Wednesday, February 25, 2009

My brother called me two days ago to say hi and to let me know he was still at Citigroup. I had been predicting Citigroup's demise for 1-1/2 years already. The following is our email exchange (redolent of the times):

Good to hear from you, bro.
>> I'm happy that you're still plugged into Citigroup (the new joke is that
>> =
>> its share price is lower than its ATM fees). I got laid off from =
>> Alzheimer's on Feb 10 (even tho 2 weeks before the prez/CEO said she was
>> =
>> sharing my ideas for maximizing income at no cost with the senior staff;
hope she doesn't use these ideas or I'll be miffed).
>> Jeff also just got laid off (Fri). I've been doing some career coaching
>> =
>> here and there and just started sending out feelers re: different =
>> consulting ideas. At least I don't have any debt and I have savings. =
>> Man oh man this is some global situation. I blame it all on the =
>> internet (as do Roubini and Taleb). Everything was done at once and is =
>> now crashing at the same time. Trading in unison, de-leveraging in =
>> unison, foreclosing in unison and firing in unison is NG. (:.
>> Kathi

From: "Wayne Berke"
To: "Kathi Berke"
Sent: Tuesday, February 24, 2009 8:16 PM
Subject: Re: Victim of Catastrophic Economic Meltdown (ha!)

> Kathi,
> Good one (about the ATM fees). Bummer about you and Jeff getting laid
> off.
> Do either of you qualify for unemployment insurance? Who are Roubini and
> Taleb? Even Wikipedia hasn't heard of them.
Blame it on capitalism with its inherent cycles of boom and bust. It's
> pretty
> similar to a bipolar disorder I think. The higher the highs, the lower
> the
> lows kind of thing. Unfortunately, we're coming off a very extreme high
> (fueled by the Internet among other things). What we should learn going
> forward, if we're smart which we're not, is that regulation is very, very
> important in the financial world. And anyone who starts talking about
> how great it is to rely solely on the invisible hand of the marketplace
> should be summarily shot.
BTW, here's a really cool, artistic depiction of how we got into this
> mess:
> Disaster Capitalism
> Love,

Nouriel Roubini is a professor at the graduate school of business at NYU.
He is also known as Dr. Doom. He predicted the collapse of the housing and
credit market back at some conference (Davos? The IMF Happy Hour?) in 2006
and they laughed at him. Now they don't laugh so much. He is omnipresent.
A rockstar.

Nassim Nicholas Talebis the writer of
"The Black Swan: The Impact of the Highly Improbable" (April 2007). He is
also a rockstar. At Davos, people like Michael Dell and others lined up to
kiss these guys' rings. Taleb's theory basically is that the financial
system pretended that it was eliminating risk by seeking to disregard the 1%
possibility that the house of cards the system was built on could fall over.
He called his book "The Black Swan" to say in essence that just because
every swan you see is white, that does not mean there are no black swans.
And by ignoring that possibility you build in the greatest risk of all,
especially if the scale is massive.

There is an equation known as the Gaussian copula function. It was
formulated by a mathematician named David Li who was trying to reduce
correlative risk to one factor. He did that by measuring credit default
swap costs (the cost of insuring against default), instead of doing the
messy job of considering all the variables involved in, say, one mortgage
pool making up a mortgage-backed security (gauging the probability of
default on the part of each of thousands of mortgage holders, all with
different situations that could all work out very differently in the
future). He merely looked back historically as far as credit default swaps.
CDSs have only really been in existence for about 10-15 years. During that
time housing prices went up, up, up. Li's equation, based on the theory
that housing prices would alway go up, delivered a single number considered
the risk factor. Everyone in the financial sector used this number to
determine the risk in their trades. And guess what, they didn't think there
was any risk!

The managers didn't understand the mathematicians, but they liked the risk
reduction represented by that single factor. The mathematicians loved the
beauty of the equation, but they couldn't see the NINAs (no income, no
assets) borrowers or the cheap crooks selling the loans making thousands on
fees. There was no overlap. No Venn diagram.

But what's going on is no longer a "subprime" crisis. It is a credit
crisis. Companies are divebombing because they can't get credit. Even very good companies. Their debt is coming due (everything runs on credit; did
you ever see anyone walk into an auto dealership with $20,000 stuffed in
their pockets?) and they can't roll it over. Even investment grade
companies (like Southwest Airlines) have to pay 10% interest to raise money
now. I only pay 12% on my credit card line. The cost of debt service alone
can kill companies. So they're selling all their assets at fire sale
prices. Or they're going into bankruptcy because the banks are calling in
their loans. Banks that are getting billions in taxpayer money.

But the real problem that hasn't been solved by any statistical equation or
the financial wizards in Washington is that of credit default swaps. The
notional value of credit default swaps is something in the range of $50
trillion (for/against default)
my dailykos
. That's why AIG is hemorrhaging money: they owe so much on the
"insurance" contracts (credit default swaps) they made with counterparties
that things wouldn't default. AIG didn't hedge against the CDSs they wrote
(no capital cushion-credit default swaps aren't regulated at all, in fact no
one knows how many there are); it just kept collecting premiums. Now the
entities it wrote contracts on are defaulting and the gov't is pouring money
into it to keep it (futilely) from defaulting itself.

Fun, huh?


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