Friday, March 21, 2008

Can’t Grasp Credit Crisis? Join the Club - New York Times

Can’t Grasp Credit Crisis? Join the Club - New York Times:
"It has been going on for seven months now, and many people probably feel as if they should understand it. But they don’t, not really....I’m here to urge you not to feel sheepish. This may not be entirely comforting, but your confusion is shared by many people who are in the middle of the crisis.

“We’re exposing parts of the capital markets that most of us had never heard of,” Ethan Harris, a top Lehman Brothers economist, said last week. Robert Rubin, the former Treasury secretary and current Citigroup executive, has said that he hadn’t heard of “liquidity puts,”....
Liquidity puts are much like other forms of putable debt without all of the limitations as to when the debt is putable. (By the way the BEST explanation of liquidity puts, indeed much of the whole issue with off balance sheet debt in general is at Seeking Alpha from back in November)

Just one more thing on liquidity puts. has an example of their Liquidity Put Agreement online. Note this key point in their exposition of it:
"Thus, even if interest rates rise and the value of the securities fall, the issuer will always be able to put the securities back to the Provider at par, eliminating the need to mark the portfolio to market"
Which is why when the write-downs did occur they were for large amounts (I think, I will ask some accountants on this and the off-balance sheet treatment mentioned in the Seeking Alpha piece).

But I digress, back to the original NY Times article:
"As is often the case with innovations, though, there was soon too much of a good thing... The mortgages were then sliced into pieces and bundled into investments, often known as collateralized debt obligations, or C.D.O.’s....Once bundled, different types of mortgages could be sold to different groups of investors. Investors then goosed their returns through leverage, the oldest strategy around. They made $100 million bets with only $1 million of their own money and $99 million in debt. If the value of the investment rose to just $101 million, the investors would double their money"

The NY Times article good. Definitely recommend and especially if you have a final that might have essay questions before too long ;)

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