bacon dreamz writes:
whoa...good work, lama! high five!
bacon dreamz | 01.19.08 - 10:15 am | #

Nova writes:
Thank you. I will need to reread it now.
Nova | 01.19.08 - 10:26 am | #

Aheadofthecurve writes:
Very interesting analysis. thanks for your work (both of you).

Just to clarify the question I asked yesterday regarding the pool of 100 mortgages worth $ 500,000 each (for simplicity's sake). Let's say this quarter 5 stopped paying. Does the bank write-down $ 2.5 mil? If so, what about the fact that eventually they will foreclose on the houses and sell them for some amount less than what is owed, but greater than zero?

Also, do they then have to say, well if 5 stopped paying, maybe 5 more will stop paying soon? If so, what happens if in fact none, or only 2 stop paying? Also, how, without knowing the borrowers does one distinguish between those who are irreparable vs those who might be able to resume paying if some accomodations were made?

I appreciate your insights and hope you can answer my questions as simply as possible.
Aheadofthecurve | 01.19.08 - 10:30 am | #

Tom in AZ writes:
Thank you. I will need to reread it now.
Nova | 01.19.08 - 10:26 am | #

You think? LOL
Need MUCH more coffee.
Tom in AZ | 01.19.08 - 10:31 am | #

Clyde writes:
We are not worthy, all hail lama
Clyde | 01.19.08 - 10:37 am | #

Disempowered Paper Puncher writes:
Reading about accrual accounting while hung over is a BIG mistake.
Disempowered Paper Puncher | 01.19.08 - 10:41 am | #

Tanta writes:
And low five to bacon dreamz, who managed what no other Calculated Risk commenter or host has yet managed to do, which is draw a pig's tail with Excel. We who are about to fall off our chairs salute you!

One of the things this lets me bring up is the whole regulatory dancing around the issue of the OA as a residential 1-4 family mortgage product. Remember the old Nontraditional Mortgage Guidance? While that document did make some real changes in the way this loan type is underwritten--and some fairly vague recommendations for how to treat ALLL classifications--it did not in any way, shape, or form declare the product itself as not acceptable in a 1-4 portfolio.

That is critical. Some of our commenters have been, in essence, taking the position that the very fact that a loan is negatively amortizing should be sufficient reason to declare it uncollectable (or at least, to declare any capitalized interest uncollectable). What you are really saying there is that neg am should not be allowed. You might, possibly, be right about that. But you really cannot expect the regulators to say on the one hand that the product is allowable, and on the other that any time it does what it is intended to do (negatively amortize) it must be immediately impaired by the amount of the negative amortization. To do that would "outlaw" the product itself: you can't have a mortgage product that is structured to produce write-offs each quarter.

So the regulators basically told banks to 1) underwrite those loans more cautiously and 2) use the fact of negative amortization to classify loans for reserve-setting purposes. That is as close as they have come, so far, to saying that negative amortization reduces collectability.

I don't happen to think that these things have any business in the 1-4 residential portfolio (as I do not believe that investment property loans belong there). That isn't the same thing as saying they should be outlawed. In the case of investor loans, those should go in the commercial loan portfolio (where, among other things, they will be treated for reserve purposes the way other business loans are, not as if they were these "homogenous" resi loans). If you want to do OA, it seems to me, you have to put it somewhere else than in the resi portfolio, because it just isn't homogenous enough and "historical" performance estimates mean nothing. It should probably go in its own portfolio, which would be managed as a kind of hybrid of resi and commercial (more loan-level analysis than resi and not quite as much as commercial).

But that's just my opinion; I suspect pigs will fly before it happens.
Tanta | Homepage | 01.19.08 - 10:42 am | #

risk capital writes:
lama thanks, good information.

for those who want to get caught up-

"MBIA's surplus notes plunged as low as 70 cents on the dollar yesterday, indicating a yield of about 25 percent, traders said. MBIA fell 67 cents, or 7.3 percent, to $8.55 on the New York Stock Exchange, taking its decline to 48 percent this week. "

http://www.bloomberg.com/apps/ne...RQQs& refer=news

"The Securities and Exchange Commission is sending out examination letters requesting information from mutual-fund companies about how they value and assess their money-market fund holdings."

http://online.wsj.com/article/ SB...8212696557.html

"NEW YORK (Standard & Poor's) Jan. 18, 2008--Standard & Poor's Ratings Services
said today that it suspended its 'AAAf' fund credit quality rating on King
County Investment Pool. "

http:// www2.standardandpoors.com...8450802447.html

Bailout?-

""I think the role of the regulator has to be a facilitator. To speed in or somehow facilitate those possible bailouts or transactions, that is our number one goal as a regulator right now," he said."

http://www.reuters.com/article/m...20080118? rpc=44
risk capital | 01.19.08 - 10:46 am | #

bacon dreamz writes:
ok, low five to Tanta.

the mighty
bacon dreamz | 01.19.08 - 10:49 am | #

Tanta writes:
Just to clarify the question I asked yesterday regarding the pool of 100 mortgages worth $ 500,000 each (for simplicity's sake). Let's say this quarter 5 stopped paying. Does the bank write-down $ 2.5 mil?

No. You write the value down to the net present value of what you think you will collect. Unless you think the collateral is really worth $0, you don't write the loan down by its principal amount. You would estimate recoveries in foreclosure, and write down to that.

Also, do they then have to say, well if 5 stopped paying, maybe 5 more will stop paying soon? If so, what happens if in fact none, or only 2 stop paying?

First, you divide your loans into NPA (non-performing assets, or the ones that have actually stopped paying) and current assets. The NPA loans are impaired by definition; you therefore reserve for those based on your estimated recoveries (which may change from quarter to quarter; if you don't FC in 90 days, you may have to write the loan down again at the next reporting period if recovery estimates drop).

On the current loans, you make some estimate of how many you think might go delinquent in the next 12 months, and then you reserve for your estimate of near-term losses on them. As Lama notes, you can use "historical experience" to build your projections of estimated loss on a resi 1-4 family portfolio. (And, as we have noticed recently, you can get burned on that if the loans in question are so far off of what you historically originated that history is a bad guide.)

Yes, if you over-reserved (estimated more losses than actually occurred) then you would "write up" the loans in the future. That's why you do this every quarter, and you consider losses for reserve purposes as only near-term (next 12 months) at each quarter. It isn't a once-and-for-all thing, and you are not expected to be able to reserve at origination for any losses in the life of the loan.
Tanta | Homepage | 01.19.08 - 10:51 am | #

Tanta writes:
Also, how, without knowing the borrowers does one distinguish between those who are irreparable vs those who might be able to resume paying if some accomodations were made?

This is where the whole concept of a residential 1-4 portfolio enters in.

You are supposed to have underwritten those loans in such a consistent manner, and to have secured them with highly marketable collateral (liquid 1-4 family residences) such that you do not have to review the portfolio each quarter all the way down to each individual loan (as you would with a portfolio of big commercial loans).

The accounting rules for calculating reserves and impairing loans are already assuming standardized and "typical" loan originations. I can't stress that enough. The problems we are having today is "nontraditional mortgages" meeting up with "traditional accounting."
Tanta | Homepage | 01.19.08 - 10:55 am | #

Aheadofthecurve writes:
Tanta-Many thanks for your very detailed answer, I think I get what you are saying. One further Q. it seems like some of these banks, especially C and MER were caught with an inordinate amount of these loans relative to their peers. Was this intentional or were they intending to sell them and got caught with a bunch of unsalable inventory?
Aheadofthecurve | 01.19.08 - 10:57 am | #

bacon dreamz writes:
by the way, Tanta, if you click The Compleat UberNerd link up top, it looks like it hasn't been updated for a while.
bacon dreamz | 01.19.08 - 11:01 am | #

rich writes:
>"MBIA's surplus notes plunged as low as 70 cents on the dollar yesterday, indicating a yield of about 25 percent, traders said.

Maybe we've all been a little naive about these surplus notes. Maybe it was just a backdoor bail-out attempt by a group of Wall Street firms. Were any of these notes actually sold to investors, as opposed to underwriters? Maybe not.

In other words, the underwriters were expecting to lose money on the notes but figured to make it up on the back-end when MBIA pays out on the collapsing CDOs and CDO-squareds.
rich | 01.19.08 - 11:02 am | #

Zach writes:
Curve- the big brokerages weren't caught with many of these loans at all. They instead held securities backed by residential mortgages. The accounting for securities is entirely different from that for loans. In essence, if the whole world knows that these loans will default in 2 years, you will take the loss know if you hold the securities, but will have to take the loss incrementally if you hold the loans.

Also - for mortgage loans you almost never see provisions for interest income until the borrower has already stopped paying the interest owed. Different places reserve at different times though, so comparing NPLs at institution A vs. institution B should be done with care.
Zach | 01.19.08 - 11:03 am | #

Tanta writes:
Was this intentional or were they intending to sell them and got caught with a bunch of unsalable inventory?

I think MER's problem is inventory. They were buying up a bunch of MBS tranches to turn into a CDO, and then the market for CDOs went away and they got stuck with this shelf full of loans they were treating as held for sale. Those are the ones getting the big MTM adjustment.

C has a big portfolio of loans held to maturity. There, they're taking impairments because NPAs are up and collectability (recovery estimates) are way down.

The investment banks don't have large HTM portfolios (at least, they weren't planning on it). Banks will have a combination of problems here (an HFS pipeline of loans they originated to sell but now can't find a buyer for and a portfolio of HTM that is deteriorating every quarter).

The HFS problem eventually goes away as you do something with the assets in question (sell them and book the loss or take them to portfolio and book the loss). The HTM problem goes on until . . . maturity. Or foreclosure. Whichever comes first.
Tanta | Homepage | 01.19.08 - 11:04 am | #

Faster Pussycat, Sell Sell writes:
Piggy, piggy, piggy!

I love that freakin' pig!!!
Faster Pussycat, Sell Sell | 01.19.08 - 11:11 am | #

rich writes:
OT

To all the bearish investors here, I'd like to say "be careful" in the weeks ahead. So far, this decline is tracking dead-on the one in 2001-02 but moving faster.

There were three significant and sharp mini-rallies in 01-02, all retracing more than half the previous declines. In a real bear, the market grinds relentlessly lower, interrupted by bursts of hope. Charts say we're due a mini-rally in the next few weeks.

But long-term, the way 2008 has begun and unfolding events say this bear market, in total, could be as severe as 01-02 and affect broader market sectors and countries.

A year from now, the economy will still be in trouble and we'll be talking about how to shore up small/regional banks and bail-out FDIC. Keep enough dry powder for the whole bear.
rich | 01.19.08 - 11:12 am | #

lama writes:
Woops, I didn't know I was "on" today. Ahem,...
Ahead, If those notes are intended to be held (i.e.: in the portfolio), then you would again look to the present value of expected cash flows. You'd have to update your assumptions about what your expectations are; will you have to foreclose on one or more, will you have to write down some others, costs associated with dealing with the borrower in the future would also come off the balance right away.
lama | 01.19.08 - 11:14 am | #

risk capital writes:
rich-

now he wants government intervention and a bailout-

and an immediate 100 bps cut-

http://www.cnbc.com/id/22728371/...xt%7C& par=yahoo
risk capital | 01.19.08 - 11:15 am | #

lama writes:
bacon, thanks, but this all pails by comparison to the mortgage pig.
lama | 01.19.08 - 11:19 am | #

Tanta writes:
Woops, I didn't know I was "on" today. Ahem,...

You mean you didn't read the email that I apparently saved as a draft instead of sending this morning? How come?

Sorry. I will just sit back and be the Village Idiot today.
Tanta | Homepage | 01.19.08 - 11:20 am | #

rich writes:
>now he wants government intervention and a bailout-

Both Cramer and Kudlow gave big air time last night to lobbying for a federal bailout of broke bond insurers. But it's a lost cause.

They both tried to make parallels with RTC. But there was a significant public interest behind RTC, bailing out federal deposit insurance. There's no perceived public interest here. And the crisis is moving much faster than Washington can move, anyway.

Congress and the President will now focus on stimulus package, not bailout, and that's all they can do at one time.

There is a public interest in this crisis, which is to make sure small municipalities have access to capital, especially for refunding older debt. But that's a longer-term issue.

The fact Cramer/Kudlow would both put so much effort into these pleas shows real desperation.
rich | 01.19.08 - 11:22 am | #

y_we_work writes:
I can see the mortarboard for the graduation from the Tanta Program at CRU. A dangling pig's tail, in the color of your choice.
y_we_work | 01.19.08 - 11:22 am | #

bacon dreamz writes:
do GuestNerds get discounts on their newsletter subscriptions?
bacon dreamz | 01.19.08 - 11:26 am | #

FFDIC writes:
The First National Bank of Tanta has been approved for a federal bank charter from the FDIC and is now open for deposits. Additional information about the board makeup will be announced soon. Thank you.
FFDIC | 01.19.08 - 11:27 am | #

MaxedOutMama writes:
I do have one issue with accrual accounting for OA loans in large portfolios. It used to be that the regulators would beat up a bank if the bank started writing a bunch of single pay loans for long terms (more than one year), and the reason was that since you are getting the interest so much later, in effect you are getting less interest. It's not necessarily an issue of collectibility. It's an difference in the present value of your accruals.

There's a heck of a real world difference between accruing interest that will be paid on a monthly or quarterly difference vs interest that you may not receive for years. Accounting should represent this difference, and accrual accounting doesn't accurately represent it.

A bank can get itself into cash flow problems, not just future collection/collateralization problems.

The answer of this is obviously that the valuation of such portfolios should be adjusted for the present value difference. There is a difference in market value between a loan paying you 5% on principal every month vs one that is paying you 2.5% every month, but at some future date will pay out another 2.5%.

However, it is extremely difficult to do this when you do not know when you'll get the interest. Sure, you can adjust for the recast, but in reality the banks who racked up lots of these were using the 2 or 3 year period as a practical payout, because that was when the individual would refinance or sell the home. These loans, in recent years, were overwhelmingly used by realtors and "investors" with cash flow issues.

When bank portfolios had a small percentage of these loans, it was less of a regulatory issue. Now it is a major issue. I haven't tried to work through the balance sheets of some of the big OA boys, but my guess is that their portfolio valuations on these loans are suspect.
MaxedOutMama | Homepage | 01.19.08 - 11:28 am | #

Jas Jain writes:
--
Thank you, Tanta, to focus on my favorite subject, or pat peeve – Accounting. America’s looming downfall, from which it will NEVER recover, has a lot to do with accountants turning into whores, or turned into whores via political pressures and lure of all might dollars. One of the great bulwarks of Anglo-American dominance was high degree of integrity in accounting and fairly high standards of conducts among banking officials.

My son was the most decorated accounting graduate in SoCal in 1998 (I thought that it was earlier but I just checked with my son) and as a result I got to seat the table with seven most influential finance men in SoCal (finance chiefs at Sony, etc.). They are agreed, off the records, that there was lot of room for accounting ‘discretion’ to manipulate the results for few years, say up to seven years. The most obvious, they pointed out, was the treatment of inventory. What else is new!

Later the same year I invited my son and three other young accountants for lunch. They all complemented me by saying in unison, “You were right about what you said about accounting practices.”

Father of an accountant, son of an accountant & all-purpose businessman, and grandson of an accountant and self-taught lawyer,

Jas

PS: In may family, integrity & morality of conduct mattered over money without any doubts or questions. To dopes it is the legality, bereft of any morality, that matters. Genes & upbringing matters! Dopes breed dopes and the process terminates badly.
Jas Jain | 01.19.08 - 11:28 am | #

dryfly writes:
Lama & Tanta - Very nice. One small request if possible...

Can you embed a spread sheet showing a simple example of the transactions... debit here, credit there... end result is [...] How the reserves migrate from journal entry to ledger to final statement. I know it is a lot of extra work but would be wonderful.

I understand things a lot better when I see simple examples. Text descriptions are fine - but 'pictures' are even better.

TIA.

dryfly | 01.19.08 - 11:29 am | #

MaxedOutMama writes:
Whoops, I see that Lama woke up and explained that already. Sorry. Great job, Lama!

This is a great post. Congratulations to you all.
MaxedOutMama | Homepage | 01.19.08 - 11:30 am | #

bklyn_rntr writes:
tanta/lama,
thanks for that excellent rundown. Now can I ask for more info? what happens when the loan defaults and the bank takes control of the collateral? how is that accounted for and how is the collateral valued? also, are there rules for how long a bank can hold onto the underlying asset (the house) before it has to sell? if it sells at a loss how is that treated in results and on the balance sheet.

Finally, how do the basel rules work If a bank has lent all of its resources and there are enough defaults/repossessions to tie up all of its liquid resources. how does it account for the restoring the balance sheet?
bklyn_rntr | 01.19.08 - 11:32 am | #

sk writes:
lama, bacon dreamz, Tanta, thanks.. I'll need to read that several times to get it. In the meantime, some clarifications please about the following issues for this algorithms-conditioned mind:

Accrual accounting means you recognize revenue when earned, expenses when incurred. A gas station would not incur an expense when they purchase gas for resale. That station would incur the expense at the time the gas was sold. That’s because the gas’ cost was a cost to produce the sale. In the time between the purchase and subsequent sale, the company holds the gas as inventory as an asset on its balance sheet.


So, am I right in thinking that the other case mentioned, the revenue was earned at the same time, that is, also when the gas was sold ? {Sorry to sound dumb, but the dangling second case stands out to me, like dangling participles to English majors I suppose ).

And since you bring up inventory, what happens to the accounting for that ? I mean it didn't mysteriously appear in the underground tank, you paid for it right ? at delivery or perhaps pro-rata as each gallon is sold ? But we just called it the cost as well - I sense double counting here - I'm now thoroughly confused.. Help! :-)


every asset on a balance sheet has a base and a reserve. The base asset value is the easy part. If someone borrows $100,000, you have a schedule with the $100,000 on it.


What is a schedule ? Is that the same as a balance sheet or a single row on it or ??

Thanks much.

-K
sk | Homepage | 01.19.08 - 11:34 am | #

MaxedOutMama writes:
Tanta If you want to do OA, it seems to me, you have to put it somewhere else than in the resi portfolio, because it just isn't homogenous enough and "historical" performance estimates mean nothing. It should probably go in its own portfolio, which would be managed as a kind of hybrid of resi and commercial (more loan-level analysis than resi and not quite as much as commercial.

Amen to that. At the very least, these loans have to be managed differently, reserved differently, and valued differently. Regulators demand that banks that write HOEPA loans have special controls and procedures to handle the risks. These loans should be treated similarly.
MaxedOutMama | Homepage | 01.19.08 - 11:35 am | #

dryfly writes:

They both tried to make parallels with RTC. But there was a significant public interest behind RTC, bailing out federal deposit insurance. There's no perceived public interest here.

Oh yes there is - the muni and and biz capital markets. They absolutely rely on insurance to sell bonds. You'll see a very significant tightening of money available to them if the insurers fail.

It wouldn't be a 'bail out' so much as a 'mop up' afterward... at least until somebody financially healthy like Buffet can step back in to provide a market solution. There isn't likely to be one for awhile if all the insures puke on CDO insurance.

And the crisis is moving much faster than Washington can move, anyway.

Very true. If there is to be an RTC like solution it has to come AFTER the insurers fail (like in the S&L crisis)... The RTC-like institution would come in AFTER the insurers default and pick up the insurance liability on only those accounts where there is a clear public good to see insurance continue - primarily in the muni world & small business.

Hell it would take gov't a year just to figure out what to do next if they started thinking about it this afternoon. But a fresh new market alternative to fill the void will eve take longer. A temporary RTC like op could be beneficial if done right & executed well.

dryfly | 01.19.08 - 11:41 am | #

RayOnTheFarm writes:
and at that point you record the loan at the lower of cost or market

dumb question...

should the market value of the loan (HTM) drop below cost, you would value it at market (as above), over time, if that market value (finally) reverses and begins to rise, does the cost then become a 'ceiling' beyond which loan cannot be valued higher than ?
RayOnTheFarm | 01.19.08 - 11:41 am | #

Misean writes:
Thank you,

That post was like sitting through Managerial Accounting 310 again...only in one sitting. I'm to far away from that class to discuss particulars, so...

How would you like us to discuss the current market with an eye to the current post? Given the fact that some of us have hangovers that could choke a chicken?

A bit of guidance please. (My brain hurts.)

Cheers,
Misean | 01.19.08 - 11:42 am | #

DCRogers writes:
I understood everything up to: To the bank, the loan is an asset and the deposit account is a liability.

Luckily for me, Lama cleared it up later: Assets are Debit accounts, so increases in Assets are Debits, decreases are Credits. Revenue is a Credit account, so increases in Revenue are Credits, decreases are Debits.

After that, it got sort of murky... gotta check my notes... (shuffle shuffle)... I'll get back to you...
DCRogers | 01.19.08 - 11:46 am | #

X-UCSB writes:
My brain hurts too...It's Saturday morning and my IQ is greatly diminished from last night.
X-UCSB | Homepage | 01.19.08 - 11:48 am | #

ron writes:
Thanks Lama, always appreciate your comments.
ron | Homepage | 01.19.08 - 11:58 am | #

lama writes:
sk, the schedule is in some beancounter's hard drive. That's all. I guess after day one of the loan, the original loan balance is just a memo, an FYI.
lama | 01.19.08 - 12:01 pm | #

Misean writes:
dryfly

"Oh yes there is - the muni and and biz capital markets. They absolutely rely on insurance to sell bonds."

You mean they rely on it to sell at par. If insurance costs rise above what they'd be rated without insurance, they'd sell without insurance. So by rely...you mean depend on for par sales?

Cheers,
Misean | 01.19.08 - 12:02 pm | #

DCRogers writes:
Was this intentional or were they intending to sell them and got caught with a bunch of unsalable inventory?
Aheadofthecurve | 01.19.08 - 10:57 am | #

I think MER's problem is inventory. They were buying up a bunch of MBS tranches to turn into a CDO, and then the market for CDOs went away and they got stuck with this shelf full of loans they were treating as held for sale.
Tanta | Homepage | 01.19.08 - 11:04 am | #

As I recall, the story is even more tortured. MER at first didn't want to hold anything, just make fees off of securitization. That worked great; especially, demand for the lower tranches (with the highest interest rates) was very strong. An unsold backlog of the "best" AAA tranches built up, and in order to keep the machine humming and keep providing these high-rate securities, MER made the fateful choice to keep the "safe" AAA tranches on its books. The rest is history.
DCRogers | 01.19.08 - 12:04 pm | #

Zigurrat writes:
sk...as a non accountant, I feel perfectly qualified to take a shot at your questions.


"So, am I right in thinking that the other case mentioned, the revenue was earned at the same time, that is, also when the gas was sold ? {Sorry to sound dumb, but the dangling second case stands out to me, like dangling participles to English majors I suppose )."

Yes... the idea of accrual accounting is to match revenue and expenses.

As far as inventory, when you buy the gas, your assets stay the same, cash goes down and inventory goes up. At that instant there is no revenue, expenses, profits or losses. $'s just move from cash to inventory.

"What is a schedule ? Is that the same as a balance sheet or a single row on it or ??"

I think that if you had an old fashioned loan, you got a payment book or an amortization schedule. Each payment had principal and interest.

Obviously when you get away from fixed rate mortgages, things get more complicated.
Zigurrat | 01.19.08 - 12:04 pm | #

lama writes:
Dry, That would be alot of detail. Does this help?

Ignoring the equity section of the balance sheet (ownership, stock), you can look at it this way:

Debits on the Balance Sheet = Good
Credits on the Balance Sheet = Bad

conversely

Credits on the Income Statement = Good
Debits on the Income Statement = Bad
lama | 01.19.08 - 12:06 pm | #

jg writes:
Jas, was your son a Sells award winner? Or, was this an accounting honor society thing?

Congrats on the fine work with your boy.
jg | 01.19.08 - 12:08 pm | #

lama writes:
I'm back. I agree with Zirurrat's responses.
lama | 01.19.08 - 12:09 pm | #

jg writes:
Tanta, enough with accrual accounting.

Please tell us how the Ambac downgrade rolls through the banks and bond market.

Thanks!
jg | 01.19.08 - 12:09 pm | #

Zigurrat writes:
Question regarding market value....

You are a bank and you do a mortgage (is do the right word?). It's solid and simple, $100k, 30 year, 6% interest.

Lets say mortgage rates jump up 1% the afternoon after the loan closes. The market value of that loan is now less then $100k.

Do you recognize this?
Zigurrat | 01.19.08 - 12:11 pm | #

Gary writes:
Tanta, your clarification is useful. I think the answer is just that: Neg Am should never have been allowed. Yes, they followed the accounting rules, but good sense says the product itself is an abomination that never should have been OK'd by regulatory agencies.

When I learned a couple of years ago that they were doing Neg-Am home loans, I knew for sure this would end very, very badly.
Gary | Homepage | 01.19.08 - 12:11 pm | #

jg writes:
Well, it's not a real number, now, and it is very early in the earnings season, but...

...earnings are down 73% year over year!

http://online.wsj.com/mdc/ public...dustryearn.html

Burn, baby, burn!
jg | 01.19.08 - 12:12 pm | #

Tanta writes:
What is a schedule ? Is that the same as a balance sheet or a single row on it or ??

It's the detail of that which the balance sheet shows the aggregation. Kinda like the schedules that go with your 1040s.

It is one big mother of a spreadsheet with every loan you got listed on it with all the loan-level detail. Nobody but the institution, its auditors, and its examiners will ever see the schedules. The publically-available financial statements include the aggregated numbers so that they don't have to be thousands of pages long.
Tanta | Homepage | 01.19.08 - 12:12 pm | #

Gary writes:
Come on lama, what's a Saturday morning without several pages of T-accounts? :)
Gary | Homepage | 01.19.08 - 12:13 pm | #

lama writes:
Ray, There is no ceiling to a loan balance, assuming it's collectible. There are ceilings for many assets. Inventory's max value is:
Cost +
Shipping and movement (including inside your company) +
Cost to purchase (purchasing payroll, etc.)
lama | 01.19.08 - 12:13 pm | #

Gary writes:
Oh, and I posted a question last night on when was the last time the markets had a week as bad as this. The answer: July 2002.

http://www.bloomberg.com/apps/ne...mzEE& refer=home
Gary | Homepage | 01.19.08 - 12:16 pm | #

lama writes:
Ziggurat,
1. If you are planning to hold it, you'd leave the balance alone unless there were extreme interest rate variations.
2. If you plan to sell, the loan would be reduced (through the contra-asset) either by the marketplace comparisons or the arithmetic of present value.
lama | 01.19.08 - 12:19 pm | #

lama writes:
I've got Tanta politely fixing my half-baked responses, and you want T accounts??
I need another coffee.
lama | 01.19.08 - 12:22 pm | #

Fair Economist writes:
I agree Neg Ams shouldn't have been allowed. They are functionally equivalent to a conventional mortgage with a HELOC layered on top, and the additional restriction that the HELOC has a maximum draw per month. A company doing it that way would charge a higher interest rate for the HELOC. Should a monthly limit on HELOC use allow a prime mortgage rate? I don't think so, and I think if it had been done that way regulators and auditors would have thrown down a penalty flag.
Fair Economist | 01.19.08 - 12:22 pm | #

Clyde writes:
Ok I have to vent:
John Mauldin of buy-side consulting fame says today that Senator Dodd is playing politics by holding up Fed board nominations.

I sent him a nastygram saying that the Fed has politicized itself by choosing not to regulate non-depository lenders as it was charged to do by Congress. What does the CR community say, did I go overboard? Read below and give me your thoughts.
http://frontlinethoughts.com/gateway.asp
Clyde | 01.19.08 - 12:24 pm | #

Tanta writes:
You are a bank and you do a mortgage (is do the right word?). It's solid and simple, $100k, 30 year, 6% interest.

Lets say mortgage rates jump up 1% the afternoon after the loan closes. The market value of that loan is now less then $100k.

Do you recognize this?

Old farts like me "write" mortgages. The young ones "do" them or "make" them.

What you do depends on whether you wrote/did/made the loan HFS or HTM (you must decide this before the loan is closed--that is, when it is committed or the rate is locked. You don't get to close first and then decide which it is). If you were intending to sell it into the secondary market, you would (presumably) have a hedge on it: a forward commitment to sell it at the price you originally locked the rate at, or something like that. Therefore you hold it in inventory until sale at market value net of effective hedges (basically meaning you still hold it at the committed price as long as your commitment is valid). The day you sell it, you book the transaction at the settlement price. (Now, the guy on the other side of that trade may have a little problem here, depending on his hedge against the forward trade he made with you a few months ago and just had to honor.)

If you are making the loan for your own portfolio, you will put it on the books at cost (you don't have to worry about intraday volatility). However, let's say you had it HFS, but your hedge blew up and you can't sell the loan at your originally committed price. If you take that loan to portfolio (switch it over to HTM), you will have to reflect the fact that it is now underwater by valuing it at market (rather than cost).

Does that make sense?
Tanta | Homepage | 01.19.08 - 12:25 pm | #

rich writes:
>A temporary RTC like op could be beneficial if done right & executed well.

There will be no RTC-like op, which means a govt. takeover of assets/liabilities and gradualy workout using govt. guarantee/taxpayer dollars as guarantor backstop.

The problem is that there's two separate sides to this crisis.

Over the short-term, it involves massive hits to asset-backed securities and investor losses when insurer assets run out. Also, it involves ratings downgrades and irrevocable destruction of the bond insurance biz model. All that will be over before Congress can blink.

Then, you get part 2, which is "how can crummy towns and agencies get funding to refi" when there is no bond insurance to prop them up? Since defaults will happen if they can't refi, Congress will step in to create some hardship funding deal. But that's not until late 2008 or 2009.
rich | 01.19.08 - 12:27 pm | #

Shylock writes:
Thank you Lama! You're beautiful Tanta, why can't I find this top quality writing in the MSM?

the lender is earning income based on what he is owed, not based on how much cash he receives,

Hurray! All those CDO holders are rich, oops! well I guess we can use those balance sheets somehwere, it's not as soft as Charmin but it will do.
Shylock | 01.19.08 - 12:27 pm | #

sk writes:
re: Zigurrat

Thanks ! That explanation of inventory and its connection to cash produced an "AHA" moment. Cool.

This matching revenue and expenses biz - I assumed that they don't have to synchronous in time - in the example of gas sold, they are of course, as discussed earlier, but it doesn't HAVE to be so, is that right ? 'cos if it HAS to be then my mental picture has to change quite a bit.


Tanta - thanks for the Schedule explanation. Sadly, I do understand Schedules on my 1040.. sad ? I mean infuriated. As an aside perhaps the schedules aren't available to me since there might be trade secrets( which customer bought a lot etc ) discernible in there - or even, as my jaundiced mind would note, some shenanigans to be discerned by looking for the devil in the details ? I shall look at SEC reporting regulations a little harder and understand their requirements a little deeper in due course.

Anyway, I was stuck at that point in the post - I can now move forward.

-K
sk | Homepage | 01.19.08 - 12:30 pm | #

SM writes:
You guys are fantastic. This blog rocks, but I still can't get over the fact that I'm reading about accounting on a Saturday Morning.

I'll take that second shot in my Bloody Mary now.
SM | 01.19.08 - 12:34 pm | #

lama writes:
sk, in strict cash accounting, you would book the expense when you purchase the gas and book the income when you sell it. Sounds ok for a tiny cash business, but think of the home builders for example. They might start and finish a house in the same year, but sell it the next year. If you saw financials with a loss for the cost to build in year 1, then a profit in year 2 for the entire price of the house, that wouldn't really tell you what's going on.
lama | 01.19.08 - 12:36 pm | #

Misean writes:
Not exactly rock blogging...but on topic...I think:

http://www.youtube.com/watch?v=X...h? v=XMOmB1q8W4Y

Cheers,
Misean | 01.19.08 - 12:36 pm | #

bacon dreamz writes:
This blog rocks, but I still can't get over the fact that I'm reading about accounting on a Saturday Morning.

embrace your inner Nerd...
bacon dreamz | 01.19.08 - 12:37 pm | #

Rob Dawg writes:
Tanta thus instructs: If you take that loan [HFS] to portfolio (switch it over to HTM), you will have to reflect the fact that it is now underwater by valuing it at market (rather than cost).

Ummmm, "have to" or "are supposed to?"
Rob Dawg | Homepage | 01.19.08 - 12:44 pm | #

sk writes:

sk, in strict cash accounting, you would book the expense when you purchase the gas and book the income when you sell it. ...If you saw financials with a loss for the cost to build in year 1, then a profit in year 2 for the entire price of the house, that wouldn't really tell you what's going on.
lama


So it DOES have to synchronous in accrual accounting then ! whereas it needn't be so in cash accounting. Right ? That concept, the concept of synchronous seems to be a key differentiator between cash and accrual accounting. I do need to adjust my mental picture then.

Sorry about belabouring the point.

-K
sk | Homepage | 01.19.08 - 12:48 pm | #

Dave writes:
I have a couple questions to ask. I'm not nearly an expert in this stuff as many of you are, so please bear with me.

Why are lenders just allowing short sales and writing off HELOCs without making more efforts to recover some the losses from the borrowers through asset siezure?

Yes, that is kinda hilarious given that just about everything people have these days is leased or loans but...

Whatever happened to wage garnishment by the courts to repay debt?

Clearly many of these people still have jobs earning income and can easily take a 10% hit now that they are effectively renters and don't have the big mortgage anymore.
Dave | 01.19.08 - 12:49 pm | #

Racer X writes:
Excellent!
Racer X | 01.19.08 - 12:49 pm | #

sysadmin writes:
Yo rich - Here is a MBI bond buyer at the offer (last couple paragraphs)

http://www.minyanville.com/artic...I/index/a/ 15524

Not that I am any brighter - closed my mbi and abk bearish positions Weds. Ugh.
sysadmin | 01.19.08 - 12:49 pm | #

JKB writes:
Tanta: "Old farts like me "write" mortgages. The young ones "do" them or "make" them. "

Could all the young ones "doing" mortgages be why so many people feel they've been screwed in recent years?
JKB | 01.19.08 - 12:50 pm | #

Tanta writes:
As an aside perhaps the schedules aren't available to me since there might be trade secrets( which customer bought a lot etc ) discernible in there - or even, as my jaundiced mind would note, some shenanigans to be discerned by looking for the devil in the details ?

The kind of "schedule" Lama is talking about here is the equivalent of the cash register tape for every gas sale the gas station did in a quarter. Would you want to see that level of detail in the financial statements? No. You have auditors for that.

There's nothing sinister about this reference to a schedule. The "schedule" is basically "the books." If we were doing cash-basis accounting, that'd be that. But since we're doing accrual accounting, those schedules don't just get summed up and totaled on the balance sheet.

I can promise you there are no "trade secrets" in a mortgage general ledger.
Tanta | Homepage | 01.19.08 - 12:51 pm | #

dunham writes:
OT: Rich,

I think Tuesday might be ugly, as market looked poised for a selloff yesterday afternoon, just held back by Op Ex. I believe historically, the day after a long weekend often continues the trend as well.

Rest of month I am looking out for a rally as well.
dunham | 01.19.08 - 12:52 pm | #

rich writes:
What the bond insurers need isn't a bailout but a referee. Somebody has to parcel out their assets so that it's fair to all insured parties.

For example, let's say the total projected losses on all insured bonds and counterparty guarantees is $200 billion. But the insureds only have $50 billion of combined capital. So, the payout would be 25 cents on the loss dollar. You can't just let the first-to-fail grab all the capital. Regulators want to make sure there is something left for muni bonds that fail in the future.

The referee will be the NY State Insurance Commissioner, and it will work best if all bond insurers are consolidated into the same receivership process under him.

If you are a workout lawyer and you want good work for a long time to come, move to Albany.
rich | 01.19.08 - 12:57 pm | #

ugh writes:
OT but really important.

Did that monoline raise their capital? They had until midnight last night.

CR, Tanta, anyone?
ugh | 01.19.08 - 12:59 pm | #

Tanta writes:
Ummmm, "have to" or "are supposed to?"

Look, that's the whole point of the LOCOM rule (lower of cost or market).

No, I can't say that nobody is flagrantly violating accounting rules. You can't say they all are.

But this is a very clear one. There are jillions of situations of shades of gray in this business, but not when it comes to taking a mortgage loan out of HFS and into HTM. The reason the rules are so clear here is that back in the really bad old days before the thrifts blew up, that crap did go on. Your investment portfolio became a place to hide losses. And since there was no penalty for moving a loan into the portfolio, there was an inclination not to hedge the HFS pipe enough or at all. We used to call that the "FDIC Hedge." Or "running naked and letting the FDIC pick up the tab if it doesn't work."

So this is one of those things that would be a very "flagrant" violation if someone ignored it. You can get into arguments all day long about reserve levels and forecasts and stuff like that. But no auditor is going to let you dump the HFS into the HTM in a down market without a LOCOM adjustment unless they want to go to jail.
Tanta | Homepage | 01.19.08 - 1:00 pm | #

lama writes:
The schedules themselves are not sinister. It's the assumptions used to calculate the asset valuation adjustments that might be called sinister (or hilarious, depending on your point of view).
lama | 01.19.08 - 1:00 pm | #

Anonymous writes:
Re: net present value of what you think you will collect. Unless you think the collateral is really worth $0, you don't write the loan down by its principal amount. You would estimate recoveries in foreclosure, and write down to that.

Assumptions and discretion dressed in the clothing of false and misleading lies and FASB helping accountants hide the truth.

All hail to Enron and FASB solutions for better accounting
Anonymous | 01.19.08 - 1:01 pm | #

leeraconteur writes:
Where is FFDIC's comment on the FDIC hiring?
leeraconteur | 01.19.08 - 1:03 pm | #

Anonymous writes:
Re: The Securities and Exchange Commission is sending out examination letters requesting information from mutual-fund companies about how they value and assess their money-market fund holdings."

IMHO, I think the SEC will ignore the reality that a lot of mutual funds and money markets are disguised as hedge funds and that they are at the extreme limits of accounting fraud.
Anonymous | 01.19.08 - 1:04 pm | #

sk writes:

Did that monoline raise their capital? They had until midnight last night.

ugh


No answer to that from me and you won't see it in SEC filings either - I just looked - they filed a 15-12b on 1/16, which is a suspension of duty of file, and the reason is they now have only 61 shareholders of record - the threshold is 300 I seem to recall.

-K
sk | Homepage | 01.19.08 - 1:07 pm | #

quartz writes:
I am pretty impressed by that pig's tail!

As fascinating as accrual is, I have an off topic question for the sports fan out there.

A fair amount of ink has been expended regarding the Treasury mortgage freeze about how it rewrites the contract with investors who now will not the get the interest income they are entitled to when rates adjust. What I wonder is just how much of that interest did they actually expect to earn?

Let's take as an example the 2/28s. While I acknowledge that anecdote is not evidence, there is strong appearance that these mortgages were designed to be refinanced at reset. Certainly, many of the borrowers claim that that is what they expected to do based on the advice of their brokers/lenders/realtors. The prevalence of pre-payment penalties may argue against that, but I think the expectation of the lenders/brokers would be that these would rolled into the new loan and provide some gravy to the lender.

My question is, do we know what assumptions were made about pools of these loans, when either held for investment or securitized? What were the assumptions about how many would prepay, i.e. refinance, and how many adjust to higher rates, and again how many would prey at 2nd, 3rd, or fourth adjustments? What percentage of these folks did investors truly expect to be paying a a double digit interest rate over the course of several years? I assume such assumptions needed to be made to price them, as well as assumptions about future interest rates. Were these supposed to be shorter term investments, that are turning out to be longer term investments as borrowers are unable to refinance and thus prepay?

Of course there is no one answer for what exactly investors/lenders were assuming other than houses would continue to appreciate, but presumably their models had t had to start wit some basic assumptions, and I wonder what some of those consensus assumptions were.
quartz | 01.19.08 - 1:07 pm | #

lama writes:
sk, you've got it. One more thing, you can manipulate cash accounting as well. Having a good year? Don't want to share it with the IRS?? Just buy several months worth of stuff at the end and pay for it all on Dec 31st. Poof, there goes your income.
This is why the IRS requires some business types to be accrual based taxpayers.
lama | 01.19.08 - 1:07 pm | #

dr strangemoney writes:
I went ahead and booked all the knowledge in this post. Haven't read the entire thing yet though. I may have to restate some of my comments at some point in the future.

You shall accrue what you sow.
dr strangemoney | Homepage | 01.19.08 - 1:11 pm | #

lama writes:
quartz,
The accounting valuation would be based on defacto or assumed outcome, not the letter of the note. If the bank would expect a prepayment on 50%, they would book those loans as such. They would likely have to wait until the borrower actually prepaid to book the income on prepayment penalty. Conservatism...defer revenue, book future losses now.
lama | 01.19.08 - 1:14 pm | #

Tanta writes:
Gary: ignore.
Tanta | Homepage | 01.19.08 - 1:14 pm | #

J. Michael Neal writes:
This blog rocks, but I still can't get over the fact that I'm reading about accounting on a Saturday Morning.

It's a good warm up for me. The new semester starts on Tuesday. Having failed a couple of the actuarial exams in the fall (which I will be retaking at some point), I decided to add accounting to my list of things I can fail tests on. So, it's Introduction to Managerial Accounting on Tuesdays, Intermediate Financial Accounting on Wednesdays, and Insurance: Theory and Practice on Thursdays.

Don't my next 17 weeks sound thrilling?
J. Michael Neal | Homepage | 01.19.08 - 1:17 pm | #

John Stark writes:
While we're at it, can someone explain the whole M1 and M2 thing that some people on another thread were fretting about yesterday?
John Stark | 01.19.08 - 1:17 pm | #

sk writes:

Don't want to share it with the IRS?? Just buy several months worth of stuff at the end and pay for it all on Dec 31st. Poof, there goes your income.
This is why the IRS requires some business types to be accrual based taxpayers.
lama


I got reminded about this once upon a time when the software budget at company X, department Y, was wayy underspend and as April approached, I was really pressuring the DEC saleman to bill me NOW - we'll take stuff later. To his credit, he refused and as I told him about the calumni that will descend upon him, the secretary told me - "Errr. I think its illegal" - not the calumni but the "pay now buy later" concept.

I did get round it - interdepartmental stuff can be innovative but...

Of course, DEC did decline and fall in the end - though I'd like to think it was technology missteps not the honesty of their staff that caused it.

-K
sk | Homepage | 01.19.08 - 1:18 pm | #

Anonymous writes:
GOVERNOR SPITZER LEADS FIRST MEETING OF COMMISSION TO MODERNIZE REGULATION OF FINANCIAL SERVICES

http://www.ins.state.ny.us/press...08/ p0801181.htm
Anonymous | 01.19.08 - 1:18 pm | #

lama writes:
sk, those big companies' departments work like government entities sometimes. Use the budget or lose it. I've shipped defects off at year end. I booked a credit to "Due to Customer" instead of a credit to Revenue on that transaction.
lama | 01.19.08 - 1:23 pm | #

lama writes:
I have to go out. Hope some of that made sense. Thanks for the help on responses Oh Great One.
What's next? Statement of Cash Flows?
lama | 01.19.08 - 1:25 pm | #

jim writes:
Write-downs reflect current estimates of future losses. The actual future can't be written down today because its not yet known (think ARM resets over the next 6 months). So the write-down process must proceed in stages. Those who are impatient with this must be impatient that the future hasn't arrived yet.
jim | 01.19.08 - 1:27 pm | #

bacon dreamz writes:
Thanks for the help on responses Oh Great One.

hey, no problem!
bacon dreamz | 01.19.08 - 1:30 pm | #

Gary writes:
I'll behave.
Gary | Homepage | 01.19.08 - 1:36 pm | #

tg writes:
Those freaking greedy saver's. Must be some way to ding them to recapture those costs.
tg | 01.19.08 - 1:49 pm | #

doc holiday writes:
Re: Some of you--bless your lovely hearts


Thanks for thinking of me dude!
doc holiday | 01.19.08 - 1:51 pm | #

dr strangemoney writes:
sk: Of course, DEC did decline and fall in the end - though I'd like to think it was technology missteps not the honesty of their staff that caused it.

It's called hubris. Sure, their shit was tight but times change. Suddenly they're just a bunch of bankrupt punks. Happens all the time. They were hurt pretty hard by the latest newcomer-come-deadbeat Sun. Next up Oracle, then Microsoft. Go ahead and pat yourself on the back while I'm eating your lunch. Free Lunch in the corporate cafeteria! Yum.
dr strangemoney | Homepage | 01.19.08 - 1:57 pm | #

David Pearson writes:
OT on a government bail out of bond insurers (as proposed by Jim Cramer and others):

These guys don't understand what the RTC was all about. First, the government already backstopped the thrifts through the deposit insurance system. In other words, the commitment to bail out DEPOSITORS existed prior to the crisis -- legislation just had to deal with the best way to go about this. Second, the RTC existed to dispose of collateral backing mortgages. Its goal was to maximize the recovery of written-off assets, not to avoid writing off assets.

Fast forward to today. There is no government commitment to the holders of insured debt. Imagine Congress creating that commitment! Sure it could be done, and if I were a Congressman I'd saddle the legislation with as many other commitments, bail outs and other "goodies" as I could imagine in my crafty little head. Not a can of worms we want to open.

More important, the path to disposition of the collateral backing insured bonds is a thorny one. Imagine an RTC entrusted with maximizing recovery on defaulted ABS-backed CDO's. Where do you start? Tanta? I'm not sure I even want to imagine that process.

The fact is the private markets can already purchase the "good" (i.e. muni) commitments from the bond insurers. All you need to do so is a triple A rating, and Berkshire has it. What about the "bad" commitments? These should be written off by the insured: i.e., they should recognize that insurer capital is (and always was!) insufficient to cover defaults, and the insurance is worthless. The insured should reflect the CDO's as part of their "net" exposure and disclose it to investors. Next, they should mark the exposure down. It is that step that Cramer so desperately wants to avoid.

And if you think its difficult to bail out bond insurers, imagine the even larger bail out that is necessary for undercapitalized CDS writers -- I'm talkin' about the hedge funds!
David Pearson | 01.19.08 - 1:57 pm | #

doc holiday writes:
As someone that like fine print, I'd like to know if The Pig ever had long pants?

Re: ... done the same way since The Mortgage Pig wore short pants
doc holiday | 01.19.08 - 1:58 pm | #

Rob Dawg writes:
Do any of the uberbrains here have anything to say about changes in maturity assumptions for the HTM portfolios? Average maturity was at one time in the low teens and more recently was in the 7-8 year range. What's been happening there?
Rob Dawg | Homepage | 01.19.08 - 2:03 pm | #

Misean writes:
dr. strangemoney,

"They were hurt pretty hard by the latest newcomer-come-deadbeat Sun. Next up Oracle, then Microsoft. Go ahead and pat yourself on the back while I'm eating your lunch. Free Lunch in the corporate cafeteria! Yum."

Go Go Google aps.

Cheers,
Misean | 01.19.08 - 2:06 pm | #

Ken writes:
Any chance we could get an UberNerd (or GuestNerd) post on accounting for CDS and couterparty risk? I keep reading articles with numbers in the form "$XX billion of [toxic waste], net of CDS" and am wondering what might happen if, e.g. one major player in CDS game is asked to pay off but can't. Did those bearish hedge funds that made 7000% return last year actually get paid, or are they simply holding IOUs that nobody will be able to make good on?
Ken | Homepage | 01.19.08 - 2:09 pm | #

Misean writes:
This post is making my brain hurt. I never did dorm room accounting geek talk whilst passing the bong around...although I know those who did.

I preferred the Star Wars/Star Trek rooms. Probably why I switched from accountancy/finance to economics/finance. It made it easier. I did not have to try to quantify fantasy.

Cheers,
Misean | 01.19.08 - 2:12 pm | #

dr strangemoney writes:
David Pearson: There is no government commitment to the holders of insured debt. Imagine Congress creating that commitment!

If it happens I will be stunned, but I won't be surprised. Can we get a blog tagline?

Calculated Risk
Always Stunned, Never Surprised.
dr strangemoney | Homepage | 01.19.08 - 2:20 pm | #

Tanta writes:
Can we get a blog tagline?

How about, "We're all Insured Now."
Tanta | Homepage | 01.19.08 - 2:21 pm | #

dr strangemoney writes:
Tanta: How about, "We're all Insured Now."

How about, "We're all Insurers Now."
dr strangemoney | Homepage | 01.19.08 - 2:23 pm | #

risk capital writes:
How bout-

"when your counterparty fails"
risk capital | 01.19.08 - 2:23 pm | #

Misean writes:
"Can we get a blog tagline?"

Bring out your dead.

Cheers,
Misean | 01.19.08 - 2:28 pm | #

risk capital writes:
stock lending and your counter party-

"Should cash have to be returned the lenders face the possibility of having to liquidate positions and potentially realize losses on positions that have been devalued as a result of the credit crunch."

http://www.institutionalinvestor.com/
risk capital | 01.19.08 - 2:29 pm | #

mp writes:
Great work, all of you! The CR Team is a never-ending learning experience.
mp | 01.19.08 - 2:31 pm | #

risk capital writes:
Big, yellow, rubber ducky award to the person that can name the largest stock lenders.
risk capital | 01.19.08 - 2:31 pm | #

dr strangemoney writes:
risk capital: To me that sounds more like a magazine article. Nice and scary... jumps out at you while in line at the supermarket. The summer blockbuster is Counterparty. Next summer, it's something lighter... Counterparty 2 starring Chris Rock and Alan Greenspan as odd-couple Fed Governors with comically different styles of regulation.
dr strangemoney | Homepage | 01.19.08 - 2:33 pm | #

Zigurrat writes:
David:

Good post.

It isn't exactly analogous, but there were calls for a bailout of holders of insured mortgage insurers in the 1930's. The result was not a bailout of either the insurers or bondholders but rather a structure led by the New York insurance department to manage the liquidation in an orderly fashion. There are links in the NY Times archives, but it is a paid subscription (I do the puzzle on line so get 100 free hits/month). Although it isn't expecially useful -- I find it fascinating.
Zigurrat | 01.19.08 - 2:35 pm | #

risk capital writes:
strangemoney-

(:- chris rock and ag

the strangest relationship I have seen is Cramer and Spitzer, this reminds me of Jesus and the Anti-Christ warming up as bedfellows.
risk capital | 01.19.08 - 2:39 pm | #

dr strangemoney writes:
Zigurrat: Have you seen Wordplay, the crossword documentary? Good movie.
dr strangemoney | Homepage | 01.19.08 - 2:41 pm | #

doc holiday writes:
OT regarding:

credit analysts^reserves^estimates, HTM, HFS (what about held for investment?), etc, and all the great blog efforts there which are great


Any thoughts out there on BOA & Countrywide and how that accounting deal will shake out? The market thinks BOA overpaid, even with tax loopholes; what think?

Re: There appeared to be a big obstacle for a Countrywide takeover after the Federal Reserve approved Bank of America's acquisition of LaSalle in September. The combined bank grew to hold 9.88% of the country's deposits. Federal law prohibits a bank-holding company from controlling more than 10% of U.S. deposits after acquiring another bank.

But the law includes an obscure caveat: The 10% limit doesn't apply to federally chartered thrifts, meaning a bank-holding company may control more than 10% of deposits in the U.S. following a thrift acquisition. Since a Countrywide subsidiary called Countrywide Bank is a federally insured thrift, that may give Bank of America room to maneuver around the deposit cap.

Bank of America is the only bank that has ever neared the 10% deposit cap. Many seasoned banking attorneys were not familiar with the caveat, as no bank has ever tried to acquire a thrift to vault above the 10% limit.

"This could be the biggest loophole in the world," said Gilbert Schwartz a partner at Schwartz & Ballen LLP and former Fed attorney. It was unclear when or how the loophole first became known to the banks.

http://futurerealestate.blogspot...escue- deal.html
doc holiday | 01.19.08 - 2:44 pm | #

Zigurrat writes:
" accounting for CDS and couterparty risk?"

I would be interested in hearing from an expert. There is material on the BIS website. http://www.bis.org/about/index.htm

Their technical stuff is readable and they seem to be ground zero for counterparty issues.

"a prime counterparty for central banks in their financial transactions
agent or trustee in connection with international financial operations"
Zigurrat | 01.19.08 - 2:44 pm | #

Tripleplay writes:
Re Taxpayer bailout of bond insurers, I will paraphrase A WSJ article about W. Buffet's takeover of a Reinsurer.

"It took four years to whittel the business from 23,218 contracts (swaps & deritatives) to 197.
Doing so involved tracking down hundreds of counterparties including a Finland bank and a small loan co. in Japan. One contract was designed to run for 100 years.
We lost over 400 million on supposedly safe and properly priced contracts. If we had to do it in one month, who knows what would have happened?"

This taxpayer is terrified of a bailout which no one has any idea of the final bill.

.
Tripleplay | 01.19.08 - 2:47 pm | #

Rob Dawg writes:
Calculated Risk, home to:
The Counterparty Party
Over 114 billion served since 2007
Rob Dawg | Homepage | 01.19.08 - 2:49 pm | #

Zigurrat writes:
Dr. Strange...

Wordplay was a really great movie. Probably the best film I saw last year.

I'm a total amateur at puzzles, and by thursday am in over my head.
Zigurrat | 01.19.08 - 2:53 pm | #

doc holiday writes:
Tripleplay,

I posted a bunch of stuff in the comments board (parade of writedowns story) yesterday related to the following, which is well worth reading:

Introduction
The failure of Penn Square Bank, N.A. (Penn Square), Oklahoma City, Oklahoma, still
ranks as one of the Federal Deposit Insurance Corporation’s (FDIC’s) most publicized,
most difficult, and most colorful bank resolutions. Penn Square failed July 5, 1982, with
$470.4 million in deposits and $516.8 million in assets. By aggressively making large
and speculative loans, especially to the oil and gas industries, the bank had grown from
$62 million in assets in 1977 to $520 million in assets by mid-1982.1 Penn Square then
sold majority interests in those loans to other banks (in the form of loan participations),
but retained the responsibility for servicing the entire loan amount.2 At its failure, Penn
Square was servicing approximately $2 billion in loans.

http://www.fdic.gov/bank/histori...ori...history2- 03.pdf
doc holiday | 01.19.08 - 2:54 pm | #

sportsfan writes:
"OT on a government bail out of bond insurers (as proposed by Jim Cramer and others):

These guys don't understand what the RTC was all about. . . . "

Oh, I think they do. They (in the rantings of Cramer) just want to see their own version of corporate socialism adopted.

He might as well be saying: "Losses are fine so long as they are the other guy's losses. When my book is hurting, the government needs to step in and cover my losses."

But, since socialism doesn't sell well here, we need a major impending event to prompt the desired action and that is the financial meltdown that will occur if mortgage insurers go BK and some banks fail as a result.

Well, excuse me, but I think we need to muddle through this problem without the government absorbing private losses in the process.
sportsfan | 01.19.08 - 2:55 pm | #

Zigurrat writes:
Doc....

Penn Square was a real mess. There was a great book by Mark Singer on it titled 'Funny Money'

For deep background, I like the BIS publication, Bank Failures in Mature Economies.

http://www.bis.org/publ/bcbs_wp13.pdf

Interesting section on earlier subprime problems.
Zigurrat | 01.19.08 - 3:00 pm | #

Zigurrat writes:
The thing I can't understand about counterparty risk on CDS's is why there isn't a system to disclose them and to compare the valuations.

You can have disclosure without regulation. The biggest problem being, in my opinion, the lack of anything close to mirror accounting. Both parties to a transaction can book an immediate profit, and probably do. The aggregate impact of this would be to overstate profits and capital.
Zigurrat | 01.19.08 - 3:06 pm | #

Hank Roberts writes:
From a long time ago, a foreshadowing:
http://diswww.mit.edu/picayune/r...yune/risks/ 1011

Barnaby J. Feder, Sophisticated software set for exotic financial
trades, New York Times, 30 March 1993, pages C1, C5.

This article concerns "a marriage made in techno-geek heaven" between computer people and high finance, specifically software for analyzing and administering complex financial transactions based on so-called "derivatives" (see Risks 15.66). ... such systems allow derivatives to be traded in much larger volumes, and in much more complex ways.

.... The potential trouble comes when massive financial edifices are engineered badly.

When a steel-and-concrete building falls down, the earth is there to catch it and a limited number of people get killed.

But that's not how financial engineering works -- one collapsing structure has the capacity to take others down with it (again, see Risks 15.66). Obviously it's in their interest to be careful, but let's hope they know what they're doing.

Phil Agre, UCSD
Hank Roberts | 01.19.08 - 3:12 pm | #

Zigurrat writes:
http://www.bis.org/publ/cpss77.htm

Since the publication by the BIS in 1998 of a report on OTC derivatives: settlement procedures and counterparty risk management, the markets for OTC derivatives have continued to expand and develop rapidly, while risk management practices have evolved and significant changes in market infrastructures have occurred.

In early 2006, the CPSS set up a Working Group, comprising representatives of its member central banks and prudential supervisors of major derivatives dealers, to analyse existing arrangements and risk management practices in the broader OTC derivatives market and evaluate the potential for risks to be mitigated by greater use of, and enhancements to, market infrastructure. This project complemented an earlier supervisory initiative that at the time was focused primarily on confirmation backlogs in the credit derivatives markets.

The Working Group conducted interviews with some 35 major dealers in OTC derivatives in the G10 countries and Hong Kong SAR. It also met with industry groups and providers of post-trade processing services. Finally, upon completion of the report, it discussed its findings in a roundtable with these entities.
Zigurrat | 01.19.08 - 3:13 pm | #

Peconic Bay writes:
Simply the best thread ever! Thanks Tanta and Lama for a virtuoso performance.

I was contemplating nibbling on some financial stocks next week, but given the unknowns on the balance sheets, I think I'm going to wait until later in the year after the majority of resets come into play.

Best to all,
Peconic Bay | 01.19.08 - 3:22 pm | #

barely writes:
Really, the entire NegAm arrangement was a disaster just waiting to happen, and it's the SEC's fault -- Post Enron. Today we have a condition where there is still a cushion unter the recast cap and already deep underwater loans are piling on more NegAm accrued interest that will never be repaid.

In fact, booking this accural as earnings should not be permitted at all. There should be some other accounting treatment. An interesting parallel is PoC accounting, done in large construction projects and then used liberally elsewhere when executives found it a convenient way to sell their options at inflated values. Basically it's possible to book unbilled revenues as earnings. It's not too tough to spot as cash flows go massively negative.

Look at EDS in ~2003. They eventually had to re-state prior earnings and take massive writedowns when it became clear they would not be able to collect. The same should happen to OptARM specialists... IMB, DSL, FED... Their cash flows will never improve and they'll end up in receivership IMO.
barely | 01.19.08 - 3:27 pm | #

sk writes:

I'm a total amateur at puzzles, and by thursday am in over my head.
Zigurrat


OK, here's some reward for educating me:

Retaliatory celebrations amongst the troupe ? Definitely ahead (3,12,5).

-K
sk | Homepage | 01.19.08 - 3:33 pm | #

Racer X writes:
J. Michael Neal don't feel too bad. My wife just got her FSA last year. She'd never failed an exam in her life but she failed 200.
Racer X | 01.19.08 - 3:37 pm | #

bacon dreamz writes:
Can we get a blog tagline?

Calculated Risk: Embrace Your Inner Nerd...
bacon dreamz | 01.19.08 - 3:43 pm | #

doc holiday writes:
Hank and Zig, anyone, Tanta, et al

Pension reform and computer modeling and obviously risk management and accounting, ok... false and misleading discretionary adjustments, collusion....I know, no one cares, but look at a link if you have 10 seconds:

http://www.dol.gov/ebsa/regs/fed.../ 2007011885.htm

Hearing on Computer Model Investment Advice Programs for IRAs [06/20/2007]

Re: After carefully reviewing the information received to date, the
Department has decided that it would be beneficial to solicit
additional information by means of a public hearing.

(however): The Department is also interested in knowing whether the scope of
relief from ERISA's prohibited transaction provisions afforded by the
statute is adequate to facilitate the use of computer-based programs
for IRAs should the Department determine that such programs are
feasible.

Attention: Computer Model Investment
Advice Programs For IRAs--Hearing.


Ok then, the heart of this matter, for those out of the loop, is the connection between DOL and the forces of evil, AKA >>> "underwriters" that are granted on-going exemptions relating to prohibited transactions...its a very long story, but it is worth time and of course, not related or on topic here.

Zig, thanks for those ideas above!
doc holiday | 01.19.08 - 3:45 pm | #

cactus_pocus writes:
OT:

did anyone see Maria Bartiromo a few days ago in the Tonight Show with Jay Leno talking about housing bubble busting, dollar sinking, Sheiks buying US companies.....

all of it while wearing a really clingy red dress and um ... no bra?
cactus_pocus | 01.19.08 - 3:47 pm | #

Gary writes:
Ain't no party like a counterparty 'cause a counterparty don't . . . oh, crap.
Gary | Homepage | 01.19.08 - 3:58 pm | #

FFDIC writes:
Richard Suttmeiers Weekly email arrived a moment ago.
"The Regulators of the Finance Sector are Running Scared" (to put it mildly IMO)
"The FDIC has stopped providing timely data on the condition among the 8,560 FDIC-insured financial institutions. (I'm not aware of this other than FDIC's typical bag of examiner tricks-of-the trade. Anybody have details?) Banks are heavily exposed to higher loan loss provisioning. (Old news) How will the FDIC administer a tsunami of bank failures, which are highly likely over the next two years? (That has been my main question for well over a year. Staffing is low due to FDIC RIFS and retirements.) Remember that president Bush told the public that the government will not bail out lenders. (Flip-flop!)"

"FDIC Chairman Sheila Bair in a speech given at a Bear Stearns Conference on Thursday. The FDIC Chair told the audience that housing starts are sinking, the unemployment rate is going up, and the risk of recession is clearly rising. (Old news.) Foreclosures are on the rise in communities across the country. (More old news.) With falling real estate values, refinancing is not an option. (Ditto.) The number of resets is simply way too big for the industry to handle one-by-one. (As Dennis Hopper says - YOU NEED A PLAN!)"
Wikipedia: Dennis Hopper:
http://en.wikipedia.org/wiki/Den...i/ Dennis_Hopper
FFDIC | 01.19.08 - 4:09 pm | #

FFDIC writes:
Reuters - Recession creeps across U.S. Midwest states
http://www.reuters.com/article/b...18? pageNumber=1
FFDIC | 01.19.08 - 4:22 pm | #

FFDIC writes:
FT - Calm surface disguises turmoil beneath (Good/bad article about ACA Capital)
http://www.ft.com/cms/s/0/ 0976af...00779fd2ac.html
FFDIC | 01.19.08 - 4:29 pm | #

FT Woods writes:
After a three year investigation, DOJ decided to drop the case against GenRe in July. Political interference? Who knows. I keep wondering: do the latest reinsurers have similar side letter agreements as those used in GenRe?
FT Woods | 01.19.08 - 4:33 pm | #

Gary writes:
Off topic, but I still can't understand why anyone would invest in an investment bank. I recall thinking this for the first time about a decade ago, watching first Bank of America and then Fleet regret buying Robertson Stephens.

The employees demand obscene bonuses. Never take a hit when there are losses (from their previous bonused work), and then bolt to another firm at the first sign of pain.

Great to be an IB, bad to invest in one.
Gary | Homepage | 01.19.08 - 4:37 pm | #

Eric writes:
Having skimmed through these posts, I have concluded that Doc Holiday is talking to himself and calling himself Zigurrat. There are medications for that sort of thing nowadays.
Eric | 01.19.08 - 4:49 pm | #

Where's T_8 writes:
status check....

How u doin?

Gonna tell us who you are now?

Are you Ken?

or , how is Kfisher doin?
Where's T_8 | 01.19.08 - 4:53 pm | #

Aheadofthecurve writes:
To those who don't want government involvement:

1. We are getting it right now except it's from the governments of Kuwait, UAE, Singapore, China, etc. These entities are not accountable to their own citizens, let alone US citizens. All in all, if the banks are insolvent and need a government takeover, better it be by the US government, which is at least marginally accountable. Keep in mind, that the government can take equity positions that someday when the banks are back on their feet could actually be sold off at a nice profit for the Treasury.

2. When discussing bailout costs keep in mind the costs of serious economic dislocations to the Treasury-lower tax revenues from wages, capital loss write-offs for businesses and individuals and higher payments for unemployment, welfare, etc. I would prefer an out and out bail out to this bogus fiscal stimulus. Even a trillion dollar bailout would be money better speant that the disgusting mess in Iraq. Moral hazrd can be dealt with through the criminal law. The fat cats fear jail more than they fear getting fired.
Aheadofthecurve | 01.19.08 - 5:07 pm | #

FT Woods writes:
Speaking of reinsurance...earlier this week:

Florida Insurance Commissioner Suspends ALLSTATE Insurance CO.

Today's decision by the commissioner follows Tuesday's action when he abruptly halted the scheduled two-day hearing into the Allstate Companies’ reinsurance program, their relationships with risk modeling companies, insurance rating organizations and insurance trade associations.

ZackAttack writes:
OK, that does it. I gotta have a Mortgage Pig t-shirt.
ZackAttack | 01.19.08 - 5:18 pm | #

RThomas writes:
Re Cramer's call for a bail out of monolines. Three weeks ago he advised underwater borrowers to walk away from their mortgage loans. Now he's begging for a government bailout of his wall street cronies. The man is insane.

Re post. As a hungover former bank accountant/auditor now retired 5 years, I can only say Ugh! I thought I'd never have to read this stuff again.
RThomas | 01.19.08 - 5:22 pm | #

mp writes:
OT

Chris Burba, Standard & Poors- "Any multiday or near-term upturn should be considered as an opportunity to liquidate any long-term bullish positions and initiate bearish positions in securities that pace the broader market," Burba wrote.

Go Bears!

http://www.businessweek.com/inve...htm? chan=search
mp | 01.19.08 - 5:22 pm | #

Gary writes:
Professor Krugman:
The real sin, both of the Fed and of the Bush administration, was the failure to exercise adult supervision over markets running wild.

It wasn’t just Alan Greenspan’s unwillingness to admit that there was anything more than a bit of “froth” in housing markets, or his refusal to do anything about subprime abuses. The fact is that as America’s financial system has grown ever more complex, it has also outgrown the framework of banking regulations that used to protect us — yet instead of an attempt to update that framework, all we got were paeans to the wonders of free markets.
http://www.nytimes.com/2008/01/1...c507&ei=5087% 0A
Gary | Homepage | 01.19.08 - 5:33 pm | #

Jas Jain writes:
Moral Corruption & Bigotry In Accounting

People, or groups within a broader society, become aware of their environment and how it may affect them and they learn to deal with it or adapt to the reality as best as can.

I became aware of certain reality that I was completely unaware of until 1998 when my son and his friends were to graduate and start looking for jobs. My son’s best friend back then and now is a Pakistani (98%+ are Muslims as is he). There were also some other Pakistanis in the class. What was known to many was that persons of certain ethnicity would have little problem getting a job with the firms they wanted to work for and persons of certain ethnicity would have very hard time getting jobs at certain firms, especially, the Big Six (or it could be soon after it became Big Four). My son interviewed with Arthur Andersen and got an offer AQAP, fully expected, which he accepted. But, his best friend, almost as good in accounting but brighter than my son, didn’t think that he would have a chance so he was not going to waste is time applying for the Big Six/Four. Some professors, as it turns out, were also aware of the problem. One of them, a white Christian woman, called my son’s best friend and asked him to apply to Big Six of his choice (more than one if he wanted) before the campus recruiters come and she will make sure that he gets interviewed. Then she called people (I assume her former students) at Big Six and pressured them to interview this guy and make him an offer (he was that good, easily in top 2%). He did apply to Arthur Andersen and Delloite and did get an offer, a bit late, which he also accepted. But, it took a conscientious person with knowledge of the problem and willingness to intervene to get the “justice” done in one case. The other Pakistanis didn’t apply to the Big Six or any of the firms with certain names.

Everyone knows what later happened to Arthur Andersen. My son left when the firm was dissolved and had no problem finding another job. The Pakistani went on his own and is doing extremely well. I still have Arthur Andersen T-Shirt and sweatshirt that I wear occasionally.

BTW, do you know who came up with the ideas, or “schemes,” that Arthur Andersen recommended to its clients, including Enron? Bankrupters and Fraudsters of New York City! Most of the schemes originate in the real sin city in America – NYC. Even the supposed sin city is dominated by the former “Gangs of New York” and Gangs of Los Angeles, which were transplants from New York City. Las Vegas’s politics and the main business is dominated by these gangs who took control.

In our economic system, accounting is the barrier between morality and immorality when it comes to finance. The stock market was turned into the Scam Market because of the forced compromises that were made by accountants under political pressure.

The financial and gambling, or “entertainment,” gangs that dominate NYC, Vegas, Boston, LA, etc., will destroy Am
Jas Jain | 01.19.08 - 5:38 pm | #

Anonymous writes:
FT Woods,

IMHO & limited opinion, I think buffett is among the biggest cons out there was his non-derivative infinite/reinsurance complexity, linked to his shareholder interest in bond rateing agencies and now going to open his own rating agency; very suspect stuff and with $33 billion in goodwill, his company can not rely on his ahh shucks, Im just a small town boy and Charlie and I got lucky routine fit for the very finest of snakeoil sales pitches!
Anonymous | 01.19.08 - 5:41 pm | #

David Pearson writes:
Ahead of the curve,

Why is it that bail out plans have such damned attractive logic? What makes them so hard to argue against?

They are like gravity. You're a liquidationist, in a stable orbit, minding your own business and expecting others to mind theirs. Then you feel the first tug. Before you know it, you're accelerating, then hurtling, towards the sun.

"Do you really want all those people to lose their jobs? What would be the point?"

Uh, well, no, I don't want those people to lose their jobs, but why should we bail out Jim Cramer's friends?

"This can't be about moral hazard. People's livelihoods are at stake! We'll deal with moral hazard later."

Uh, well, I guess we could help out some subprime borrowers. You know, ones that might lose their homes.

"No, no, no. Not enough. We have to rescue to bond insurers. Its all about the bond insurers! If you don't rescue the bond insurers, all of us are toast."

Bond insurers? Okay, I guess, as long as we stop there.

"Stop there? What about all those hedge funds that wrote CDS? We need to buy those CDS from them. If we don't: 10% unemployment."

Hedge funds?! Aren't those rich people?

"10%!"

Well sure, no one wants 10% unemployment. So we buy the CDS, and that takes care of the...

"Consumers aren't spending! They need to spend or this'll make the Great Depression seem like a party at Paris Hilton's house. We need deficit spending, ultra-mega-low rates for savers, and, and -- I know! -- the government needs to guarantee credit card ABS and auto loans!"

And so on...
David Pearson | 01.19.08 - 5:44 pm | #

Jas Jain writes:
--
Continuation...

The financial and gambling, or “entertainment,” gangs that dominate NYC, Vegas, Boston, LA, etc., will destroy American economy, first, and then the political system that is also controlled by these gangs. It was not a surprise that the sub-prime and other toxic mortgages originated in SoCal and some of the players came from NYC, Boston, etc.

In capitalistic system one must always be on guard against financial gangs. Americans didn’t and now that must pay the price.

Well, the reason that Americans weren't on their guard is that Americans were turned into dopes with the success of the propaganda machine that began roughly a hundred years ago. With the birth of the so-called baby boomers America was turned into a Dope Factory!; hence, the term that I use -- Baby DOOMERS. They were BRED to lead to America’s doom and they will succeed. They have done all the hard work. Now, we just have to wait for the time bomb to go off. The trigger is the next depression.

Jas
Jas Jain | 01.19.08 - 5:59 pm | #

Anonymous writes:
I dont know if people here have run across examples of what I would call, circular derivative accounting as with Enron or Citi, maybe Countrywide, but some of these explanations from corporations as to how they engineer financial confusion can be entertaining, and as accounting complexity increases -- I think its helpful to understand why risk management is so important now (for investors). Some of the REITs have these diagrams, but I dont have an example off hand, and just wondered if anyone has seen a good example.

http://en.wikipedia.org/wiki/Ven...ki/ Venn_diagram
Anonymous | 01.19.08 - 6:05 pm | #

OC Smokes writes:
As a long-time lurker and learner, I just wanted to send a heartfelt thanks to the wri