Top 10 2008

As I suggested yesterday, here are some top 10 lists to end the year. If you find others of interest, please leave a comment and I will be happy to link them.

Top 10 Stupid Moves That Created This Mess

1. Securitized Debt. Call it mortgage backed securities, CDOs, CDOs squared, CDOs cubed, CDOs quadrillionthed or whatever, but the process of those underwriting the risk not keeping the risk led to, well, lots of risk. All was fine and well while housing continued to climb, or at least appeared to be fine and well. You know the rest of the story.
2. Rating Agencies. The rating agencies were being paid to rate the securitized debt and when you are paid handsomely to do something you do it. Seems the money making aspect of the process was perhaps the driver for some ratings that, at least in retrospect, were foolish at best. I don't care what tranch you are talking about, subprime mortgages, like liar loans and 100% LTV loans, never deserved triple A ratings or anything close.
3. Credit Default Swaps. Credit default swaps are to blame for AIG's demise. Otherwise they have not been the biggest player in creating the mess but may be the biggest player in cleaning it up. It would be nice to be able to let some of these players fold in an orderly fashion and support just those that survive. The problem is that the folding process will undoubtedly trigger some of the CDS contracts, which may result in taking down other entities in the process. With what was once estimated to be $62 trillion in CDS contracts in play, this is no small problem.
4. Commodity Futures Modernization Act. Try saying that five times real fast. While the act, which was enacted in 2000 in the final days of Clinton's presidency with no debate in either the House or the Senate, did various things, the key thing it did was legalize CDSs, which arguably were illegal before then. To the extent someone bought a CDS to protect them on a bond, for example, that was insurance and should have been regulated as such. To the extent the person buying the CDS had no interest to protect, they were simply betting that a company would default, which is gambling. The Commodity Furtures Modernization Act made sure CDSs did not get treated as insurance or gambling.
5. SEC. In 1975 a regulation was passed that limited the leverage certain financial institutions could take on, in relation to capital, to a 12-to-1 ratio. A few years ago the SEC provided an exemption to a handful of institutions, including Lehman Brothers, Bear Stearns, Merrill Lynch and Goldman Sachs, allowing them to go up to 40-to-1. Oops.
6. Liar loans, 100% LTV loans, option ARMS and the like. Closely tied to the securitization issue was the scope of mortgage products being made available. People could get mortgages with no or minimal documentation, with no money down, with payments that did not even keep up with interest accrual and with poor credit ratings. If you could fog a mirror, you could get a loan. Those taking out these foolish loans, on the expectation that prices would continue to rise, are as much to blame as anyone.
7. The Fed. The Fed, under Greenspan, kept interest rates too low for too long following the dot com bubble bursting. It also was a staunch advocate for deregulation and free market principles. Greenspan spoke openly on how CDSs for example, were good for the economy because the reduced risk. Having $62 trillion in obligations out there waiting for the shoes to drop is not my version of reducing risk, but to each his own.
8. Special Purpose Entities. These are orphan companies set up by a company, such as a bank of financial institution, that keeps certain assets and/or risks off of the sponsoring entity's balance sheet. Financial institutions have been able to hide a great deal of loss this way. Enron is a prime example of how these off-balance sheet entities can be abused.
9. Ben and Henry. They downplayed the problems for far too long and when they did react their plans were poorly conceived and executed. We seem to be following the Japanese play book and everyone can see how well that worked out. Throwing money at the institutions that created the problem is not helping anyone but those institutions. We would be better off to stand in their shoes and lend the money instead of giving it to them and hoping they will lend (which of course they are not doing).
10. The Shadow Banking System. You know who they are. Some of them are gone and some have had to merge. Some have now agreed to change their form and be regulated. These entities went unregulated and self-supervised for way too long and we are all paying the price. Some of the problem here is their compensation scheme that handsomely rewards large profits, even when they are earned at the expense of future stability. These behemoths should be dismantled, but instead we are supporting their attempts to become bigger. Iceland learned what happens when financial institutions get to big to fail and too big to save, but we never learn.

This is by no means a complete list but it is a nice start. Feel free to make suggestions.

Top 10 Records Set in 2008

Setting records can be a good thing or a bad thing, it depends on the record. As you might have guessed, this is a list of the not-so-nice records of 2008.

1. $30 trillion in market valuation losses. This is a very big and painful number. For the U.S. it comes at a time when baby boomers are getting ready to retire, so the timing is terrible (as if there ever is a good time for this to happen). While some of this will eventually reverse itself once the recession ends, it could take well over a decade for valuations to return overall, and certainly for many companies they never will. http://www.bloomberg.com/apps/news?pid=20601109&sid=ataVotdLreS0&refer=home
2. $50 billion Ponzi scheme. The biggest and perhaps longest running Ponzi scheme, engineered by Madoff, has come to an end, and the impacts are far and wide. This one does not even have three degrees of separation from Kevin Bacon. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=asjgOZK87JDI
3. Highest number of foreclosures ever. I hope 2008 will be the peak, but expect foreclosure activity to be high throughout 2009 and into 2010. They will be shifting from subprime to Alt-A and prime, but they will continue as housing prices decline, jobless claims rise and credit remains tight. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aRhcv8yIAheo
4. Record 18% decline in home prices. It is what it is, though this is through October, so it may not be a record for the calendar year once we know the year-end data. Still bad by any standard. http://www.monkeybusinessblog.com/mbb_weblog/2008/12/caseshiller-housing-index-decline-sets-another-record.html
5. $700+ billion in financial company write-downs and still counting. Most have predicted this will eventually exceed a trillion and some say two trillion. A trillion here and a trillion there and this starts to add up to some big money. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aRhcv8yIAheo
6. Largest bankruptcy ever. Lehman Brothers bankruptcy filing, with $613 billion in debt, was the largest ever. The 158-year-old-firm had survived the Great Depression but it could not survive 40+-to-1 debt to capital ratios.
7. Record redemptions from hedge funds. Not a biggie here except that this will impact stock prices as hedge funds have to liquidate further next year. http://www.ft.com/cms/s/7b886520-d6a2-11dd-9bf7-000077b07658,Authorised=false.html?_i_location=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2F7b886520-d6a2-11dd-9bf7-000077b07658.html&_i_referer=http%3A%2F%2Fwww.nakedcapitalism.com%2F
8. Record Oil Prices and Record Decline. Oil hit $147 a barrel earlier this year only to be followed by its biggest price drop ever. Kinda like following the bouncing ball.
9. Largest nationalization. The U.S. increased its debt load by about $5 trillion when it nationalized Fannie Mae and Freddie Mac. The irony of the bastion of capitalism doing the largest nationalization ever is not lost on the taxpayers.
10. Three-month Treasury yields below 0%. Not even during the Great Depression did rates go this low. We are effectively paying the government to keep our money. Now that spells panic.

There you have it. Not a pretty picture. For those interested, here is a nice piece by Fortune on the 21 Dumbest Moments in Business for 2008.

http://money.cnn.com/galleries/2008/fortune/0812/gallery.dumbest_moments_2009.fortune/index.html

Disclosures: None