Blame Game.....

The financial meltdown in US and currently shaping up in Europe ignited politicians for a play of the “blame game.”  At the moment we see that President Bush or Vice President Cheney are the scapegoats of the hour. When the Great Depression was underway, several decades ago, President Herbert Hoover was singled out for blame. In Germany the Nazis liked to blame the Jews. Russian Prime Minister Vladimir Putin likes to blame the United States for the world’s economic problems, though the Kremlin has always embraced economic stupidity as a matter of state principle.  

Some analysts commented that it started during Clinton time, way back in 1995 of “The Strong Dollar Policy”. This myth was a conceptual concoction of former Treasury Secretary Robert Rubin and his protégé Lawrence Summers.

Another view forwarded that it started in 2001, during Bush Presidency. In the aftermath of the 9/11 attacks in 2001 the Federal Reserve cut the Fed Funds rate in half, to 1.75%. The rate would stay below 2.0% for almost three years. Those low nominal rates, negative in real inflation adjusted terms, stoked a building and buying boom in housing.

The bubbling Real Estate industry encouraged the production of very high risk mortgage applications (sub prime lending). With the full knowledge and support of Congress, most of the Banking System ignored its responsibility to monitor the credit worthiness of mortgage applicants. Wall Street then sliced and diced these worthless loans into  billions dollars of highly questionable securities called Collateralized Debt Obligations (CDO). In the process, everyone involved dipped their hands into the cookie jar. Millions and billions of dollars. Get rich selling worthless paper. Easy than the Ponzi or Pyramid Scheme.

When the Fed brought rates back to 5.25% at the end of June 2006, the bubble began to deflate; the housing based credit crisis began a little more than a year later. Market bubbles always burst.  But at the time the risk of the dicey mortgages (CDOs) had spread throughout the financial system, supposedly insuring the whole against default.

As CDOs or the subprime credit crunch began expanding into other credit areas over last year, especially the similarly structured finance product CDS. The financial player in the credit market became jittery.   

CDS ( credit default swap) was originally used as a form of insurance against bad debts, these instruments became a tool for financial speculation..

During the Real Estate boom which coincide with the souring economy and corporate defaults were few, making swaps a low risk to collect premiums and earn extra buck for a bank. CDSs focused early in the 1990’s on municipal bonds and corporate debt, not on structured finance securities. Investors flocked to the swaps in the belief that big corporations would seldom go bust in such flourishing economic times.

The CDS market then expanded into structured finance, such as CDOs, that contained pools of mortgages. It also exploded into the secondary market, where speculative investors, hedge funds and others would buy and sell CDS instruments from the sidelines without having any direct relationship with the underlying investment.

Consequently, the problem of CDOs and sub prime mortgages affected the  CDS . CDS investors start worrying whether the parties holding the CDS insurance after multiple trades would have the financial wherewithal to pay up in the event of mass defaults.

By end of last year., i.e. August, there's been a deterioration in market liquidity and the ability to get willing buyers for structured finance securities causing the values of the securities to fall.

By the  end of 2007,  American International Group reported the biggest loss in the company's history largely due to an $11 billion writedown on its CDS holdings.  Swiss Reinsurance Co., the industry's largest reinsurer, took CDS writedowns in the fourth quarter and warned of more to come in the first quarter of 2008. A Single or Monoline bond insurance companies, such as MBIA and Ambac Financial Group Inc., have been hit the hardest as they scramble to raise capital to cover possible defaults od CDS and CDO and to stave off a downgrade from the ratings agencies.

Early on, the sub prime and CDS debacles, were viewed insouciantly by the Europeans. Comments from Christian Noyer the Governor of the Bank of France “that there is no drama in front of us” and from Peer Steinbruck the German Finance Minister that “ the US was “the source …and the focus of the crisis”,

When the credit squeeze started affecting the banking institution in Europe, the politician started  the blame game. Outside the Anglo-American world, there was an outburst of resentment against the US and British approach to finance and banking. This is coincidence with New York and London as the two major financial market in the world.

In theory from my basic understanding of Finance and the American’s Political system, this financial mess should never have happened. The Bush Administration should have provided the leadership and management necessary to ensure America’s federal agencies were doing their job. And under the American “system” of checks and balances, if the cognizant federal agencies continued to screw up, then Congressional oversight should have kicked in to fix any problems.

But the system is broken. Financial ruin is the norm. The stinking sludge runs both wide and deep. It suck the financial infrastructure in US and Europe and without doubt the rest of the world especially we in Asia.