Carnival of Debt Reduction – Sub Prime Crisis Edition
I thought that I would never really make the deadline for this carnival of debt reduction. John told me earlier this week that I would be hosting and I did not really find out until friday that Mrs Credit Card arranged a trip to New York until Monday to get away for the kids spring break! I was tempted to send John an email asking if someone would swap places with me. While I could put together the carnival quickly if I decided to, I had always put in some effort into making a carnival interesting if I was hosting it. Furthermore, people who have been hosting carnivals are getting more creative in terms of having themes and even lots of photos!. But I decided to shoulder on.
So here I am writing on a Sunday night after visiting the Museum of Natural History with the kids the whole day. My feet are really hurting so I did not mind spending some time on the laptop. After logging onto the hotels internet access and paying $9.95 for 24 hour access, I suddenly realize that I did not have much time. Plus I was getting really tired. And I have no theme! So here is my ramble, and I hope the pieces do fall together.
Bears Stearns in Trouble?
One of the events that stuck to my mind this week was the fact that on Monday, a couple of friends of mine who work on wall street’s bond departments told me that Bear Stearns credit default swaps were trading at 900 basis points. Essentially, they were trading at distressed levels. On friday, Bear’s stock collapsed despite getting emergency funding through JP Morgan. Funny things was how the bonds guys knew this might happen and the stock trading community did not know about it until it was too late. If we look at our own lives, perhaps there are signs that we can gather if we are heading towards a financial disaster. How to Know if You’re in Deep Financial Trouble by Terry of Savvy Frugality is a good check list for yourself.
Diversify Your Revenue and everything!
Bear Stearns is likely to be put on the block for sale and part of the reason is that they did not diversify their revenues when things were great the last few years. While most investment banks are have thriving bond, stock and investment banking departments, Bear’s strength is mainly in bonds (and Mortgages!). The lesson here is that one has to diversify one’s revenue stream so that you do not become too cyclical with the economy. Applying that to a personal level, PT presents 12 Ways to Make Yourself Recession-Proof posted at Prime Time Money. Another important lesson comes from Steve Faber who says that simply reducing expenses is not enough. We also have to “grow our revenue” and he encourages us to enroll in – Continuing Education Certificate Programs to Earn Extra Money.
Where’s the risk management tool?
But Bear’s story is just the latest news headlines that have hit us since last summer when the sub-prime crisis first unraveled. It started to really make headlines when Merrill Lynch, Citibank and in fact all big banks announced massive write downs on the mortgage securities. Given the amount of write downs, it makes you wonder how banks look at their risk. Aren’t they sophisticated enough? Haven’t they looked at their total risk profile. Worse to come, AIG also announced massive writedowns. Bill Gross from PIMCO described this whole fiasco as the unwinding of the “shadow banking system”. The equity analyst also did not anticipate this because many of these securities were derivatives held “off-balance-sheet”! I guess the lesson is that there is no such thing as off balance sheet items. You have to look at everything as InvestorBlogger writes in his blog aptly titled Is your bank book your financial statement?.
Speaking of risk management systems, it is clear that today’s financial institutions have been found wanting in this area. To be fair, it is a very complicated area as many loans and securities today are modeled by PhDs! For us mortals, our situation can get complicated but fortunately, we do not need rocket scientist to figure that out. There are lots of tools available and they all serve their purposes. Here are a few reviews and thoughts on the latest tools.
Millionaire Money Habiits writes about mvelopes personal finance software review
Hire the Best – Fire the Crap
When Merrill Lynch and Citibank announced massive losses on their sub prime securities, their CEO took the heat for that. And rightly so. When John Thain came to Merrill, he opened said in interviews that their risk management system could be improved upon. That must have been the understatement of the year. We have to give kudos to Merrill to looking outside and hiring someone with better risk management background. In the same spirit, The Happy Rock has just fired himself as his own CPA! and now Spends The Big Money For Tax Prepation.
History Always Repeats Itself
In 1998, Long Term Capital blew up when liquidity dried up and all their trades went sour and they could not unwind them. They were also high leveraged. You would think those lessons have been learned, but we all know history always repeats itself. Recently, Carlyle Capital has gotten into trouble because of margin calls and over leverage. And to think that they were some of the smartest guys in private equity. Here are a few posts that reminds me of this.
debt freedom fighter presents Money, Mathematics, and Personal Behavior – Dave Ramsey is Right! posted at Discover Debt Freedom!.
Why Minimum Monthly Payments Will Cost You Big advice will always be ignored by most.
Would Carlyle have learned anything by reading these articles? ha – probably not. But once again, to folks like us, I would devour every word of these.
Over leverage is dangerous
A major reason of the mess that we are facing is simply the amount of over leverage in the system. From financial institutions to hedge funds and to us as individuals. Financial institutions have “off balance sheet” items (which are legitimate). Individuals as well got over leveraged because we could get 0% downpayment, get our brand new plasma TV with our HELOC! Warren Buffet used to describe an LBO as putting a dagger on the steering wheel. It makes you careful (debt makes you efficient!), but one accident and that’s it. The lesson here is do not set yourself up such that you have a razor thin margin for error. Here are a couple of posts that relates to that.
But how this all this happened?
After the fact, every financial journalist began to talk about how this whole sub prime mess cam e about. Easy financing, new debt securities that carved and tranched risk into different risk profile and then sold them off to investors. Because of the investors huge appetite for risk, underwriting standards become lax. This is all good and well writing on “hindsight”. insert : : Here’s an interview by Emily Starbuck Gerson with Debtors Anonymous!
Problem is why didn’t anyone foresee this years ago? Maybe it is time we looked at some trends in the personal finance world that might get us into trouble these days. For example, FMF has warned us to Be Careful with Home Equity and 401k Credit Cards. Actually, he did not even write this post! But I’ll let him get away with it since he got a good guest blogger.
To mark to market or not
Since AIG had to announce a massive $11bn write down, they have made noises and arguments against “fair value accounting”. In fact, there has great amount of debate about this recently. While investment banks and hedge funds have to “mark to market”, banks and insurance companies can shift their declining assets into their “long term and hold books”. Part of the debate going on now is whether having to mark to market in a declining market actually makes things worse since everyone has to sell in a falling market which sets a spiral. However, the other side of the argument is that the Japanese banks were not required to mark to market in the 90s and they took ages to finally get around their bad debt problem. As far as folks like us are concerned, we are marked to market and it is for the better. In the spirit of full disclosure, Aryn discolses February Debt Reduction Process at Sound Money Matters
Not everyone was hurt
Despite the market action during the last six months, not every hedge fund or money manager was hurt. Paulson fund was a standout. He correctly anticipated the sub prime mess and was massively short short prime related securities. His funds were up a few hundred percent and one of them was up about as high as 500%! Who says manages cannot beat the S&P. His 2007 performance alone means he can lag for as long as he wants going forward! In the spirit on Paulson’s fund outperformance, here are a few stand outs from this weeks submission.
Vicki is now credit card debt free.
Debbie tells us how How She Got Out of Credit Card Debt.
Take Action – Replenish Capital with Sovereign Funds
So far, we’ve already have had a big big financial institutions replenish their capital from investments from Sovereign funds. Merrill Lynch, Citigroup, UBS have all had foreign investments to shore up their capital. Congress may get jittery about this but these banks did the right thing because having adequate capital in times of a liquidity crunch is vitally important. Mr. Debtbeater recently Cut Up His Credit Cards. Hey, if that is what it takes, so be it.
Well, even George Lucas had to delete tons of scenes from his final movie and unfortunately, here are some posts that can’t fit into the movie (or could it be that it is midnight and I’ve no desire to stay up any longer!). But at least, these post are still in the collectors DVD!
Dividend Money Presents student loan reduction strategy
Amanda presents 4 Credit/Debt/Money Documentaries
Squawkfox presents Rent vs. Buy Calculator
Erek Ostrowski presents Getting Out of Debt (Part 1)
Bear sells out for $2
Just when I thought I could go to bed, the news is out that Bear has sold itself to JPM for just $2 a share! What more can I say?