D1

Roger Haineault

Stumble Upon

del.icio.us

Digg

Facebook

Print

Email

Speak Up

What a week! Believe it or not, I was reminded by someone last week that I had stated there was an economic crisis coming that was going to become the lead story - not just on the business pages - but internationally.

What made his reminder funny was that I offered to provide a clinic to the newsroom on how this was going to happen - two years ago.

In the interest of disclosure, not that I was blessed with any great insight, but I was following a company in the United States that for a number of years had a division making tremendous profits through the originations of sub-prime mortgages to people of poor credit, without verifying much of their personal statements (like do they really have a job?).

Not that I'm particularly bright, but when I hear people use phrases such as, "We mitigate our risk through the use of qualifying specific entities that obfuscate the liability for our parent by selling the securitized residual interests, while providing the purchaser with warranties to return the purchased loans and we then retain the right to recognize these losses."

I don't know what that means, but it doesn't sound good. So this is the fundamental domino that starts the pattern. People who are in homes they can't afford default and the sheer number forces the real estate market down.

As an accelerator to this consider derivatives. I know it sounds like a smart investment, but basically it's a bet. It's in the name - the reward is derived from something else happening. If you were in the sub-prime mortgage business and you were worried about your portfolio, you would buy a credit default swap derivative that would perform like insurance.

Someone would collect a premium from you and ensure that they would make up your losses if you had a bunch of foreclosures. But what happens if everyone loses at almost the same time and the people who sold the swaps couldn't pay? After all, there is a reason hedge funds have hedge in their category name. In the meantime, these mortgages and securities and insurances are all carried as an asset on all of the companies' books.

And that in a couple of paragraphs pretty much sums it up. Nobody knows how much anything is worth. So the American government steps in and bails everybody but Lehman Brothers out, and the rest of the world follows suit.

How do they do this - by injecting capital into the financial system? But since all these banks have taken a pounding, instead of having confidence to go out and do business, they hoard the liquidity forcing even more drastic action.

Regular readers will know that I indicated here that we would see some stability by the American Thanksgiving. Last week, the Dow Jones Industrial Average was up in every trading session and Wall Street enjoyed its best week in almost 30 years.

No need to ask "how long has it been since that's happened?" Now that the holiday shopping season has arrived and people have confidence in president-elect Barack Obama and his team, we should see continued stability.

Respectfully, this basically means that everyone else needs to take a pill. Governments need to consider making orderly tax cuts in a systematic fashion to give confidence to constituents. They also need to consider how best to financially assist employers so they can continue in business.

Think of the ripple effect if someone large fails. On the other hand, a regime change because it seems like the thing to do, isn't necessarily the best course of action. While I don't want to see General Motors fail, devising a bailout independently of Washington might be the most foolish thing that could be done.

You can be sure that there will be some short-term funding made available. Working with the new American administration is probably the tack that's needed to structure their long-term salvation, and if we're going to look at new coalitions maybe now is the time to invite an old hand back to help out: deputy bank chairman, former ambassador, political master and successful businessman Frank McKenna probably has something to offer, if he can be enticed.

* * *

Roger Haineault is with Help 4 Taxes. He can be reached by email at roger@help4taxes.ca or by calling 443-HELP (4357). His column appears Mondays.