February 2009

Just Because it's Math Does it Mean No Criminal Charges? - AIG run like a Scam - New York Times

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Just because it's one division and they covered it all up with excuses like complex math, or structured finance does it make it less of a scam and a fraud?

The New York Times article Propping Up a House of Cards has gone a little more in depth on precisely what was going on inside AIG and why (supposedly) it couldn't fail (Joe Nocera Journalist).

Friday Movie Night - Bad Math Edition

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It's Friday Night! Party Time!   Time to relax, put your feet up on the couch, lay back, and watch some detailed videos on economic policy!

 

Earlier this week I took a first pass look at a flawed probability model behind various types of derivatives.

With that in mind I went looking for information on further mathematical follies which resulted in economic collapse.

Two films goes over Black–Scholes as well as the hedge fund debacle Long Term Capital Management and it's use of mathematical models, bounds and assumptions, which caused it's demise.

The carefully designed disaster at Fannie and Freddie

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The situation at the mortgage giants of Fannie Mae and Freddie Mac continue to get worse. The news yesterday is that Fannie Mae lost another $25.2 Billion last quarter and has requested another $15.2 Billion bailout just to stay afloat.

“We expect the market conditions that contributed to our net loss for each quarter of 2008 to continue and possibly worsen in 2009, which is likely to cause further reductions in our net worth,” Fannie Mae said in a statement.

The other player here, Freddie Mac, is watching defaults on its mortgage debts accelerate to record highs. Freddie will need another bailout as well.

CDOs Backed by Risky Mortgages now Worth 5% of their value

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Remember those toxic assets and how the government was going to buy them up, sell them later to recover their value?

You must read this Financial Times article:

Here is the Magic Secret Decoder Ring to translate:

CDO - Collateralized debt obligations
Mezzanine - Underlying asset is subprime, "risky" mortgage
ABS - Asset backed securities
Tranche - Slices of risk levels within a bundled group of securities

From late 2005 to the middle of 2007, around $450bn of CDO of ABS were issued, of which about one third were created from risky mortgage-backed bonds (known as mezzanine CDO of ABS) and much of the rest from safer tranches (high grade CDO of ABS.)

Out of that pile, around $305bn of the CDOs are now in a formal state of default, with the CDOs underwritten by Merrill Lynch accounting for the biggest pile of defaulted assets, followed by UBS and Citi.

The real shocker, though, is what has happened after those defaults. JPMorgan estimates that $102bn of CDOs has already been liquidated. The average recovery rate for super-senior tranches of debt – or the stuff that was supposed to be so ultra safe that it always carried a triple A tag – has been 32 per cent for the high grade CDOs. With mezzanine CDO’s, though, recovery rates on those AAA assets have been a mere 5 per cent.

Why New Home Sales' Cliff-SPLAT! is not bad news

January New Home Sales, released yesterday, were -- perversely -- good news! Despite the perfectly correct mantra that new home sales continued to cliff-dive, and that, as my friend Bonddad said not once but Twice(!) yesterday, "We're Nowhere Near a Bottom in Housing" the simple fact is that the housing market is showing ample signs of the beginning of a transition.

FDIC reserves running out

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Lowest reserves since 1993.

The fund held $52.4 billion at the beginning of 2008. One year and 25 bank failures later, the fund held $18.9 billion.

So far this year, 14 banks have failed, draining another $1.7 billion from the insurance fund.

If money cannot be collected quickly enough from the industry, the FDIC could be forced to borrow money from taxpayers by taking a loan from the Treasury Department.

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