Cut All You Want Part III

Question of the day: The twin 50 bps Fed cuts will save?

A. The housing debacle and declining home values
B. The economy
C. The stock market
D. The debt market
E. A combination of the above
F. None of the above

After the Fed cuts, optimists think that the worst has past... not so fast Joe, if you picked F, you are correct.

Jon Markman at MSN in
Are we headed for an epic bear market? explains how the debt market implosion is just beginning.

"we're actually still in the middle of the national anthem before a game destined to go into extra innings."

This excellent missive touches upon many of our past natterings, financial modeling, leverage, derivatives, MBS, CDO's, ABCP, LBO's, stock buy backs, yield chasing...

financial chicanery, off balance-sheet accounting entities, greed fostered by originate to sold, rather than hold...

and the mountain of debt that is about to implode. "And it won't end well for the global economy. We're on the verge of a bear market of epic proportions.

The cause: Massive levels of debt underlying the world economy system are about to unwind in a profound and persistent way
".

How will it play out? Like the 13-year decline of 90% in Japan from 1990 to 2003 that followed the bursting of a credit bubble there? or like the 15-year flat spot in the U.S. market from 1960 to 1975?

Blame it on Rio or Canada? NO!

"Regulators who stood by as U.S. banks developed ingenious but dangerous ways of shifting trillions of dollars of credit risk off their balance sheets and into the hands of unsophisticated foreign investors;

hedge and pension fund managers who gorged on high-yield debt instruments they didn't understand;

and financial engineers who built towers of "securitized" debt with math models that were fundamentally flawed
."

We Natter about a QUINELLA of leveraged borrowing...

An asset (real estate) bought with borrowed money (a leveraged mortgage), which was made by a bank with leveraged borrowed money...

packaged into a leveraged derivative, sold to a leveraged investor (who borrowed the money to buy it), at this point its a triple borrowed asset.

borrowed against again as collateral for commerical paper (the short-term borrowings of banks and corporations), which were purchased by "low risk" money market funds.

You get the picture? "53% of the $2.2 trillion commercial paper in the U.S. market is now asset-backed, with about 50% of that in mortgages.

When you add it all up, a single dollar of "real" capital supports $20 to $30 of loans.

As subprime loan default rates doubled, in contravention of what the models forecast, the CDOs those mortgages backed began to collapse.

much of the past few years' advance in the stock market was underwritten by CDO-type instruments, (LBO's & stock buy backs)

not only will those pillars of strength for equities be knocked away, but many recent deals that were predicated on the easy availability of money will likely also go bust.

timetable for the start of the next serious phase of the unwinding is later this year or early 2008
."

From our past natterings: OCT 31st is a major market inflection point.

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