We all ought to pay more attention to the comments on EphBlog. This was a year ago today.

Having run Citibank’s MBS trading desk some years ago I would suggest that you have only seen the tip of the iceberg in the credit disaster. It is not an issue of which CEO to fire, or having made loans to “risky” borrowers. Back in the 80’s S & L’s went belly up mainly due to the disintermediation that was permitted on the liability side of the balance sheet. To past the “thrift test” a savings bank needed to have 85% of it’s assets in mortgages. In NY State the usury rate for mortgages was 8%. Volker inverts the yield curve, short rates go to 16% and then you have to compete with the Merrill RAT for short term money…instant insolvency…add to the that the Fed disallowing regulatory net worth certificates as RAP capital and bang. Fast forward to 2003-2006. Mortgage loans are now originated by fly by night companies with no capital, sold to the street, for inclusion in CDO’s and SIV’s. The rating agencies run their Monte Carlo simulations, and determine the likelihood of defaults, monoline insurers, subordinate tranches, and suddenly a residential mortgage with no down payment, inflated appraisals, and no income verifications, are now AAA. And who ends up the owners of these 30 year term 8 yr duration negatively convex instruments…hedge funds who then lever them 6 to 1 and fund them overnight to ride the curve …in order to garner 25% returns. It is highly likely that they have in the past 3 years refinanced a trillion dollars of home loans 30% above the real value of the properties. That puts the real losses near 300 billion not the 14 billion at citi or the 8 at Merrill. Just because you can create a derivative security doesn’t mean you should. And where the hell were the regulators? They have a role because home mortgages are the last remaining deductable debt…because…property taxes are the backbone of local governments and school finance. If the fed doesn’t flood the market with cash (driving the dollar to an additional 25% decline and oil to 125, and gold to 1000+)…the housing market has 30% more to go on the downside, financial stocks down the same, insurers chapter 11…etc etc etc…The street has just inadvertently created hundreds of billions of dollar of junk bonds with no natural buyers…that’s why they keep writing them down but never sell (superfunds, SIV rescue funds)…once they sell all hell will break loose…can you spell depression?

Too bad we didn’t listen. What does this financially sophisticated Eph say now?

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