The conundrum of America’s economy - Economist

"The market was so leveraged, and the instruments so complicated, that no one seemed understand what would happen if it all began to unwind." - Economist

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That is the key phrase, everything.... and I mean EVERYTHING, revolves around things that nobody understands. DS

The conundrum of America’s economy - Economist
Abstract: There are plenty of ominous signs. The housing market, long the mainstay of America’s economic boom, is sagging. Defaults in the subprime lending market grow ever more worrisome. The core inflation rate, which excludes food and energy, is not exactly subdued: consumer prices were up by 2.2% in May from a year ago. Add in the tepid GDP growth and the mix is making consumers nervous.(...) As vexing a concern is the effect that a slowing housing market will have on the mountain of debt and debt-related instruments that were issued to finance the boom. The most frightening aspect of the problems at two hedge funds run by Bear Stearns, both heavily exposed to the subprime-mortgage market, was not that a big bank had been plunging into risky assets; it was the revelation of how little anyone knew about the risks involved. The market was so leveraged, and the instruments so complicated, that no one seemed understand what would happen if it all began to unwind. READ IT ALL

Ask Not For Whom The Bell Tolls...

"The Seventh Seal" - Ingmar Bergman

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Dong...... Dong...... Dong...... Dong...... Dong...... Dong...... Dong........ Dong.... DS

Does it all add up? - Financial Times
Abstract: When Wall Street creditors last week threatened fire sales of CDOs seized from the stricken Bear Stearns funds, thus creating a market price for them for the first time, they also threatened to create a wider shock for the system. Fire sales rarely realise anything close to the previously expected value of assets. But if these deals went ahead, they would provide a legitimate trading level that would challenge current portfolio valuations. In the event, Bear Stearns' creditors sold only a fraction of the assets put up for auction. Market participants suggest that this was in part because bids fell far below expectations, with traders increasingly reluctant to take on CDOs tainted with subprime exposure. But the crisis at Bear's funds has left investors, brokers and regulators asking an uncomfortable question: can the pricing models that have provided the foundations for this new financial edifice really be trusted? Or will valuations turn out to be over-optimistic and result in further investor losses?(...) Christian Stracke, analyst at CreditSights, a research company, says: "With so little truly relevant historical data on the behaviour of subprime mortgages, and with such massive structural changes having occurred in the mortgage landscape in recent years, any time-series analysis approach is little more than a not-so-educated guess."(...) That means that on the rare occasions that instruments are traded, a large gap can suddenly emerge between the market price and its book value. This week Queen's Walk Fund, a London hedge fund, admitted it had been forced to write down the value of its US subprime securities by almost 50 per cent in just a few months. That was because when it was forced to sell them, the price achieved was far lower than the value created with the models the fund had previously used - which had been supplemented with brokers' quotes.(...) Some bankers and policymakers argue that this is simply a teething problem that will fade as structured finance becomes more mature. History suggests that most opaque, illiquid markets eventually become more transparent when they grow large enough - and behind the scenes, the Bear Stearns hedge fund problems are prompting bankers and investment managers to re-examine their valuation techniques. "We are getting a lot of calls from worried people," says one third-party data provider. However, history also shows that large-scale structural dislocations - such as a serious mispricing of assets - are rarely corrected in an orderly manner. Thus the big risk now is that if thousands of banks and investment groups suddenly have to slash the value of the securities they hold, the wave of accounting losses might at best leave investors wary of purchasing all manner of complex financial instruments. At worst, it could trigger more distressed sales and a broader repricing of financial assets, not just in the subprime sector but in other illiquid markets too. "If every CDO [manager] was forced to mark to market their subprime holdings, it would be - well, I can't think of a strong enough word to describe what it would be," confesses a US policymaker. READ IT ALL