Tag Archives: credit crunch

AIG: Too Big to Fail

The phrase “too big to fail” (TBTF) has been used a lot throughout the credit crunch of the last twelve months or so. Now it seems that American International Group (AIG) was too big to fail as it was bailed out by the US Federal Reserve (the “Fed”), while Lehman Brothers was not and was allowed to collapse in ignominy. For those outside the financial markets, it probably doesn’t make a lot of sense (not that it makes much more sense for those on the inside), so what is going on here?

There is an old saying that if you owe the bank $1,000 that’s your problem, but if you owe the bank $1 million that’s their problem. Something similar is at work at the moment in the financial markets.

In theory, companies in a capitalist economy are free to stand or fall on the results of their own business decisions. If they do fall, investors who chose to buy shares or bonds will lose out, but that risk is supposed to keep everyone focused on making better decisions. Banks have always been a little bit different, for two reasons. First because they take deposits from “mums and dads” (or, as the banks call them, retail depositors) and it is in the interests of the smooth-running of the whole system that this money is put into banks rather than under the mattress. Hard experience over the years of bank runs has led to various forms of depositor protection around the world, such as Government guarantees in the US through the Federal Deposit Insurance Corporation (FDIC). Of course, banks make a decent, albeit shrinking, profit from all these protected deposits.

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NAB takes $830 million hit

nab, the largest of Australia’s banks saw its share price fall by almost 14% today after they announced an A$830 million (US$795 million) provision on mortgage-backed CDOs (“collateralised debt obligations”).

It has been estimated that the US sub-prime mortgage crisis has resulted in over US$450 billion in write-downs to date and, earlier this year, the IMF suggested that the figure could rise to almost US$1 trillion. Up until now, Australian bank balance sheets had appeared fairly clean compared to their global peers, and they had avoided the large write-downs that have become common-place elsewhere over the last year. So what happened at nab?

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The Axe Falls at Moody’s

A month ago, I blogged about news of a bug in a Moody’s structured credit ratings model. The story was originally broken by the Financial Times and now they are reporting that Moody’s is sacking their global head of structured finance, Noel Kirnon. Moody’s have also taken the unusual step of sending a letter to all of their customers outlining the findings of an independent review conducted by the law firm Sullivan & Cromwell. Also this review concluded that employees of Moody’s did not change their rating methodology to hide the model error, a suggestion made in the original Financial Times reports, it was concluded that a monitoring committee “engaged in conduct contrary to Moody’s Code of Professional Conduct”.

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Anatomy of a Bubble

The Joint Economic Committee is a standing committee of the US Congress is charged with reporting on US economic conditions. Needless to say, the Committee is making a close study of the financial turmoil triggered by the collapse in US house prices and rising delinquency rates among “sub-prime” borrowers. Recently Alex J. Pollock gave testimony to the Committee entitled “Regulatory Implications of the Housing and Mortgage Bubble and Bust”. Continue reading

Moody’s Colossal Bug

A Financial Times story has been doing the email rounds in the markets over the last couple of days that points to a colossal stuff-up on the part of the financial ratings agency Moody’s. It seems that a programming error in the model they used to rate “Constant Proportion Debt Obligations” (CPDOs) meant that they assigned a rating of AAA to billions of dollars of securities which they should have rated A+, a whole four notches lower! To make matters worse, FT claims that when Moody’s found the error, they tweaked their rating methodology so that they wouldn’t have to lower the ratings. Shortly afterwards, of course, the credit bubble burst and the price of CPDOs collapsed. Whoops!

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