Great entertainment value. Jim Cramer loses it.

http://www.itulip.com/forums/showthread.php?t=1726

8/5/2007 11:30:50 PM

"Oh no, my millionaire buddies are losing some money. Won't the government help them out???"

8/5/2007 11:32:54 PM

That video is funny--but it's also wrong on so many levels.

8/5/2007 11:40:13 PM

By the way, for the uninitiated, if you're wondering what had Cramer so worked up, some of the mortgage (and hence credit) companies are dying because they made too many bad loans to regular people that could not afford them, and a lot of hedge funds and banks and investment firms bought those companies' mortgage-backed securities and are paying the price. Cramer was reacting to a comment from Bear Stearns' CFO where he said "this is the worst market in the fixed income market he's seen in his 22 years". Bear Stearns last month stated they lost $3.2 billion in investors' money in two hedge funds with Alt-A mortgages, one level above subprime. They're now in lawsuits with investors such as Merrill Lynch. Cramer is asking for the Fed to do what they did with Long Term Capital Management in 1998 and just pay off everyone in major financial difficulty so there's no financial disruption.

New York Times:

Quote :

"“The market dropped particularly sharply yesterday afternoon after investors were rattled by remarks by executives at Bear Stearns, the investment bank that has been heavily involved in mortgage securities. The firm’s assurances about its own financial position were overshadowed by bleak comments by its chief financial officer about the credit markets.” “‘I have been at this for 22 years, and this is about as bad as I have seen it in the fixed-income market,’ said Samuel L. Molinaro Jr., Bear Stearns’s chief financial officer.” “Lenders say they are increasingly unable to persuade investors to buy packages of home loans made to borrowers with little or no down payment or those who cannot fully document their incomes. As a result, many companies are no longer offering such loans to potential buyers.” “‘I have never seen it happen so quickly,’ said Steve Walsh, a mortgage broker in Scottsdale, Ariz. ‘Banks always do these little cutbacks here and there. What they are doing now is a liquidity crunch. It’s a credit freeze.’” “‘It seems to me things got every bit as silly in the credit markets in the last few years as they did in tech stocks in the late 1990s,’ said Douglas M. Peta, chief market strategist at J. & W. Seligman & Company, an investment firm based in New York. ‘I still think we may have a ways to go in this.’” "

Dow Jones:

Quote :

"“The secondary market that supports a big part of the U.S. mortgage industry has ground to a halt in recent days, a development that dramatically could increase the cost of home loans in expensive regions, experts said.” “The private, secondary mortgage market ‘is not functioning,’ Mike Perry, CEO of home loan specialist IndyMac Bancorp Inc., wrote in an email to IndyMac staff.” “It’s currently difficult to trade even AAA-rated parts of private mortgage- backed securities. Only mortgages that conform to the standards of government- sponsored enterprises, or GSEs, like Fannie currently are trading, Perry said.” “That account was confirmed by Scott Valentin, a mortgage company analyst at Friedman, Billings, Ramsey. ‘We’re hearing securitizations have frozen up,’ he said in an interview. ‘No one wants to bid on these things and then find out that the loans are worthless tomorrow.’” “‘If home buyers are in loans that don’t conform with Fannie or Freddie, given present market circumstances, they will have to pay at least 100 basis points more,’ explained Andy Chow, portfolio manager at a $14 billion San Francisco investment firm. (A basis point is one hundredth of a percentage point).” “That will have a big impact on the housing market in California, Florida and other places where home prices are very high, he said.” “‘In these areas, if home buyers don’t have much money as a down payment, their loans will be too large to conform with Fannie and Freddie’s standards,’ Chow explained. ‘That means people will pay much higher interest rates.’”"

[Edited on August 6, 2007 at 12:41 AM. Reason : /]

8/6/2007 12:28:58 AM

It sounds to me like the trading system has not frozen up. Government standard mortgages are trading freely, if hesitant. If it is only the risky mortgages that are having trouble finding buyers, and even then just at a 1% premium, then I don't see an addressable failure here: liquiditiy is forthcoming, just at slightly unfavorable rates.

I think the fed should hold pat, not changing rates. That is, unless it appears the crunch is altering expectations in other markets, at which point they have no choice but to start inflating (even if they only cut a percent or two).

8/6/2007 8:38:02 AM

Quote :

"Jim Cramer loses it"

he "lost it" long ago....dude's crazy

8/6/2007 8:51:36 AM

What really frustrates me, and I really do hate to admit this because I'm not a huge Cramer fan, is that he's right. There's a serious information asymmetry between the action of the government as well as the rating agencies, and the reality of the market. How do these bonds get into hedge funds that are supposed to be low-risk? Who's doing the derivative math that makes these actions in the secondary market look like AAA when they're barely above junk? And why isn't there greater action from those in power to break down this information asymmetry that's made a LOT of money evaporate to nothing?

8/7/2007 2:38:57 AM

oh noes rich people loosing money!!!!!!!!!!!!!!!

8/7/2007 8:08:47 AM

ok..... one thing that I'm still confused about the subprime crash is why these mortgage companies were giving loans to these people in the first place? The whole point of giving somebody a loan is calculating the cost/benefit and only giving them the loan if the expected payoff is high enough. With subprime borrowers, I know they jack the interest rates up (or do interest only, or 2/1 ARMs, whatever) to make sure they get an influx of cash at some point, but didn't these companies know that the borrowers would default? Wouldn't a high risk of default seriously skew the expected return on the loan? Were the lenders hoping all along that a bigger company or the government would bail them out when their shitty borrowers couldn't pay them back?

8/7/2007 8:27:39 AM

Quote :

"How do these bonds get into hedge funds that are supposed to be low-risk?"

Who says hedge funds are low risk? Hedge funds can be anything their managers want them to be, since they are unregulated. The use of hedging does not necessarily imply less risk, especially when the bets are highly leveraged. It's up to the investor -- big institutions, funds, rich people -- to investigate the hedge fund to be sure it's what they want.

Since there is no regulation, the free market decides how much transparency, reporting, etc hedge fund need to have. If a fund collapses and people lose money, they learn to demand more information next time. Hedge funds evolve. No government is needed. This is exactly what big investors wanted.

Quote :

"Who's doing the derivative math that makes these actions in the secondary market look like AAA when they're barely above junk?"

I'd guess your average fund manager.

Quote :

"And why isn't there greater action from those in power to break down this information asymmetry that's made a LOT of money evaporate to nothing?"

Because "those in power" personally made bank off of hedge funds over the years.

----------

Quote :

"ok..... one thing that I'm still confused about the subprime crash is why these mortgage companies were giving loans to these people in the first place? The whole point of giving somebody a loan is calculating the cost/benefit and only giving them the loan if the expected payoff is high enough."

Because when the lender's stock goes public, the owner becomes rich regardless of whether the loans become non performing.

Quote :

"Were the lenders hoping all along that a bigger company or the government would bail them out when their shitty borrowers couldn't pay them back?"

As a matter of fact, yes. Fannie mae and freddie mac fueled the market for subprime by liberally buying up packages with subprime loans. The lenders issued mortgage backed securities that the government automatically bought. Thus, the lenders made almost automatic profit.

The political goal was so that everyone could achieve the american dream of home ownership. Everyone assumed that if the government was lapping these things up, they were safe, and no one questioned it since they were making short term money hand over fist.

Long term loan payoff doesn't really drive any actor in this scenario.

8/7/2007 9:37:58 AM

^^ Here's an explanation from MoneyWeek:

http://www.moneyweek.com/file/31699/subprime-mortgage-collapse-why-bear-stearns-is-just-the-start.html

Quote :

"From subprime mortgage to MBS It all starts with the mortgage. About six million people in the United States who have no money have borrowed about 100% of the value of a house, right at the top of a housing market which has since fallen sharply. These are the subprime borrowers. The lenders, however, did not have to worry very much about the risk of default, because they rolled these mortgages into bonds called Mortgage-Backed Securities, which they then sold. They got to be off-risk within a few weeks, because by then these re-packaged mortgages belonged to other financial organizations. But it is not always easy to sell a package of these Mortgage-Backed Securities (known as MBS for short). Selling such a product demands that the credit quality is assessed; and because the underlying mortgages are subprime they are quite likely to go into default. So a credit-ratings agency will only give the subprime MBS a low credit score, which means it is not considered investment grade. That disqualifies it from the portfolios of many professionally managed funds. This is where it pays to get a bunch of smart investment bankers involved. The investment bankers slice the MBS into several "tranches". These are known as Collateralized Debt Obligations, or CDOs for short. The idea is to create some higher risk assets and some much safer ones by slicing up the MBS into what are called equity (high risk), mezzanine (middle risk) and the much sought-after investment grade bonds (low risk). Higher risk equals higher returns, of course, so the equity tranche of the MBS will earn the highest profits if things go well. But if things start to go wrong, the equity is lost first, and then the mezzanine. Even then, the investment-grade bonds could still get fully paid out. This persuades the credit ratings agencies to give the lowest-risk tranche a high enough credit rating to qualify for the critical investment grade rating. In this way the investment bank has created a decent proportion of highly marketable bonds out of a package of low-quality mortgages. Fairly standard, for example, is to convert a large package of MBS into perhaps 80% investment-grade bonds, 10% mezzanine, and 10% equity. How investment banks distribute the debt The original mortgage lender is in a hurry to get the whole MBS sold off, because this raises cash which can then go to fund fresh mortgage loans to new subprime borrowers. The investment bank is well motivated to slice up the MBS, because selling investment products is what it does best. It won't want to keep much, if any, of the newly created CDO tranches, because investment banks earn their money primarily by deal-making and distribution, rather than by taking risks with borrowers. In the market for CDOs, the investment bank will find it relatively easy to sell the investment grade bonds. They go mostly to respectable institutions. But the mezzanine and particularly the equity tranches can be trickier to dispose of. The effect of concentrating the risk, as well as the upside, in these tranches is to make them "hot" – so hot, in fact, that investment insiders sometimes call them "toxic waste". "

I cut the article off. Below this point it talks about where all these CDOs go. Mainly to hedge funds, pension funds, investment groups in general if you're interested.

The mortgage companies that are going out of business now are going out because no one down the line will buy their MBS, and some governments have told them to stop doing mortgages in their states as well due to the company's default/bankruptcy risk.

Quote :

"Who says hedge funds are low risk? Hedge funds can be anything their managers want them to be, since they are unregulated. The use of hedging does not necessarily imply less risk, especially when the bets are highly leveraged. It's up to the investor -- big institutions, funds, rich people -- to investigate the hedge fund to be sure it's what they want. Since there is no regulation, the free market decides how much transparency, reporting, etc hedge fund need to have. If a fund collapses and people lose money, they learn to demand more information next time. Hedge funds evolve. No government is needed. This is exactly what big investors wanted."

Exactly. And what Cramer is asking for is for the government to be needed and to pay off via cheap debt all the big companies so they won't lose money or fail.

It's kind of like that old joke where the people that are always loudest calling for deregulation are always the first people clamoring for re-regulation once they realize they don't have their safety net when business goes bad.

[Edited on August 7, 2007 at 10:00 AM. Reason : .]

8/7/2007 9:47:08 AM

I think one of the reason why these loans were issued was because people were nearly guaranteed to make money during the most torrent parts of the housing boom. Thus, even with an interest only loan, you were making money on your property. Just buy and flip and boom, you had cash.

This sort of risk was rather stupid of course given that everyone knew the housing market was going to slow down or collapse sooner or later. C'est la vie.

8/7/2007 9:52:27 AM

Quote :

"In this way the investment bank has created a decent proportion of highly marketable bonds out of a package of low-quality mortgages. Fairly standard, for example, is to convert a large package of MBS into perhaps 80% investment-grade bonds, 10% mezzanine, and 10% equity. "

How do they break the MBS up like this? It seems to me if one MBS is likely to default, each segment would be equally high risk. Unless they were just securing the different tranches out of their own pocket.

8/7/2007 9:58:06 AM

A 1% interest rate jump can work wonders. These investors are trying to get a higher return than 5%, which they can get for no effort. They expected defaults to be higher, but thanks to the majority that did not default, the higher interest payments from the majority were supposed to compensate for the losses among the minority.

What went wrong, however, was that the minority turned out to be larger than anyone imagined and the losses on each individual were higher than expected (the banks could not get out of the houses what the buyers put into them). They expected only to lose the costs of re-selling the property, not sell them at a loss.

8/7/2007 10:14:40 AM

Quote :

"The investment bank might choose to set up a hedge fund, possibly even using some of its own money to get the fund started. The hedge fund's objective is to trade in the high-risk equity and mezzanine CDO instruments. Let's imagine that the investment bank puts up the first $10 million. The hedge fund then buys the equity tranche of the CDO from the investment bank. In effect, the investment bank is actually buying the equity from itself. With a bit of luck – and this is what happened over recent years – the housing market then goes up. Now the CDO equity is floating higher in the water, because there's a cushion of higher house prices preventing those original subprime borrowers from defaulting. This rather obscure equity instrument, which is not traded on any open market, and so is not a liquid asset that can readily be bought and sold, should now be worth more than it was at issue. It gets marked up in value, and it gets marked up much faster than the underlying house prices, because all the price volatility is concentrated in this thin slice of CDO equity. The hedge fund is now a real performer! And that means it will be rewarded by further investment from outside. So what started as a vehicle with a little investment bank cash can grow the funds it manages under its own steam. Next, and this is what hedge funds are all about, it will leverage its risk, too. The hedge fund goes out to an unrelated lending bank, holding its high-performing but illiquid toxic waste in its hand, and it asks to borrow money using the waste as collateral. The lending bank has access to cheap money, and so it has the prospect of lending for spectacular profits. Now the MBS wheel is fully in motion. With a little co-operation from the investment bank, to which it is closely related, the hedge fund loses no time in marking up the value of its equity CDOs, on the basis of rising house prices. There is an overwhelming pressure to do so, not least because the hedge fund managers are rewarded on performance. Alas, in the absence of a genuine open market, it is too easy to manipulate the CDO's price up to an unrealistic value. The lending bank can see its collateral floating higher and higher in the water, and so it lends ever more cash against it to the hedge fund, and it picks up the new CDOs bought by the hedge fund as further collateral on new loans. Naturally, as with all collateral, the bank claims the right to sell the bonds if the underlying debt gets into trouble. But it doesn't look like a real danger at this stage. So the money lent by the bank against the CDO equity goes back to the hedge fund, which buys more CDOs from the investment bank, which buys more MBS from the mortgage lender, which provides more money to subprime borrowers, who then buy more houses, pushing real-estate prices higher again. This solution only gets into trouble when house prices turn sharply down. The lending banks ask for their money back, but the hedge funds haven't got it. All of it has been invested in CDO tranches. So the collateral needs to be sold. No problem, surely. It's on the books at a few billion dollars after all. But with its concentration of risk in a falling market, the equity slice has been hemorrhaging value, without ever being bought or sold in an open exchange. It's incredibly painful for the investment banker to mark down a paper price in these circumstances. First, he doesn't actually know for sure that the price is falling any more than he knew it was rising when he marked the price up. But he does know that marking the price down will immediately be bad for him, his team, his bank, his customer and everyone else. He doesn't have to be totally evil to put off marking down the price until tomorrow – or maybe the next day. That's why the lending banks which later get hold of their collateral can be presented with a very nasty surprise when they finally try to redeem the situation with a sale. It simply won't fetch anything like the price it was last marked at. Something like this is what happened to Bear Stearns' hedge funds. Its two funds were leveraged 5 times and 15 times respectively. That's the number of times they went round the financing wheel of leverage. The smaller, more cautious fund had 5 times as much money invested in CDOs as it had received from its hedge fund investors in cash. This means that its balance sheet may have looked like this: Assets Liabilities $5bn CDOs $4bn bank loans $1bn hedge fund investment Whereas the bigger fund was 15 times leveraged. So its balance sheet could have looked like this: Assets Liabilities $15bn CDOs $14bn bank loans $1bn hedge fund investment So far, only the smaller hedge fund has been rescued and we await developments on the larger one. The picture that is emerging is that the providers of the bank loans became increasingly nervous as US house prices turned down, and they wanted their money. Clearly, there were no cash assets in the hedge funds. So the banks took hold of the CDOs – their collateral – and went to sell them. The first out of the door, rumored to be Merrill Lynch, mostly got the collateral it was owed, but it exhausted the CDO market of buyers. The rest found no bids and quickly stopped trying to sell for fear of advertising the rock-bottom prices of something which currently sits in many portfolios at funds all over the world. Worse still, we are advised that the Bear Stearns funds were not actually invested in the toxic waste. They had bought the investment grade bonds. That clearly means the toxic waste and the mezzanine bonds have no value. We do not know who owns these."

8/7/2007 10:19:13 AM

The humorous part is that the same shit happens every real estate bust. People just convince themselves that "oh no, we have this new financial instrument XXXX, so it can't happen again!!!"

8/7/2007 9:59:04 PM

And you know what's the best thing if you have money in a hedge fund?

If they go belly up, you probably won't get your investment back because it'll be liquidated in the Cayman Islands, where 3 out of every 4 hedge funds are set up.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aX9aWxCf9y3o&refer=home

Quote :

"Bear Stearns Cos.' decision to liquidate two bankrupt hedge funds in the Cayman Islands instead of New York may limit creditors' and investors' ability to get their money back. While most of their assets are in New York, the funds filed for bankruptcy protection July 31 in a court in the Caymans, where they are incorporated. The bank also used a 2005 bankruptcy law to ask a U.S. judge in Manhattan to block all lawsuits against the funds and protect their U.S. assets during the Caymans proceedings. The Bear Stearns cases may establish a precedent that would let other failed hedge funds liquidate in the Caymans, where judges have a track record of favoring management. The local monetary authority estimates that three out of four hedge funds globally are incorporated in the western Caribbean islands. ``This is definitely going to be closely watched,'' said Evan Flaschen, a lawyer with Bracewell & Giuliani in New York, who has represented companies and creditors in international bankruptcy cases. ``Other hedge funds might do the same thing.'' The funds, which invested in securities tied to home mortgages, collapsed amid rising defaults on subprime loans, made to people with weak credit. Bear Stearns, the fifth-largest U.S. investment firm by market value, on Aug. 5 ousted Co-President Warren Spector, who headed the mortgage and fixed-income business. "

8/8/2007 1:22:26 PM