"Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed into hopelessly unproductive works."

John Stuart Mill,

Charts and Table Zup...

Time to do the deed;
Way past actually;

Here's whatzup;

UPDATED 3/23

The dotcom crash happened. Lots of smart guys with money took a big hit, but they had money left over that they needed to do something with. Alan Greenspan never saw anything unpleasant that couldn't be papered over with more money and lower rates so he flooded the market with liquidity and squashed rates JUST LIKE HE ALWAYS DID. There was money to loan everywhere almost for free. The post dotcom recession was almost played out when 9/11 happened. Lower rates and more money was an easy answer. Rates gor down to 1% for the banks and 0% for me. The economies of Brazil, Russia, India and China (BRIC) started to take off. They had resources, and educated populations and the need to develop. Worldwide, other nations realized that once the BRIC nations joined the US as economic super powers, they would be reduced to economic and political footnotes. So they kicked it up and the world finds itself with a multitude of nations in a race to develop from a resource and labor rich economies into a modern comsumption based societies. Now everyone was joining in the new millenium economic revolution. So there was money everywhere for free, and there was worldwide development leading to worldwide consumption and it was gaining speed.

So individuals in the US started to borrow cheap money to buy a house or to refinance their homes and take money out and spend it or invest it. Financial markets have a component called velocity. A financial entity loans out all its money in real estate 30 year loans, gets fees, and collects payments. New money like new deposits make new loans possible, but existing mortgages lock money up until they are paid off in 30 years or when the current mortgage is replaced when a owner moves or dies. you make money, then you wait. There is little velocity. So what if you could unlock the money by selling the mortgage? Then you could loan the money out again, get another round of fees, sell the mortgage and do it again. Money velocity is hugely multiplied. Every house sale now longer locks up capital for longer than a few months. The money starts to slosh around and chase assets higher. Housing valuations took off.

But who ya gonna sell the mortgages to? Enter the rich guys burned by the dotcom crash but with money to invest. These guys want 15+% a year with perfect safety. How ya gonna sell these guys a buncha 6% mortgages? Here's how. You give the appearance of diversifying for safety. You package a buncha mortgages from different areas and different quality together. Prime mortgages in Detroit, subprime from San Diego, Alt A mortgages from Key Largo. See, they all can't go down at the same time. Ya got a $100 mil package of mortgages that yield 6% overall with the prime giving you security and the subprime giving you the 9% pizazz. Default rates are low 'cuz ya got a lotta money chasing prices higher. Can't make the mortgage? Refi at a higher price and lower rates and take money out. Defaults are an opportunity to resell the property at a higher price and charge a new round of fees. These are can't lose assets for 5 years. So why not leverage these "can't lose" assets to boost the yield; Use the $100 mill package of mortgages as collateral to borrow another $100 mil. Buy some more mortgages. And some GMAC paper, and some Winnabago paper, and some Harley Davidson paper. Leverage those loans to buy some more mortgages and some....... Now ya got $100 mil holding $300 mil of paper yielding 18% on the original $100 mil cash investment and paying only 15%, just in case. You also sell these packages to pension plans and to municipalities and anyone who would otherwise buy a bond.

The only problem with this is, "What if the assets held drop?" Ya got $100 mil of cash backing up $200 mil of loans. That's a 1:2 leverage. If the $300 mil of assets drops 15%, that $45 mil of money evaporated. That's almost half the actual money backing up the holdings. If I was the source of the loan, I'd want to see $50 mil more in cash to replace what was lost and I'd ask to see $100 mil of the portfolio sold to reduce the leverage from 3:1 to 2:1. Say it takes selling 40% of the portfolio to sell $100 mil rather than 33% 'cuz it's not worth what it used to be.. Now the investors find themselves not with a one time payment of $100 mil to get 15% return on a SAFE investment, but having paid $100 mil plus $50 mil to keep a $150 mil portfolio afloat that pays 10% and furthermore is the source of rumors of defaulting, suspending payments or cutting the payout to 5% or lower. The call goes out to "GET ME OUTA HERE", and the market is flooded with inventory that can be bought ever cheaper the longer you wait. Think death spiral.




To be continued this week as time and circumstances permit.....