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Credit Crisis 2009?

Posted by: Ben Steverman on August 11, 2008

What will the credit crisis look like on its second anniversary? BW colleague Will Andrews offers his tongue-in-cheek predictions:

After another orgy of writedowns and a Niagara of red ink among U.S. financial firms (in which Lehman Brothers (LEH) accidentally wrote down the same assets twice), Fed chairman Ben Bernanke executed one final bold plan to shore up the U.S. banking system. The Fed chief arranged for the consolidation of the remaining big U.S. financial firms into two new entities: GoldmanBofAMerrillCiti and JPMorganStanleyBrothers.

Under terms of the deals, which were consummated at a weekend swap meet in Pavonia, N.J., Goldman (GS) and JPMorgan were the nominal acquirers of the other firms, but it was the Fed that provided the financial muscle. The central bank opened its (that is to say, your) pocketbook to the tune of $200 billion in YYMAPTB (Yes, You Must Absolutely Pay This Back) and STTWBOTH (Seriously, the Taxpayer Won’t Be on the Hook) term facilities.

OK, I won’t give away all the jokes. Assuming you’re not too nervous to laugh at our financial system’s bleak outlook, check out Will’s Subprime City Confidential for the whole thing.

Reader Comments


August 11, 2008 1:39 PM

so good!

Jolinar Maktub

October 17, 2008 8:21 PM


Having worked in Financial Risk Management for the last 4 years at a large bank, I was in a unique position to analyse the technical causes behind the current so-called "credit crisis".

Financial Risk Management involves the use of 'pricing models' to estimate potential future values of financial instruments. These models calculate the risk of an instrument based on the number of variables, and with interest based products, the most important variable used is the 'mean time to default'.

The "mean time to default" is basically the credit rating. So as long as these CDOs had a credit rating of 'AAA', the model would assume that the mean time to default of about 8 years, whereas a subprime mortgage debtor has a mean time to default that is closer to 3/4 years, which would be a credit rating of B or CCC.
(I'm simplifying, more information here

Now not all of the mortgages in the CDO were subprime, as these types of instruments are generally made up of tranches of different mortgages on the bank's mortgage book. So the risk on the whole of the CDO was definitely not B, but it certainly wasn't AAA either.

The real crunch here though is that the credit rating determines the coupon (interest) rate. AAA assets have a very low yield, because their risk is virtually non existent. B assets have a high risk, and so investors expect a much higher yield to cover the risk (this is known as the risk premium).

So the banks were selling BBB instruments (CDOs) at AAA risk premiums, and making the spread between them. Given that there is often a large (up to 100 basis points) spread between those two I can see why the banks were keen on this practice. Lend at 600 and borrow at 500? Where can I get me some of THAT action !! ??

Given the massive profitability of this fraud for banks, one has to question the role of Moody's/S&P in all of this in their rating the CDO paper as 'AAA'. No doubt they will claim they were duped by financial whiz kid quants at the banks, but I think only the American taxpayer would be silly enough to believe that story.

On that final note, the Rest Of The World (tm) would like to extend a big 'Thank You' to the American taxpayer for volunteering to pay for our investment mistakes in your financial system. We could have done our due diligence on your mortgage backed derivatives ourselves and found them overpriced for the risk, but instead we decided to buy them anyway, and now you have agreed to pay the risk premium through your taxes.

THANK YOU, and remember not to vote!


October 19, 2008 4:31 AM

coorperation need to know were there money flows to . if not there is goning to be action not to prevent world wide nervousness towards financal institutions

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Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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