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Reading this story on FoxNewsreminded me to post my thoughts on the growing cries for more government regulation of the mortgage and brokerage industries.  Basically, I think we need to stop the Fed interventions and roll back the regulations we have now.

That comes with a caveat though - no regulation and no intervention also implies no bailouts.  That means that Bear Stearns would have shut their doors last week. That means that Citi and JP Morgan wouldn’t be able to dip their hands into the Fed’s cookie jar to stay afloat.  That means that more home owners would be in foreclosure.  But I happen to think that those are all good things.

The trillions of dollars of CDO’s, CDS’s, and derivatives that are based on bad mortgages (and that are being propped up by the Fed’s intervention) need to reflect the losses they’re actually sustaining at some point.  You can’t carry a bad mortgage on the books as an asset at full face value forever, and the longer they delay writing off the losses, the longer it will take to sort through this mess.

Get it out there, get it over with, and move on. 

gk

Nice article in the NY Times today about some of the problems in the financial world.  I hate to say I told you so (not really, but it’s sounds slightly less smug) but I’ve said all of this before.  Despite Mr. Krugman’s pessimism, he is still underestimating the size of the problem. 

For example he says “But what worries me more is that the move seems trivial compared with the size of the problem: $200 billion may sound like a lot of money, but when you compare it with the size of the markets that are melting down — there are $11 trillion in U.S. mortgages outstanding — it’s a drop in the bucket.”

By comparing the size of the Fed bailout to the amount of outstanding mortgages, I think he’s missing the bigger picture - the derivatives that are using that $11 trillion as leverage.  (To be fair, probably less than 10% of the mortgages will default, but that’s still about $1 trillion.)  

I don’t remember right now where I read this, but the average leverage is something like 20 to 1.  That means that the $1 trillion in eventual defaults will lead to more like $20 trillion in losses.  That’s where the problem lies.  That’s why companies are getting margin calls.  That’s why they aren’t able to meet those margin calls.  And that’s why many of them will not be around next year at this time.

Who will be the first big name to disappear?  If I knew that, I’d be getting paid some big bucks for the info!  But rumour has it that Bear Stearns and Washington Mutual are very highly leveraged.  And for what it’s worth, Citigroup has been talking a lot lately about how much they have in reserve.  Me thinks they protest too much….   I have no position in any of these, just giving my opinion.

gk