Long Term Capital Management is an entity many people have forgotten what with the unending stream of big bankruptcies that seem to be accelerating, isn't it? This group died a miserable collective death a mere five years ago. The men who created this group were all friends of Alan Greenspan. When Russia went bankrupt so did they.
The idea behind LTCM was quite simple to articulate but not necessarily that easy to implement. LTCM was to look for arbritage opportunities in markets using computers, massive databases and the insights of top level theorists. These opportunities arose when markets deviated from normal patterns and was likely to re-adjust to the normal patterns. By creating hedged portfolios the risks could be reduced to low levels. According to the model developed by Merton the risk could be reduced to zero, but in practice some of the crucial assumptions of Merton's model did not hold so the risk of the hedged portfolios was not really zero, as subsequent events proved.Ah, the zero risk derivatives that magically make money just pour into one's lap while one is busy with going to parties or bidding on properties in the Hamptons!
A lot of people were burned in this crash and Greenspan rushed to play his monetary magic, dropping interest rates suddenly. I remember that time because just a few months earlier, he huffily said he wasn't going to drop interest rates despite mounting unemployment.
Derivatives are a strange beast that exists because of "gaps" in relative values as money travels from one ledger to another, as it is translated into other forms. This game of leeching pennies from every dollar that moves through the systems is a game played in the World Casino. Everyone who is anyone plays this game. All the great banks and all the great nations have a hand in this little game. They know that money doesn't really exist so sucking up a portion every step of the way can't be stopped or noticed by the peons.
This money has grown in leaps and bounds until today it is gigantic dwarfing the size of 2000's derivatives market.
Federal Reserve Chairman Alan Greenspan again pushed for limits on the multibillion-dollar mortgage holdings of Fannie Mae and Freddie Mac, saying such restrictions would not hurt the thriving housing market.Where to begin? Tearing hair out? Screaming about human folly? Since when, starting with Adam and Eve, has any humans done anything "right" even half of the time?
Greenspan, who has been pressing Congress to limit the holdings of the two mortgage giants, warned on Thursday that their debt poses a risk to U.S. financial markets.
As Fannie and Freddie grow ever larger, their ability ''to quickly correct a misjudgment in their complex hedging strategies becomes more difficult,'' Greenspan said. ''We are thus highly dependent on the risk managers at Fannie and Freddie to do everything right.''
This is why we develop "fail safe" systems and all sorts of checks on doing things. The Flying Wallendas could do amazing things...only they died regularily when things didn't go "right" for just a split second.
At the end of 1990, Fannie's and Freddie's combined portfolios amounted to $132 billion, Greenspan said. By 2003, their combined holdings came to $1.5 trillion.Fron $132 billion to $1.5 trillion in less than 13 years? Pray tell, what happened during that time?
''The assets required for Fannie and Freddie to achieve their mission are but a small fraction of the current level of their assets,'' Greenspan said. Thus if Congress were to limit the two companies' holdings so that they can achieve their mission, a substantial liquidation would be required over time, the Fed chief said.
Did Americans go on a savings spree? So there was an extra trillion dollars to spend on mortgages and "things". What are these "things"? Since mortgages of money of dubious origin isn't the bulk of the money held by these mortgage entities, what are they? One shudders to think. What are the money managers betting on? Remember, derivatives are not investments. They are bets placed concerning relative values and speed of movement of money. Who are they betting against? And how is this worm working its way into the heart of the financial systems doing?
$1.5 trillion is a funny number. This is about the amount of American debt China and Japan are holding right now. Isn't that funny?
Unwinding some of Fannie's and Freddie's holdings would not raise mortgage rates for homeowners because so many big banks and other lenders compete with them in the home-loan market, he said.Earth to Greenspan: the "portfolios" that are grinding out all that gold that is going into Ma and Pa Kettle's pockets as their properties shoot up in value even as everyone just sits at home comes from somewhere and it ain't Scrooge McDuck. If Fannie Mae and Freddie Mac didn't have access to this Magic Mill that grinds out gold only if the Giants China and Japan didn't work day and night turning the churn, there would be no money for mortgages in America at all. Except at realistic interest rates, namely, rates that attract savings rather than people begging for cheap loans.
Greenspan said the Fed also sees little evidence to support the notion that the availability of fixed-rate mortgages is tied to the size of Fannie's and Freddie's portfolios. He also said it is ''difficult to see'' how the two companies' portfolios can influence home ownership.
Recently I have recieved "offers" from banks, we being in the zero debt classification, to deposit money in a bank and get a $50 bill as a "gift". I told them, "How about giving me 6.5% interest." They laughed nervously. Hahahaha. Yeah, right. No way.
Much of the increase in home ownership seen in recent years seems to be due to growing incomes of households and generally low borrowing costs, he said.Greenspan doesn't want to change this bizarre system. We note he won't chat candidly about these mysterious derivatives. He just wants to keep handing out mortgages only slightly more severe terms, that is all. When the derivatives accounting scandal happened, we waited to hear a real accounting about the accouting, For unaccountable reasons, this never really happened.
''Without the needed restrictions on the size of (Fannie's and Freddie's) balance sheets, we put at risk our ability to preserve safe and sound financial markets in the United States, a key ingredient of support for housing,'' he said.
Federal regulators last year accused Fannie Mae of serious accounting problems. It was ordered to restate earnings back to 2001, a correction that could reach an estimated $11 billion. The accounting fiasco, which partly involved how derivatives were accounted for, led to the ouster of the company's chief executive and top financial officer.
Freddie Mac had its own accounting debacle in 2003, which also involved how derivatives were accounted for, and three top executives were forced out. It had misstated earnings by $5 billion for 2000-2002.
Open up the books! We need to know where all this money is coming from and where it is going and who is on the high wire, gingerly walking over the Grand Canyon of Debts.
NEWS: Krugman of the NYT says this:
Here's what I think will happen if and when China changes its currency policy, and those cheap loans are no longer available. U.S. interest rates will rise; the housing bubble will probably burst; construction employment and consumer spending will both fall; falling home prices may lead to a wave of bankruptcies. And we'll suddenly wonder why anyone thought financing the budget deficit was easy.Great minds think alike, no? Or someone is reading this after all!
In other words, we've developed an addiction to Chinese dollar purchases, and will suffer painful withdrawal symptoms when they come to an end.
I'm not saying we should try to maintain the status quo. Addictions must be broken, and the sooner the better. After all, one of these days China will stop buying dollars of its own accord. And the housing bubble will eventually burst whatever we do. Besides, in the long run, ending our dependence on foreign dollar purchases will give us a healthier economy. In particular, a rise in the yuan and other Asian currencies will eventually make U.S. manufacturing, which has lost three million jobs since 2000, more competitive.