GM announced it took a $39 B loss reserve.   But cash was not affected nor the ability to take the tax credits in the future. It seems the FASB in their wisdom came up with this sort of impairment charge. If you lose money for the same three consecutive quarters you have to write down the value of the tax credits you have. A tax credit is only valuable tothe extent of earnings.  And with no earnings, GM posted a whopping $39 B paper loss. 

This is another reason why we study accounting, to understand such requirements and how they can affect earnings or non operating earnings in this case.

Robert Samuelson takes a measure of the current economy and recessions past, not such a bad thing he surmises.

Do you know the difference between a recession and a depression?  It’s a recession when your neighbor loses his job but a depression when you lose yours…

Well click here to see the speech Mike Douglas made in Wall Street about this.

If the link does not work just go to YouTube and put in Mike Douglass Greed Speech Wall Street.

I responded in the thread to Jerry’s question about why people make loans to poor credit risks and why people borrow such money, here is my reply.

Linda Craib is entering the Yale Health Care MBA program.  Her background is strikingly similar to many or our students at UNT Dallas. Can we learn something from her experience?  I wonder what she thought lay ahead with three kids and a degree in art history. I appreciate art as much as anyone, but did she really need to major in it?

As usual Jerry Flint sees the Big Picture.  This article details recent problems at Toyota.  It seems Toyota has been virtually unstoppable, but now there are a rash of bad news events. It is nothing really major yet but..certainly the departure of some top Toyota execs to join, gulp, Chrysler, has raised eyebrows. You can read about the other details.

My point is that about the Tome the general consensus has some company or someone as unstoppable, they seem to stop.  Here are some recent examples

In 1989 everyone thought Japan Inc was going to own the world.  They did everything right we did everything wrong. Then an earthquake hit the country and the stock market went into a ten year plus slump. One hears little about Japan even today.

On the retail front here, WMT assumed Japan like Godzilla proportions.  It was speculated that WMT would soon engulf all retail buying.  Now WMT has had execs in trouble, harassment suits, and seems to be competing against itself more than anyone else. In the meantime J C Penny as arisen from its ashes and TGT continues to gain customers. 

Another example was the unstoppable Information Tech revolution.  Then the dot.coms went bust.  Tech has produced far fewer jobs than plain ole fashioned health care.

To listen to the faithful when I moved to Central Texas in 1999, all you had to do was put all your money in DELL.  Mike Dell was the Round Rock Superman, he and his gorgeous wife were everywhere and doing everything, building a 25,000 ft home, starting the Jewish Center, contributing  the Dell Diamond baseball park, hiring folks right and left, re inventing computer selling on the net, and then, Apple and HPQ struck back. Seems folks wanted to buy their computers at the store all of a sudden. Steve Jobs make Napster legal at 99 cents a copy and well look what happened.

Bill Gates was also hailed as a genius and had enough genius to quit and go into the philanthropy business.  Meanwhile Balmer has gone exactly nowhere with MSFT, does anyone want a ZUNE?  MSFT options are worthless and turnover has zoomed at the famous Redmond Campus.

No way Google was going to by pass Wall St and sell their stock in a Dutch Auction.  Today it hovers around $700.

Alan Greenspan said he was a gold watcher.  Funny now Bernake watches it at $80 as the US Dollar sinks, what happened there?

And so it goes, don’t get taken in by conventional wisdom.

Okay now that we have covered margin calls, here is where the supposedly safe idea of mortgage trading went awry.

Here is how it is supposed to work. We all deposit $1 M in the local savings and loan. The S & L makes ten $100,000 loans and ten houses are built in the community.  Then the ten loans are packaged and sold as a one million dollar round lot’ to Fannie Mae or Freddie Mac, the govt created mortgage buyers and sellers. FNM and Freddie re sell the mortgage packages to insurance companies or other individuals or institutions who collect the mortgage interest on their investments. While there are many thirty year mortgages, the average life of a mortgage is about 12 years.  Folks move and sell their homes.When that happens the mortgage is paid off in that group or tranche.  These mortgage pools can have different speeds, the length of time it takes for the mortgage to pay off.   In some communities houses turn over quickly and in others more slowly. And since the government insures such mortgages, the buyer can be assured of getting paid, that is if the mortgage package meets all the specifications.

As you can imagine everyone along the way that re packages or sells these things takes a cut of the action so to speak. 

At least two things happened that changed the relatively conservative nature of this process. Make that three things.

The first change is that the banks putting these mortgage packages together started mixing up the contents.  We learned in Chapter 6 that a bond consists of s stream of interest payments and a principal re payment.  Well some of these things might contain only the interest payments or only the principal payment or some other combination.

Next, the sellers started becoming participants, a big change. Not content with re selling the package for a fee, CITI and MER became principals by actually owning the package themselves.  They would sell commercial paper which is sort term money. This would finance buying mortgages at a higher yield  Then MER or CITI or Bear would make the difference.  Of course this meant that the seller of the commercial paper has to continue to make short term interest payments from their long term mortgage pool.  Hmmm things are getting more complicated here.

Now the third change, still not content with a simple idea, why settle for a mere 6% mortgage when there is 7 or 8% to be made. That could be done by selling homes to folks that do not qualify  for a normal mortgage. Perhaps they don’t meet the take home pay requirement that the mortgage payment be no more than say 30% of take home pay. Perhaps they have no down payment. Perhaps they have had a house foreclosed.  Perhaps one of the two is out of a job, what they heck, let’s loan them the money anyway.  And interest rates are cheap they can probably pay. This would be a sub prime mortgage.

Okay, guess what….interest rates were often adjustable. So when rates start up the payments start up. With no down payment at stake, the buyer simply walks away from the house unable to make the payment.  Now the mortgage is not worth any more than the re sale value of the house. If multiple homes are foreclosed, it is not a stretch to imagine that they cannot be re sold for the same price in fire sale conditions, particularly now that interest rates are up. So, now MER et all cannot make their payments on the short term paper they sold in the commercial paper market.

And so the commercial paper market came to a halt because the buyers were not sure what they were buying. And this is when Secy  Treasury Paulson started proposing some sort of super SIV that would buy mortgages, but are they going to buy the bad ones, that is the question, well er ah no,well then who will.

And that is when things started being written down as impaired values.

Are we having fun on Wall Street yet?

Now how many ethical failures of fiduciary oversight can you spot here, gee more than I can count.

Now the companies that sold this paper to the public cannot re sell it to anyone and are stuck with the losses.  So how many more failures are out there, we don’t know and that is why the Broker and Banking Indices are falling through the floor.

This is as good a summary of the sub prime crisis as I have read.  I have previously posted articles about MER and CITI.

Okay let me attemtp to shorten all that. First one has to grasp the concept of a margin call. When one buys securities with borrowed money and the securities fall in value, one can be asked to put mp additional collateral. This is a margin call, the owenr of the securities is literally called up one to put up more margin, and RIGHT NOW!  This of course is the problem.  Here is an example.

Let’s supose we boughty 1,000 shares of CFC Countrwide Financial at $40 earlier this year.  We put up half the purchase price  in cash and borrowed the other $20,000. Why did we do this? this is employing debt which is the concept of leverage.  We have leveraged our ownership to more than our own cash resources would allow.  We of course are certain that CFC is going up as it is the number one lender in the never ending housing boom. Now as we know CFC proceeded to fall in value.  As it gets to say $35 we are now $5,000 underwater with our lender.  The stock is only worth $35,000 but remember we borrowed $40,000, while the stock is falling the original debt is not.   So the lender will ask us to put up collateral for the value the stock has lost.  Suppose the lender wants half the drop in value, in fact there are specific rules about how much and when but this is hypothetical to give you a flavor of what this all means.  Okay if we did not have the extra cash to do this in the first place where are we going to get it?  We either have to borrow it somewere else or we have to sell some CFC, and we have to do so at the reduced price of $35.  Here we would need to sell 71.42 shares to raise $2500. But wait a minute, this is like the dog chasing its tail, if we sell some of the CFC now we only have 930 shares left, so from that standpoint we have less collateral than we started with, ie fewer shares. THe better idea is that if one has received a margin call the entire thing ought to be sold as it is going down not up and things are not liable to get better soon.  Well in fact CFC dropped to $14.35 as of the close this past Friday Nov 2. YIkes, once it dropped below $20 we had lost our entire $20,000 wse borrowed. Needless to say the lender would have been pounding on our door all the way down as the stock dropped in price.  If we had not been smart enough to sell all back up there at $35 we could conceivably have wiped out our entire investment making margin calls in which case we would have lost all our $20,000 we put up. 

Now unless this is perfectly clear there is no point in proceeding because this is at the heart of the problem. When asset values fall, as the wiki article points out, SIVs CDOs whoever is required to meet the margin calll. What to sell, that is the question as Hamlet might put it.  Ford had to sell Aston, CITI will have to liquidate something that it CAN liquidate, and that is not liable to be the subprime stuff it has in the SIV or CDO.

Send me some posts with questions before I go on so i know where you are on this!

Jerry Herrera asked in a blog post, who is buying Aston Martin, Jaguar, etc? Good question!

David Richards, the British equivalent of America’s Roger Penske bought Aston Martin. I urge you to read both these articles.  Richards owns Prodrive Racing and has big plans for Aston, which has gone from 200 units sold in the US in the early 1990s to 7,000 this past year, an amazing recovery for a niche car maker.  And with Kuwait money behind it and Ulrich Bez as CEO this is a winner.

Cerebrus a private hedge fund bought Chrysler.  And no doubt some similar consortium wil step up to buy Jaguar. There are more folks than ever with the money and proclivity to show off their wealth to buy such cars.  And finally Ford has made a success of Jaguar after pouring billions into the project.  And that is the irony.

Ford paid $2 billion for Jag. Then they have spent probably another $10 B fixing the problems.  Now with the new XK model in demand, they are having to sell. 

One has to sell the good assets to save the less than good assets. I made the observation on this blog that I had much rather be with Richards and his Kuwait investors with Aston than in the union mix with Alan M. at Ford.

The Editor of Motor Trend discusses the re invention of Ford in this article. Now my question is, will CITI have to do the same thing?  See the last post about CITI and its all of a sudden capital shortage.  Now CITI will have to do what Ford is doing, sell the good assets to preserve what is left!

CITI is undercapitalized.  Read this article and take note of how many concepts we have discussed that are in the article.  Too manyacquisitions, not generating income, increasing dividends, and all while the stock market was going up. In sort values were increasing and CITI was buying as prices went up, never a good strategy. And it gets worse. Why?

Because when one accumulates second tier investments, once the bubble pops there is no market for tem.  and so one has to sell the family jewels so to speak to try and keep the surviving entity alive.  Ford is now selling finally profitable Aston Martin and then Jaguar, GM had to sell half of crown jewel GMAC, ouch sell GMAC and keep Buick, I think I will pass on that one. And now CITI is in the same shape.  CITI will not find a market for its shakey investments and will no doubt emerge a smaller entity when things are said and done. Also note thew new alphabet soup of SIVs, CDOs, tranches, do you know what those mean?

Speaking of getting worse, off balance sheet derivative exposure may make things much worse than Paulson or Bernake ever imagined.  Both have touted supposedly sophisticated risk avoidance schemes involving derivatives.  It used to be that folks bought gold and silver as hedges, at least one had the gold. What does one have with ‘collateralized tranches of sub prime debt?"  No wonder gold is up.

Read these as we will be discussing them in class.