I keep wondering every time I hear about the Huge write-downs that Mortgage lenders are taking, what happened to the Private Mortgage Insurance protection that lenders claimed the were building when they charged a "premium" to insure against defaults? Any borrower that did not have 20% equity or was considered high risk had to pay this. Why did this not help lower industry loses? What were lenders doing with this money if they were not using as insurance against defaults?

Very astute observation NC. But they didn't collect 9 billion in PMI

I'm willing to bet it was a "self funding" PMI.. which means there isn't an actual policy that "insures" a mortgage.

And if you look at the "fine print" of PMI, you will see it is all a scam-- depending on the state it varties in its application...

in some instances it only covers the difference between the amount "owed" by the borrower and the amount realized by the lender after foreclosure.

WMD Owl Wrote:I'm willing to bet it was a "self funding" PMI.. which means there isn't an actual policy that "insures" a mortgage.

And if you look at the "fine print" of PMI, you will see it is all a scam-- depending on the state it varties in its application...

in some instances it only covers the difference between the amount "owed" by the borrower and the amount realized by the lender after foreclosure.

While it would not cover 100% of mortgage balance, if the PMI proceeds had been invested in a hedge fund indexed against energy or precious metals the value of that investment should have covered the defaults after the property was sold. I suspect this money was reported as income and a significant portion went into executive bonuses. This is something congress should hold hearings on, NOT steroid use in MLB Baseball. PMI was put in place to avoid another industry crisis like the one in the early 1990's, which was a much smaller scale than the one today.

What most banks are writing down and taking (paper) losses on are Collateralized Debt Obligations ("CDO"), not mortgages. Most residential mortgages are sold on the secondary market to quasi-government entities (Fannie Mae and Freddy Mac). CDO are a kind of marketable security known as a structured credit product. The value of CDOs are based on the risk of non-payment, not on the value of an actual mortgage, as the underlying collateral is a mortgage-backed security. In essence this structure puts a new level of risk between the mortgage holder (usually Fannie Mae/Freddy Mac), and the buyer of a CDO. In other words, a CDO is a "bet" that people will make their mortgage payment. When a much higher than anticipated number of mortgage holders defaulted, the value of the mortgage-backed security plumented and therefore the CDO - even before actual foreclosure proceeding begin. PMI will (evenually) protect Fannie Mae/Freddy Mac, but not the holders of CDOs.

Bankerman Wrote:What most banks are writing down and taking (paper) losses on are Collateralized Debt Obligations ("CDO"), not mortgages. Most residential mortgages are sold on the secondary market to quasi-government entities (Fannie Mae and Freddy Mac). CDO are a kind of marketable security known as a structured credit product. The value of CDOs are based on the risk of non-payment, not on the value of an actual mortgage, as the underlying collateral is a mortgage-backed security. In essence this structure puts a new level of risk between the mortgage holder (usually Fannie Mae/Freddy Mac), and the buyer of a CDO. In other words, a CDO is a "bet" that people will make their mortgage payment. When a much higher than anticipated number of mortgage holders defaulted, the value of the mortgage-backed security plumented and therefore the CDO - even before actual foreclosure proceeding begin. PMI will (evenually) protect Fannie Mae/Freddy Mac, but not the holders of CDOs.

Great info. so that explains how this hit the investment bankers. They bought in to worthless paper.

And Wall Street made a mint selling this crap. Fears that the credit crunch will spread is due to the fact that not only are there billions of dollars of mortgaged-backed CDOs floating around, but also trillions of CDOs backed by other types of derivatives. This whole house of cards could fall. These so-called "synthetic securities" have been purchased by a growing number of asset managers, insurance companies, mutual funds, investment trusts, commercial banks, investment banks, and pension funds.

I just googled CBO's. Scary stuff and all the major players are involved. What's crazy no one knows what they are buying. They just like the ten percent returns. Guess what? The riskier the higher return. All of us like higher returns. I heard about people losing their asses on derivatives in the 90's. An area school lost 200,000 and the school treasurer was on 60 minutes. What's crazy they seem to be fairly new. they exploded in 2004 according to the article I read. Just google it.

Read this beauty of a definition of synthetic securities:

A synthetic security is created by combining securities to mimic the properties of another security. The security being mimicked may not actually exist.

A relatively straightforward example of mimic the properties of an actual security is the use of a portfolio of derivatives to reproduce the returns on their underlying. An example that might be familiar to some readers is that a portfolio consisting of a (long or short) position in the underlying security and cash (or a negative, debt, position) can be constructed which delta hedges an option. This is used to derive the Black-Scholes formula.

Obviously this implies that same holding of a derivative plus cash or debt can replicate the underlying security. Inverting these holdings (swapping long for short), gives a portfolio of a derivative plus cash that reproduces the cash flows of the underlying security. By packaging these together (through a securitisation), a synthetic security is created.

As a simple example of the creation of a synthetic security that creates a wholly new security consider this: the combination of strips and zero coupon gilts to create what amounts to a government bonds that does not otherwise exist.

To create such a security one would combine:

A zero coupon gilt with the same expiry date as the gilt being synthesised.
A strip with the same expiry date and the same interest payments as the gilt being synthesised.
Another example of a simple synthetic is the packaging together of a bond and a swap to create a floating rate security from a fixed rate one or vice-versa.

One reason for buying a synthetic is clearly to be able to buy a security that does not exist other than as a synthetic. There are a number of other possible reasons, including:

It may be cheaper to buy the synthetic than the security it mimics, because of commissions, spreads, and the volume that needs to be purchased.
The synthetic may be superior in some way: it may be less volatile, for example. Unless there is some balancing drawback (which is usual), the law of one price is violated.

Machiavelli Wrote:Read this beauty of a definition of synthetic securities:

A synthetic security is created by combining securities to mimic the properties of another security. The security being mimicked may not actually exist.

A relatively straightforward example of mimic the properties of an actual security is the use of a portfolio of derivatives to reproduce the returns on their underlying. An example that might be familiar to some readers is that a portfolio consisting of a (long or short) position in the underlying security and cash (or a negative, debt, position) can be constructed which delta hedges an option. This is used to derive the Black-Scholes formula.

Obviously this implies that same holding of a derivative plus cash or debt can replicate the underlying security. Inverting these holdings (swapping long for short), gives a portfolio of a derivative plus cash that reproduces the cash flows of the underlying security. By packaging these together (through a securitisation), a synthetic security is created.

As a simple example of the creation of a synthetic security that creates a wholly new security consider this: the combination of strips and zero coupon gilts to create what amounts to a government bonds that does not otherwise exist.

To create such a security one would combine:

A zero coupon gilt with the same expiry date as the gilt being synthesised.
A strip with the same expiry date and the same interest payments as the gilt being synthesised.
Another example of a simple synthetic is the packaging together of a bond and a swap to create a floating rate security from a fixed rate one or vice-versa.

One reason for buying a synthetic is clearly to be able to buy a security that does not exist other than as a synthetic. There are a number of other possible reasons, including:

It may be cheaper to buy the synthetic than the security it mimics, because of commissions, spreads, and the volume that needs to be purchased.
The synthetic may be superior in some way: it may be less volatile, for example. Unless there is some balancing drawback (which is usual), the law of one price is violated.

Doesn't seem like the synthetic security would be cheaper in most cases. I know with options at least, the bid-ask spread is normally significantly larger than that of the underlying security, and the commissions are usually a little higher too. Seems like a good way for a brokerage firm to make additional money on commissions. But I've never tried a synthetic of anything, I've always wondered what the advantage would be.

Wall Street Braces for More Volatility

NEW YORK (AP) - With Wall Street falling precipitously almost by the day, investors are asking what it will take to revive it. Market experts are increasingly coming to the same answer: Time.

There is no piece of economic data, no corporate earnings report, no move by the Federal Reserve and no government tax plan that will be able to soothe the market's anxiety in the next couple weeks over the weakening economy.

That's not to say the stock market will keep plunging the way it has been. To be sure, bargain hunters will likely see Wall Street's recent slides as buying opportunities, particularly if encouraging news comes along like a hefty interest rate cut or better-than-expected profits at the nation's big-name companies.

Upbeat financial results in the coming week from some of the large, multinational companies that make up the Dow Jones industrials - Microsoft Corp. (MSFT), AT&T Inc. (T), Johnson & Johnson (JNJ), Pfizer, Caterpillar Inc. (CAT) and Honeywell International Inc. (HON) - could lead to some rallies. But no one should be surprised if the gains evaporate as soon as they developed.

Investors simply have too many questions to buy into stocks with confidence - questions that are not going to be answered until all fourth-quarter results are in, and until Wall Street has a better sense of how the still-young first quarter is going.

"We've baked in a lot of bad news. But we don't know the magnitude of the bad news yet. We don't know if we've overdone it," said Arthur Hogan, chief market analyst at Jefferies & Co. "I don't think there's any combination of things next week that will necessarily turn things around."

The Dow sank 4.02 percent last week, the Standard & Poor's 500 index dropped 5.41 percent, and the Nasdaq composite index fell 4.10 percent.

Last week brought exactly what investors feared: a wretched manufacturing reading from the Philadelphia Fed, dismal home construction data from the Commerce Department, a worse-than-expected profit at Intel Corp. (INTC) and historic losses at Citigroup Inc. © and Merrill Lynch & Co. (MERPO)

Even the more profitable banks, such as JPMorgan Chase & Co. (JPM) and Wells Fargo & Co. (WFC), said they were bracing for more problems in a wide swath of consumer credit, from home equity loans to auto loans and credit cards.

This week will bring earnings from more banks, notably Bank of America Corp. and Wachovia Corp. Companies outside the financial sector with a strong global presence might ease some of the anxiety about America's corporate muscle, but it is unlikely they will cure it.

"There is an earnings recession," said Hugh Johnson, chief investment officer of Johnson Illington Advisors, noting that S&P 500 operating earnings growth was lower in the third quarter of 2007 than in second quarter, and is sure to be lower in the fourth quarter of 2007 than in the third.

"The real key question is not whether there's going to be an economic recession. It's not when the economic recession is going to end," Johnson said. "It's when is the earnings recession going to end?"

Martin Luther King Day on Monday is a market holiday and, after that, the government will release only a few economic reports ahead of the Fed's Jan. 29-30 meeting on interest rates. Wall Street will probe those that do come out more closely than usual for clues about how deflated the economy is and how that might affect business.

The Labor Department's weekly jobless claims data will also be watched, as will the National Association of Realtors' report on December sales of existing homes. Economists expect existing home sales to slip again after inching up in November.

With market pessimism at heights not seen in years, it is certainly possible the market is near its bottom. But there are few investors eager to bet on when stocks will resume their climb, and how long it will be before new records are reached again.

"Maybe by the end of the first quarter, things will line up for the market to find to some stability," said Steven Goldman, chief market strategist at Weeden & Co.

The Dow is now 14.6 percent below its Oct. 9 record close of 14,164.53, and is less than 100 points away from slipping beneath the 12,000 mark, which it first surpassed in October 2006

http://apnews.myway.com/article/20080120/D8U9QS5G0.html