Another Obama neolib fail at the SEC

Obama's pick to run the Securities and Exchange Commission seems to have come close to obstruction of justice in the Bernie Madoff case:

After Bernard L. Madoff’s giant Ponzi scheme was revealed, the Securities and Exchange Commission went to great lengths to make sure that none of its employees working on the case posed a conflict of interest, barring anyone who had accepted gifts or attended a Madoff wedding. 

But as a new report made clear on Tuesday, one top official received a pass: David M. Becker, the S.E.C.’s general counsel, who went on to recommend how the scheme’s victims would be compensated, despite his family’s $2 million inheritance from a Madoff account.
Mr. Becker’s actions were referred by H. David Kotz, the inspector general of the S.E.C., to the Justice Department, on the advice of the Office of Government Ethics, which oversees the ethics of the executive branch of government.

The report by Mr. Kotz provides fresh details about the weakness of the agency’s ethics office and reveals that none of its commissioners, except for Mary L. Schapiro, its chairwoman, had been advised of Mr. Becker’s conflict.

It says Ms. Schapiro agreed with a decision to keep Mr. Becker from testifying before Congress, where he would have disclosed his financial interest in the Madoff account.

This is simply not acceptable. And, it's not unique, certainly not to Mary Schapiro.

Columbia Journalism Review has even more background. This all gives a certain degree of credibility to Ron Suskind's new book. Either Obama is incompetent for listening to others' advice in his financial oversight picks, or we're gathering yet more evidence that he personally is that much in bed with Wall Street. Take your pick.

And, folks, let's be honest. A fair amount of this didn't start with Obama.

But, it didn't start with Bush, either.

Predatory lending, if not necessarily in the venue of subprime loans? It got a bit of start under H.W. Bush and accelerated under Clinton. An overview of the background is here.

Both parties do it. They have for years. And until you stop voting for Democrats as well as Republicans, they'll still do it. Certainly, at a minimum, until we have national public financing of Congressional elections.

Banksters fess up to illegal mortgage problems

Wells Fargo, Bank of America and Citigroup, as part of annual financial filings with the SEC, admitted that state attorneys general investigations (and a lame-o one by the feds so far) into their, well, illegal use of MERS software in mortgage paperwork filings could well be a financial deadweight and not just a perception issue.

“The current environment of heightened regulatory scrutiny has the potential to subject the corporation to inquiries or investigations that could significantly adversely affect its reputation,” Bank of America said in the filing.

The state and federal inquiries “could result in material fines, penalties, equitable remedies (including requiring default servicing or other process changes), or other enforcement actions, and result in significant legal costs,” Bank of America said.

Wells Fargo said in its filing that it was “likely that one or more of the government agencies will initiate some type of enforcement action,” including possible “civil money penalties.”

Well, boo-hoo. Dr. America prescribes 30CCs of "cramdown" for the sick bankster patients.

More seriously, here's my tentative grand bargain:
1. State AGs as a group, agree to suspend investigations, both on the illegal use of MERS, and on banks wrongfully repo-ing deliquent-mortgage homes to which they don't have clear title in particular, for 18 months.
2. In exchange, without admitting guilt for past use, the banks agree that MERS, by not providing actual paperwork to county clerks, is illegal in all such states with such a requirement, and stop using it ASAP. (I'm assuming they're still using it, in the middle of this mess.)
3. Banks agree to triple their current mortgage-modification programs.
4. Banks agree to reveal what "minimum," as percentage of mortgage principle, they currently have as a cutoff rate for walkaway deals and other mortgage modifications, and to lower that minimum by 10 percentage points.

That's just some back-of-the-napkin figuring. I'm guessing that, given this was part of an SEC filing, that doing all of that would still hit the bottom line no harder than would state financial penalties, should the banksters dig in their heels.

Take THAT, JPMorganChase (and other subprime banks)

Old Republic National Title says that, due to questions about how foreclosures have been processed, it's going to stop offering title insurance on JPMorganChase residential foreclosure properties.

Several notes:
1. This is not automatically good news for homeowners in foreclosure; JPMC can always go shopping for another insurer.
2. Even if this does motivate JPMC, along with Bank of America, which has also stopped foreclosures do to processing legality issues, and any other financiers that may wind up in the same spot, it's still not necessarily long-term good news for homeowners. These financiers may simply tack the costs of additional work onto the foreclosure process. Or, it could cause other problems:

Mark P. Stopa, a lawyer in Florida who represents defaulting homeowners, said that if more title insurance firms began to shy away from insuring foreclosed properties, the entire housing market could suffer. The prices of foreclosures would plummet, because lenders will not issue a new mortgage without title insurance.

“Judges have to force banks to do foreclosures correctly,” Mr. Stopa said. But that would require a significant increase in staff, he said, and “I’ll believe it when I see it.”

So will I, Mark, so will I.

We've already seen, whether in a state that requires judicial proceedings for foreclosure or ones where individual homeowners have been fighting back, that judges haven't really done this.

And, state legislatures, if any of this additional staff means additional judicial/legal staff, aren't going to like that idea anyway.

Chris Dodd contines to sell out consumers

I don't know what Dodd continues to vainly chase Senate GOP votes by watering down his consumer protection bill again and again.

To me, if a bill creates a new Consumer Financial Protection Bureau, even if it's housed inside the Fed, it needs to provide funding for that agency, right? Well, isn't that the angle to use Senate reconciliation procedures?

And, if not, is The One ready to go crusading for this bill after health care? Make Republicans defend not wanting to protect consumers?

That said, even a bill that has a Consumer Financial Protection Bureau, if it's inside the Fed, is too weak. The Fed's charge is, above all, monetary policy. To the degree it's a regulatory agency, it's supposed to focus on larger banks and related financial institutions. It's not designed to focus on mortgage brokers who peddled many of the subprime loans in the first place.

Anyway, read the whole analysis piece; it looks at several main areas, including derivatives, consumer abuses, executive compensation, legal authority and the "too big to fail" issue.

On most of these issues, not just what I mentioned above, it's too weak.

Banks like about subprime loan responsibility

Here’s the proof. By the way, especially as we see h ow much so many Team Obama folks, namely aides to Treasury Secretary Tim Geithner, were on the gravy train, are you surprised?

Moody’s as financial manipulation enabler put in the dock

If there’s a person, creature or corporation more to blame for the subprime crunch, the credit-derivatives crunch, and everything else FUBAR about today’s finance situation, it’s Moody’s the not-so-humble bond-rating service.

Having branched beyond bonds into larger credit ratings, it’s quite arguable, as one person puts it in the story, a preview of a New York Times Magazine story for this coming Sunday, that Moody’s, along with Standard & Poor and Fitch’s, moved from “gatekeepers” to “gate openers.”

Arthur Levitt, the former chairman of the Securities and Exchange Commission, charges that “the credit-rating agencies suffer from a conflict of interest — perceived and apparent — that may have distorted their judgment, especially when it came to complex structured financial products.”

No shit. The next couple of webpages of the story read like the financial-world equivalent of politics’ infamous “sausage making” process of legislation.

Here’s stuff Moody’s ignored on one special-purpose vehicle, or SPV:

Moody’s learned that almost half of these borrowers — 43 percent — did not provide written verification of their incomes. The data also showed that 12 percent of the mortgages were for properties in Southern California, including a half-percent in a single ZIP code, in Riverside. That suggested a risky degree of concentration.

And more fun on this same bundle:

In the frenetic, deal-happy climate of 2006, the Moody’s analyst had only a single day to process the credit data from the bank. The analyst wasn’t evaluating the mortgages but, rather, the bonds issued by the investment vehicle created to house them. A so-called special-purpose vehicle — a ghost corporation with no people or furniture and no assets either until the deal was struck — would purchase the mortgages.

In other words, a single guy just spent a business day playing the equivalent of the lotto with a $430 million bundle of papers.

Ironically, if you will, increased federal regulation of things like pension and mutual funds gave Moody’s more things to rate, setting the stage for the dereg hothouse of the late 1990s and on.

Issuers thus were forced to seek credit ratings (or else their bonds would not be marketable). The agencies — realizing they had a hot product and, what’s more, a captive market — started charging the very organizations whose bonds they were rating. This was an efficient way to do business, but it put the agencies in a conflicted position. As (Frank Partnoy, a professor at the University of San Diego School of Law), says, rather than selling opinions to investors, the rating agencies were now selling “licenses” to borrowers. Indeed, whether their opinions were accurate no longer mattered so much. Just as a police officer stopping a motorist will want to see his license but not inquire how well he did on his road test, it was the rating — not its accuracy — that mattered to Wall Street.

Problem is, even before the bubbles started bursting, CDOs were defaulting at a rate higher than traditional bonds, as page 5 notes. But, because a lot of these CDOs were coming from high-volume repeat customers, Moody’s kept the rubber stamp hot.

The Securities and Exchange Commission refused to look at the incestuous nature of the modern credit-rating agency after Enron blew up, despite a directive from Congress. And, of course, in both the House and Senate versions of housing bailout legislation, nobody in Congress is proposing a serious oversight reform bill, not just a nudge to the SEC.

More financial “sausage making” on page 6, from a subprime package called XYZ:

Moody’s monitors began to make inquiries with the lender and were shocked by what they heard. Some properties lacked sod or landscaping, and keys remained in the mailbox; the buyers had never moved in. The implication was that people had bought homes on spec: as the housing market turned, the buyers walked.

By the spring of 2007, 13 percent of Subprime XYZ was delinquent — and it was worsening by the month. XYZ was hardly atypical; the entire class of 2006 was performing terribly. (The class of 2007 would turn out to be even worse.)

But, although Moody’s started re-rating individual mortgage-based bonds by soon after this time, it still didn’t do anything about collateralized debt obligations, or CDOs. And, was using a different set of ratings analysts, and giving ratings without knowing what bonds a particular CDO would buy!

A CDO operates like a mutual fund; it can buy or sell mortgage bonds and frequently does so. Thus, the agencies rate pools with assets that are perpetually shifting. They base their ratings on an extensive set of guidelines or covenants that limit the CDO manager’s discretion.

One misrated CDO was estimated to have a loss potential of 2 percent at the time it was rated triple-A. Latest estimate? At 27 percent; a 16 percent slice of triple-A bonds downgraded all the way to single-B.

It’s clear that only major federal regulation can put this horse back in the barn and keep it there.

Boy, the subprime/alt-mortgage crowd just doesn’t quit

On the door of my apartment this morning, I found an invitation to a block party in a new development in the suburb directly east of mine, where I used to live, while working at another newspaper in our group of suburban weeklies.

It specifically mentions “$0 down $MOVE IN” immediately beneath the top “Millbrook Block Party” line.

Foreclosures double from year ago

They even jumped 36 percent from July. It sounds like there could be plenty of fallout to come:

“The jump in foreclosure filings this month might be the beginning of the next wave of increased foreclosure activity, as a large number of subprime adjustable rate loans are beginning to reset now,” RealtyTrac Chief Executive James J. Saccacio said.

One in every 510 households is now facing foreclosure. In Nevada, the hardest-hit state, it’s up to 1 in 166; California is not too far behind with 1 in 224.

Oh, and Texas politicians claiming the Lone Star State is immune from housing problems?

Wrong. Texas is No. 9 by foreclosure percentage among states.

A simple solution to the subprime crisis: loan officers’ pay

Put them on salary rather than commission:

As he drives through the Slavic Village neighborhood (of suburban Cleveland), passing homes stripped of aluminum siding, copper pipes and other remnants, Marc A. Stefanski says, “There are still S.& L.’s and banks that lend with a conscience, but, man, you got to find them.”

Mr. Stefanski should know: as the chief executive of Third Federal Savings and Loan, a Cleveland thrift that his parents founded in 1938, he has an unusual perspective on the mortgage mess. Unlike most of his competitors, Mr. Stefanski resisted the urge to cash in on the subprime lending boom.

His bank never offered no-money-down loans, piggyback mortgages, exploding adjustable-rate mortgages or the other financial exotica that ultimately tripped up the Sweets and millions like them. Third Federal pays its loan officers salaries, rather than commissions, so there is no incentive to go for volume. Even more remarkable is that Third Federal holds onto a sizable portion of its mortgages and keeps them on the books, rather than selling them to Wall Street to be sliced and diced into asset-backed securities owned by investors on the other side of the globe.

The result is that unlike many other mortgage lenders, Third Federal has a vested interest in making sure its loans do not go bad, so foreclosure is a last resort.

And, Third Federal practices what it preaches in selling more risky loans, when it does:

Third Federal has created a program for more risky borrowers like the Sweets, with required classes so that mortgage holders understand exactly how their loans work and what they will owe.

If the majority of American lenders were like Third Federal, we would never have had the problems we do.

A final, post-subprime bust kick in the crotch from the IRS

If your house gets repoed because you can’t keep up on a mortgage, the IRS
wants to tax the amount of the debt you had eliminated.

Foreclosure is one way that beleaguered homeowners can fall into this tax trap. The other is when homeowners are forced to sell their homes for less than the value of the mortgage. If the lender forgives that difference, they are liable for income taxes on that amount.

The 1099 shortfall, as it is called, stems from an Internal Revenue Service policy that treats forgiven debt of all types as income even if the taxpayer has nothing tangible to show for it, unless the debt is canceled through bankruptcy.

The Center for Responsible Lending expects that 20 percent of the home loans made in 2005 and 2006 to people with weak credit, commonly called subprime loans, will end in foreclosure. Because so little money was required as a down payment during the boom, the value of many of these houses may be less than what is owed.

Some people in this predicament are fighting the I.R.S. and winning. Sometimes, lower payments can be negotiated with the I.R.S., tax experts say.

In other cases, bankruptcy or a claim of insolvency can eliminate the tax burden.

Even though you may have some legal recourse, in general, this is ridiculous and non-sensical. And, it’s punitive, as well as being stupid.

It will also contribute to more of an economic downturn, taking more money to buy things out of peoples’ pockets.

Financial analysts should have seen the subprime bomb ticking

In fact, some did:

“All of the old-timers knew that subprime mortgages were what we called neutron loans — they killed the people and left the houses,” said Louis S. Barnes, 58, a partner at Boulder West, a mortgage banking firm in Lafayette, Colo. “The deals made in 2005 and 2006 were going to run into trouble because the credit pendulum at the time was stuck at easy.”

“I’m one guy in a research department, but many people in our mortgage team have been suggesting that there was froth within the market,” said Jack Malvey, the chief global fixed income strategist for Lehman Brothers. “This has really been progressing for quite some time.” …

“We’ve contended for a while that there was an issue in subprime debt,” said Neal Shear, global head of trading at Morgan Stanley. “A year ago, we were aware that delinquencies were going to rise.”

Meanwhile, since everybody who has followed this issue knows that the incestuous action of ratings agencies like Moody’s, touting subprime derivatives on which they stood to profit, is a fair part of the problem, the European Union is planning to investigate possible conflicts of interest. Where’s the SEC, on our side of the pond?

And, the anti-Cassandras also bear blame for being in denial still, primarily through their claim that this is a just a problem with subprime mortgages.

No, it also has affected a number of Alt-A mortgages, the next class above subprimes. Therefore, it has affected more collateralized debt obligations. It’s also caused other classes of mortgage to hike their interest rates.

And, with the peak in number of adjustable rate mortgages due to reset nearly a year off, we’re still not at the bottom of this.

Money markets latest to catch the subprime bug

Even though money market accounts are supposed to be “safe” investments, it looks like at least one got tempted to dip its hand into the subprime cookie jar:

Sentinel Management Group asked the Commodity Futures Trading Commission to help it stop Sentinel's investors from withdrawing their money, according to CNBC. Sentinel doesn't manage money funds for retail investors. Rather, it helps commodity trading firms and hedge funds invest the cash they accumulate in short-term, interest-bearing vehicles, according to The Wall Street Journal.

Money funds, similarly, invest in short-term, high-quality obligations called commercial paper. But in an effort to gain a competitive edge, some companies that run the funds stretch a little further out on the risk spectrum. Though it's not clear yet what securities Sentinel holds, there has been speculation in the market in recent days that some money funds owned short-term paper — including mortgage-backed securities — issued by banks with exposure to problems in the subprime-mortgage market.

The problem is twofold. One, Sentinel doesn’t have the type of liquid capital to pay off many investors. Two, the commodities commission said it has no power to do what Sentinel wants.

And, the problem has its own shockwaves

Sentinel is not a mutual fund company, and should not be confused with Sentinel Funds of Vermont, which today posted at its website that it is “in no way affiliated with the Sentinel Management Group (of Illinois).” …

Spokesmen for Fidelity Investments, Vanguard Group and T. Rowe Price said their firms have no significant exposure to commercial paper backed by subprime mortgages.

If other money-market funds are exposed, watch out. Calls on money could become stampedes, which will only further tighten business liquidity and cut the availability of business credit.

CDOs and the Great Depression

Collateralized debt obligations based in fair part on subprime mortgages and in fair part on highly leveraged debt of various types strike me as being the modern equivalent of stocks being sold on just 10 percent margin in early 1929.

California home mortgage defaults at record pace

And the subhead in the Los Angeles Times’ online version of the story even uses the word “recession” in describing the problem:

Foreclosures soared to 17,408 for the three months ended June 30, an increase of 799 percent from the same period last year. The current rate handily exceeds the previous foreclosure peak set in 1996, when the state was in the final throes of a six-year slump.

“The economy will bend further under the weight of the mounting housing and mortgage problems, but it will not break,” said Mark Zandi, chief economist at Moody’s Economy.com.

That’s what passes for optimism these days. Others are more downbeat.

“All the artificial stimulus housing gave the economy is going to go away,” said Rich Toscano, a financial advisor with Pacific Capital Associates in San Diego who runs the popular Piggington.com real estate website. “There will be individual pain for people who made the wrong decisions. We all may end up in a recession.”

The good news, as seen by Toscano: “I don’t envision a ‘Grapes of Wrath’ scenario where we all have to pile in the family car and look for harvesting work.” ...

Most analysts say the housing market won't stabilize until 2008 or 2009. The so-called soft landing that was much talked about last year is rarely mentioned anymore.

The rising foreclosure rate is tied to stricter lending standards and weakening home values. With housing prices flat or falling, lenders are less willing to refinance loans — especially to borrowers with shaky credit who are most likely to miss payments. ...

One reason foreclosures are rising faster than defaults is that strapped owners are having a harder time saving themselves.

As recently as a year ago, most homeowners who had slipped behind in their payments found a way to get current again. Nearly 9 out of 10 defaulting borrowers got out of trouble by selling their house or refinancing, according to DataQuick.

Fewer than 6 out of 10 are able to do so now. “People have stretched their finances to the breaking point,” said DataQuick analyst John Karevoll.

There’s already a year’s supply of houses on the market in San Bernardino and Riverside counties, up from a three-week supply at the height of the boom, said Ron Barnard, owner of Home Center Realty in Norco. Many are foreclosures that banks are trying to unload.

Will this be an “as California goes, so goes the nation,” scenario? As I’ve posted in the past about this issue, even states like Texas which look good on paper aren’t so solid.

In the sense of not liking or wanting a recession, it gives me little comfort to have my analysis confirmed by a major seven-day daily newspaper. But, in the sense of confirming that I’m not Chicken Little, it shows indeed that I’m on the right analytical track.

Subprime crisis moves right into prime-market loans

Countrywide Financial has prime-level mortgages at least 30 days late increase more than 250 percent:

Shares of Countrywide Financial Corp. tumbled today after the nation's biggest mortgage lender signaled that rising defaults and delinquencies are spreading beyond the troubled sub-prime market to higher-quality "prime" loans.

The Calabasas-based company reported a 33 percent drop in its second-quarter profit and slashed its outlook for the rest of the year, citing an “increasingly challenging” housing market. ...

Countrywide said payments were at least 30 days late at the end of second quarter on 4.56 percent of prime home-equity loans serviced by the company, up from 1.77 percent a year earlier.

Payments were late on 23.71 percent of sub-prime mortgage loans, up from 15.33 percent at the end of the same period in 2006, the company said.

Bill Clinton said, 15 years ago: “It’s the economy, stupid.”

I give you 1-3 odds we’re in a recession in 12 months. It will be the economy, again, as well as Iraq, on the presidential and congressional campaign trails.

I increase those odds to 1-2 by Jan. 20, 2009, especially if Bloomberg’s is right about $100/bbl oil. Whoever is elected president will have to deal with this.

Update: DuPont was among slumping stocks today, with profit projections tumbling due to a decline in housing starts, home remodeling and related business affecting demand for countertops.

Why hasn’t Wall Street reacted to the subprime crisis the way it “should”?

Because the Street has a lot to protect. Note the words “contained,” “suppressed” and “protected” in the Bill Fleckenstein analysis quoted below:

The problems have taken a long time to play out, largely because of what we've recently come to discover but probably could or should have known all along: that the building blocks of the housing ATM — more accurately referred to as structured credit — were created in such a way that these securities were rarely marked to market. Rather, they were allowed to be marked to a model, based on a variety of assumptions. Essentially, therefore, one's assets were impaired only when the ratings companies downgraded them. ...

Fast-forward to last February and March, which saw the implosion of a couple of dozen subprime lenders. Wall Street reacted by proclaiming the problem “contained.” Though I essentially laughed at that sanguine response, now I understand what it meant: Those in the know understood that nothing was going to be marked to market, so the subprime-loan-originator implosion didn't matter.

Next, we saw the blowup of Bear Stearns’ High-Grade Structured Credit Strategies Enhanced Leverage Fund. That happened, in part, because manager Ralph Cioffi had tried to hedge some of its weaker credits with an ABX index that did get marked to market. Thus the fund lost money and was hit with redemptions.

At the time, I said that redemptions were going to force price discovery into the market — although, as Jim Grant so eloquently put it in a recent issue of Grant's Interest Rate Observer — Bear Stearns had a totally different opinion: “Price discovery could wait until the return of blue skies and normal pulse rates. The first order of business was price suppression.”

This price suppression was the outcome folks had hoped for. After all, according to a July 11 article in Bloomberg, Wall Street took in about $27 billion in revenue from underwriting and trading asset-backed securities last year alone. It’s a mighty profitable business that they are protecting.

In other words, until the Street gets as “rational” about sunk costs as classical economists believe people are supposed to be, it’s not going to own up to the size of this problem.

More subprime worries: Is it time to talk recession?

First, the dollar continues to sink against other currencies as the Guardian notes.:

Wall Street's financial institutions and pension funds are thought to be heavily exposed to possible losses in collateralised debt obligations (CDOs) - packages of debt including mortgages owed by American households that are bought and sold in the financial markets.

When the Canadian dollar is trading nearly one-for-one with the U.S. dollar (the “loonie” at nearly 96 cents earlier this week) how can you not worry about our economy?

And, the mere fact that this story is gaining more traction in the international press indicates its seriousness.

Meanwhile, the “holdout effect” may keep the spiral going downward as well according to one economist. The details:

Sal Guatieri, economist at BMO Capital Markets, said the troubles in housing will continue to drag on the overall economy.

“The US housing correction shows no sign of stabilizing,” Guatieri said.

“Foreclosure rates are at all-time highs, with many subprime borrowers throwing in the towel. Continued moderate home price deflation, though helping affordability, is also discouraging buyers from taking the plunge.”

Market Watch, meanwhile uses “Moby-Dick” language to describe its concern:

Standard & Poor’s just drove a huge harpoon into the heart of the mortgage credit bubble, and it's going to take a long time to clean up the mess once the beast finally dies. …

But the bigger news is that S&P isn't going along with the charade anymore. S&P said it would change its methodology for rating hundreds of billions of dollars in residential-mortgage-backed securities. And it would review its ratings on hundreds of billions of dollars in the more complex collateralized debt obligations based on those subprime loans.

A lot of debt will be downgraded to junk status. A lot of that debt will have to be sold at fire-sale prices. A lot of pension funds and hedge funds that once thrived on the high returns they could get from investing in subprime junk will now lose a lot of money.

S&P’s announcement is a death warrant for the subprime industry. No longer will mortgage brokers be able to help buyers lie their way into a home. Fewer stressed homeowners will be able to refinance their mortgage, thus extending and exacerbating the housing bust.

“We do not foresee the poor performance abating,” S&P said.

And, I’m far from the only blogger to wonder, “Where was S&P two or three years ago?” as Business Week reports.

Homebuiders’ stocks reflect the ongoing concern, continuing to stumble and continuing to get stronger “sell” recommendations.

So, is it time to wonder about a possible recession? I say, “yes.” I’ll give you 1-in-3 odds we are in a recession within 12 months, and 1-in-2 odds we are by Jan. 1, 2009.

How much of a worry should subprime mortgages and collateralized debt obligations be?

Maybe even more than I’ve written before.

First, according to Counterpunch, financial derivatives have 10 times the float of all publicly traded stocks combined. That’s a lot of dinero, and no matter how much the Dow is up, ultimately, the broader investment market just can’t run from that:

Noriel Roubini puts meat to these bones. In his June 27th blog, Roubini wrote:

“The fallout of this CDO mess is likely to end up into $100 billion plus of losses for banks, financial institutions, hedge funds and investors once these CDOs and subprime mortgage backed securities are marked-to-market rather than being marked-to-a-delusional — misrated-model. Thus, the Bear disaster is only the tip of the iceberg of a much bigger financial mess that will unravel in the next few months: the pile of rising subprime and nearprime delinquencies will take a toll on the toxic waste of mortgage backed securities that a rating ‘voodoo magic’ pretended to turn below-junk securities into A-rated ones.”

Meanwhile, the Bank of International Settlements is worried about how the Fed has first mishandled this situation, then hedge funds. (Are hedge funds being used to “vent” the subprime crisis just like Greenspan used housing to ‘vent” he dot-com bubble?)

Here’s just how bad the problem is:

The BIS referred to the toxic effect of the $470 billion in collateralized debt obligations (CDO), and a further $524 billion in “synthetic” CDOs which have spread through hedge funds industry. These CDOs are the loans (many sub primes) which were bundled off to Wall Street and turned into securities which are highly leveraged in hedge funds for maximum profitability. As Bear Stearns is discovering, these CDOs are like roadside bombs. …

Banks doubled the amount of CDOs outstanding in the past two years to $2.6 trillion, including a record $769 billion sold last year, according to J.P. Morgan.

And, just because Wall Street is doing fine, that doesn’t mean the economy is so great, in case you’re wondering how it can be looking at 14,000 in the face of all that debt:

The current rise in stock prices does not indicate a healthy economy. It simply proves that the market is awash in cheap credit resulting from the Fed's increases in the money supply. Consumer spending is a better indicator of the real state of the economy than stocks. When consumer spending drops off; it is a sign of overcapacity, which is deflationary.

Here’s the bottom line:

The underlying problem is not simply the Fed's reckless increases to the money supply, but the growing “wealth gap” which is undermining solid economic growth. If wages don't keep pace with productivity; the middle class loses its ability to buy consumer items and the economy slows.

The reason that hasn’t happened yet in the US is because of the extraordinary opportunities to expand personal debt. The Fed's low interest rates have created a culture of borrowing which has convinced many people that debt equals wealth. It's not.

On mortgage refinancing, the purchasing of second homes as investments, etc., that confusion of wealth and debt is now coming home to roost.

And, if that’s not enough to wake you up:

The rise in housing prices has created the illusion of prosperity but, in truth, we are only selling houses to each other and are not making anything that the rest of the world wants. The $11 trillion dollars that was pumped into the real estate market is probably the greatest waste of capital investment in the nations' history.

Harsh words, but at least a fair-sized grain of truth behind them. This reminds me of Paul Kennedy’s book “The Rise and Fall of the Great Powers.” Somewhat for the Netherlands, and definitely for Great Britain, Kennedy states the move from manufacturing and industry to a focus on financial services was a key part of the decline of these great powers.

Caveat emptor.

Subprime crunch continues to belie “go-go” Texas economy

Texas is now third in the nation in foreclosures.

A large part of the problem here? The story details a Hispanic family who don’t speak Engligh well — easy pickings for an unscrupulous mortgage broker.

Meanwhile, national problems continue to mount:

More than 2 million home loans across the country could face default because of subprime lending practices, according to the Center for Responsible Lending, a nonprofit organization in Durham, N.C.

Again, there’s the ripple effect, of real estate agents, mortgage brokers, etc. having their jobs impacted. Defaulting homeowners have their credit rates shot and can buy less on credit in the future, too.

Subprime crisis a reflection of larger debt-investment problems; possibly comparable to Enron derivatives

Jim Jubak explains the incestuous relationship between credit-rating agencies and banks, and how the subprime crisis has left a lot of emperors’ new clothes exposed:

It's important to understand that bond professionals don't want to think badly of the job done by the credit-rating agencies. The bankers pay the rating agencies' fees. (Bet you didn't know that. Yep, the issuers of debt are the ones who pay the bills.) The bankers literally sit across the table from the rating agencies. The banks poach anybody on the other side of the table that they think has the talent to work for them. And the banks rely on the credibility of the rating agencies to sell their debt offerings. It's a pretty cozy club.

But the subprime debacle has been big enough to disrupt the club. Buyers of packages of subprime mortgages and derivatives based on these packages that have been burnt by rising defaults on these mortgages and falling prices for the debt they hold have angrily wondered if banks issuing the debt disclosed all the risk. And the banks have passed the buck, saying, that they relied on the ratings from the three agencies.

As a result, Jubak said, this is part of why not just the ratings agencies in particular, but Wall Street in general, hasn’t reacted faster to the subprime crisis and its possible larger economic effects, specifically the problems with mortgage-based securities.

Several issues here.

First, where is a Democratic Congress, in failing to push for new regs out of either the SEC or FDIC to eliminate this incestuousness?

Probably waiting for “new Democrat” financial donors, which it has often been since the Clinton days.

This would be like Ford or GM paying Consumer Reports for their car ratings. It’s ridiculous.

It’s ridiculous it took the subprime crisis to expose this, if “expose” is the right word for something still generally flying well beneath the Big Media radar.

Beyond that, there’s the fact that these particular securities, known as collateralized debt obligations, are big turkeys in their financial performance. And, to the degree small investors have gotten talked into them, they could take a bit of a bath.

And, these are very complex debt-based securities. Jubak says many people, not small-time buyers, but even bigger pros, can’t analyze them well. He even draws Enron-type comparisons.

It’s ridiculous nothing has yet been done.