Sunday, 10 November 2013

Legalized fraud- structured financial instruments

Having presented how the officially fraudulent 'energy credits' used by Enron, creating non-existent future profits to attract investors, became legal as carbon trading, using the excuse most people still believe (even though it's hardly happened for years) of global warming, here's one better. Fraud actually allowed as far as I know worldwide (as these pieces of shit are traded worldwide) by allowing financial traders to sell mock auction lots, with the triple whammy of blaming the victim using due diligence, buyer beware, and official ratings. But the due diligence actually cancels out the official ratings, as like cheap beef sausages these lesser objects only need to contain about 3% meat, probably a lot less. The problem was customers were recommended these by dodgy companies before the 2007 crash, and by accepting the product without knowing this simple formula saw much of their wealth flushed down the toilet, as all the bad debts from sub prime mortgages and stratospherically leveraged companies (like 40-1 instead of the usual 3-1 debt-asset ratio).

The formula is so simple if you knew it you wouldn't touch one.

1) The contents of the package are secret, so much so many sellers did not have a clue what was in them.

2) The rating applies (the agencies know what's in them) as long as there's any AAA material in them, rather than rate according to the average risk.

3) All customers were permitted to know was the rating and very little else yet they bought in billions.

Imagine an honest broker (what are they nowadays?), I have a package for you they call AAA but technically the law (who made that?) says they are unknown and probably based on highly leveraged debt and mystery mortgages, from uncertified borrowers. Not many would have been sold then.

However, the real scandal is not that people were stupid enough (including huge companies) to fall for this utter crap even though a quick enquiry would tell you exactly what I just have, but that it is allowed by all the countries who allow trading in them. All of them as far as I know. So not just a few bent governments, like Britain (the freest market in the world according to Max Keiser, free of rules and regulations) let this garbage pass from seller to buyer, but as many as I have seen fall like cards when the defaults happened.

Here's a polite description while others prefer to tell it more how it is

"After 2001, a major, rapid transformation of financial markets occurred, as US banks and other retail institutions extended their loans to risky borrowers (subprime loans) and transferred these risks to the overall financial market using credit risk transfer instruments via securitization. CDOs of these mortgages were the most popular structured instruments for credit risk transfer. The AAA ratings that were initially attributed to many of these structures by the rating agencies were clearly erroneous, as many of these products defaulted when the underlying subprime loans started to default in 2005.
Subsequently, many of these structured products were downgraded by the rating agencies. By then, however, most of the damage had already been done.
During this period, securitization transformed low-grade assets into investment-grade assets via complex financial instruments such as asset-backed commercial papers (ABCP) and CDOs whose effective default risk was much higher than that of traditional AAA bonds. The crisis was accelerated because banks were under pressure from the financial market to increase the supply of high risk mortgages in order to generate assets with high yields in a period of low interest rates. This repackaging was very lucrative, which encouraged these CDO equity holders to issue a second generation of CDOs with lower yield, which in turn increased the demand for first-generation and mortgage-backed securities (MBSs). When the subprime loans started to default, these financial products externalized the damage to the international markets. This financial crisis has caused external damage to the real economy (unemployment) and the monetary economy (low credit conditions for consumers and business firms even if the prime rates of the Central Banks were very low). It has eroded confidence in financial institutions and rating institutions that induced consumers and investors to take large risks."
These are the official details, wise after the event. Of course, had everyone known that in 2001 onwards the financial crash would never have happened. And guess what, hardly any rules have changed, and now only large companies know to steer clear of this junk, not because it's illegal but because they've discovered what it really is. Unlike the current punters. If you want to learn more check out Max Keiser's numerous videos on the topic.