesting, I have ordered this book to give it a read.

 

[Gardnr]

Gotta hand it to the financial engineers - this is damn clever! Essentially, they created 'virtual subprime mortgages', and then packaged these into CDOs and sold them. Momma mia - amazing.

Naw, we don't need to regulate these guys! The market will keep them in check and keep them honest.

These guys were like Frankenstein, creating a monster in the laboratory. The monster got loose and he's terrorizing us. (Sorry to literary buffs if my reference isn't totally accurate. It's been quite some time since I saw the movie! I may have mixed this up with some sci fi. )

 

[audreyh1]

Those are some pretty good quotes - really pack a punch. Amazing what a bizarre financial virtual reality (with lots of fees made on the way) was created in the past few years. Just boggles the mind. I don't think I can read the book myself (too much work), but I appreciate you sharing the hard-hitting quotes.

Audrey

 

[ladelfina]

Gardnr.. or a golem
Golem - Wikipedia, the free encyclopedia
Ran across another comment that likened the banks to parasites taking over the host.

socca, thanks for the review..