Friday, February 27, 2009

Twenty-Five Standard Deviations In A Blue Moon

Twenty-Five Standard Deviations In A Blue Moon
Even The 'Quants' Got Busted!

By Bill Bonner | 25 October 2008

What's going wrong in the financial sector is not so unusual after all. One of the funniest moments in the Great Credit Crunch Of 2007-20?? came in the summer of 2007. "We are seeing things that are 25-standard deviation events, several days in a row," said David Viniar, CFO and chief 'quant' of the smartest financial firm in the world, Goldman Sachs.

That Viniar. What a comic.

According to Goldman's mathematical models… August, Year of Our Lord 2007, was a very special month. Things were happening then that were only supposed to happen about once in every 100,000 years. Either that…or Goldman's models were wrong [[not possible! : normxxx]]

We recall looking out our window. Outside, we saw a summer day much like any other. And inside, what we saw in the news was also rather typical— a credit crunch. No, credit crunches don't come along every day… but nor do 100,000 years separate one from another. In the United States, recently, we have had the crash of the dotcoms, the crash of Long Term Capital in '98 and the crash of '87; outside of the United States, there have been a number of credit crunches, in Japan, Russia, Mexico and various Asian countries.

When you make loans to people who can't pay the money back, trouble is only a couple standard deviations away.

[ Normxxx Here:  Feb. 12, 2009 (Bloomberg)— U.S. foreclosure filings exceeded 250,000 for the 10th straight month in January as falling prices trapped owners in homes worth less than their mortgage, RealtyTrac® ( said. (See Center For Responsible Lending for the running total since 1 January of this year, 2009.) RealtyTrac®, the leading online marketplace for foreclosure properties, released its 2008 U.S. Foreclosure Market Report™, which shows a total of 3,157,806 foreclosure filings— default notices, auction sale notices and bank repossessions— were reported on 2,330,483 U.S. properties during 2008, an 81 percent increase in total properties from 2007 and a 225 percent increase in total properties from 2006. The report also shows that 1.84 percent of all U.S. housing units (one in 54) received at least one foreclosure filing during 2008, up from 1.03 percent in 2007. Nearly 1.3 million homes were in some phase of foreclosure in 2007.  ]

The individual amounts of money weren't very large, not by Wall Street standards. But when the money didn't show up, it had an alarming effect. The press for October 17, 2007 brought estimates of total losses of over $13 billion at Citi. Morgan Stanley is said to be facing $8 billion in losses. Merrill Lynch set records with estimated losses of $18 billion. The cat still has Goldman Sachs' tongue. But when the losses are toted up, they will probably be spectacular. Altogether, there is more than $1 trillion in subprime debt outstanding; much of it will go bad.

[ Normxxx Here:  More Good News: A Barclay's report says $227 billion of option-ARM loans will reset in 2010 and 2011. The resets are already starting to grab headlines. FirstFed Financial of California saw its ratio of nonperforming assets rise from 2.34% in November 2007 to 7.54% in November 2008, due largely to skyrocketing option-ARM, not sub-Prime, losses. FirstFed is deleveraging its balance sheet, offering bondholders $0.33 per $1 of par value on $150 million of outstanding debt.  ]

Already heads are rolling. First, Warren Spector of Bear Stearns got axed. Then, it was Peter Wuffli at UBS. He was followed by Stan O'Neal of Merrill Lynch. O'Neal made the headlines when he was pushed out of the corporate jet with a 'golden parachute' valued at $160 million. After O'Neal hit the ground, along came Chuck Prince of Citigroup— America's largest bank. The firm is expected to write down $5 billion this quarter alone. Chuck was chucked out.

What went wrong? The business model seemed so pure and simple. You simply bought up subprime loans from the knaves who made them…then, you cut them up, slicing and dicing them into a kind of mortgage spam. You got the rating agencies to bless them…and then you sold them off to naïve investors. The idea was to earn huge fees upfront…while laying the risk onto the fools who bought the stuff.

When the going was good, it looked as though no business could be better. You were providing 'a valuable public service', helping people buy houses by redistributing the risk from the people who incurred it to people who had no idea it was there. And in the process, you earned such large fees you would get your picture in the paper, build a huge mansion in Greenwich and acquire some abominable paintings to put on the walls.

But wrong it did go. The Financial Times provides more detail on what happened at Citigroup:

"The bank reported that, at the end of September 2008, it had around $2.7bn of unsold collateralised debt obligations— pools of debt securities that are repackaged and distributed to other investors.

"But it also had $4.2bn of subprime loans it had bought previously, and about $4.8bn of loans to customers which were secured by subprime collateral. In addition, the bank had $43bn of exposure to the most 'highly rated' tranches of CDOs based on subprime mortgage assets."

It turns out Citi was fool and knave at the same time. It sold dubious subprime debt to its customers. But it bought some too… and took it as collateral.

Gary Crittenden, Citi's chief financial officer, claimed that the firm was simply a victim of unforeseen events. The losses were, "driven by some events that happened during the month of October, 2008" he said, referring to recent downgrades by rating agencies. No mention was made of the previous five years, when Citi was busily consolidating mortgage debt from people who weren't going to repay… pronouncing it 'investment grade'… mongering it to its clients… and stuffing it into its own portfolio… while paying itself billions in fees and bonuses.

No, according to the masters of the universe, downgrades by Moody's and Fitch's were completely unexpected… like the eruption of Vesuvius; even the gods were caught off guard. Apparently, as of September 30th, Citigroup's subprime portfolio was worth every penny of the $55 billion Citi's models said it was worth. Then, whoa, in came one of those 25-sigma events. Citi was whacked by a 'once-in-a-blue moon' 'fat tail'.

Who could have seen that coming? [[Who, indeed?: normxxx]]

(27 February 2009) Moody's May Downgrade $680 Billion of 2005-2007 Subprime Debt Securities



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