Financial Crisis May Bankrupt Cities

The US financial crisis, driven by the sub-prime loan feeding frenzy, is now threatening to bankrupt US cities as mounting losses pressure the three largest bond insurers. Here’s how it works. Greedy banks and investment houses, for the first time in history, bundled vast numbers of sub-prime residential mortgages into investment instruments called mortgage-backed securities or collatoralized debt obglitions (CDOs). These instruments were then marketed to banks and funds worldwide. Thus, the traditional roles and responsibilities of lenders and borrowers changed - as the rush to cash-in on the profit side trumped good judgement. This formula for disaster produced massive mortgage defaults and major insurers got way nervous.

Trouble is, these same insurers also back municipal bonds across the country. Those are the financial instruments used by cities to fund basic infrastructure repair and buildout. So the crisis threatens a long list of projects including schools, bridges, municipal water services, sewer services, ariports and museums. New York governor, Elliot Spitzer, outlined the scope of the potential problem before congress last week. Check out this report on his testimony.

Insuring debt, especially “safe” municipal debt, has always been a major piece of the insurance industry’s profits. Now, with the worst-case scenario actually playing out, trillions of US dollars in debt losses are threatening the very survival of the insurance industry. After all, they are bound to make good on their policies and cover the losses. So according to reports, they’re considering breaking themselves up. Read what an analysis in the London Times had to say about that here. The implication of this action is clear: without some kind of radical solution, the entire bond market including munis is facing risky times. And that does not bode well for our cities.

Last Friday, one of the big three insurers announced (under some pressure) that they were considering breaking up their operations into two business units; one for municipal bonds, the other for mortgage-backed securities. Uh-huh. I’m hearing some desperation in these announcements. Like we needed this.

Pop Impulse called this recession, and identified its causes and culprits, weeks before the story hit the mainstream media. The Author has been reluctant to use the "D-word," it's just so negative and sensational. But not all have shown this kind of reluctance. Take financial giant AIG's senior analyst, Bernard Connelly, for example. He's already talking about a worldwide depression. Read about his comments here. If you want even more detailed background, check-out Doug Noland's lengthy commentary on the issue in the Asia Times. As they say, read it and weep.

Sub Prime Crisis Leaves Schools Holding Junk

Florida Schools are borrowing money to pay teachers as school district investment funds are frozen, according to this report today on Bloomberg.com. This is an alarming situation. The growing subprime loan crises now is taking its toll on US Schools. That's right. Greedy bankers are sinking our schools.

Here's how it works. School districts receive funding in a variety of ways: from annual state payments to bond proceeds. So large districts often have substantial sums of cash on their books that is better invested than parked. Makes sense, money needs to make money so ground isn't lost to inflation. So a bunch of large funds sprung up to service these needs. You know what's coming, don't you?

Sure enough, many of these funds invested in loan-backed securities including large portfolios of now worthless sub-prime loans. In Florida's case, the state "froze" the investment fund behind fears of a classic "run" on the assets. Fund losses were so large that massive withdrawals by client school districts would have literally broken the bank. Not a pretty picture. To make matters worse, a lot of towns and fire departments also use these funds to invest taxpayer dollars - according to the Bloomberg report. So just because your own personal property may escape foreclosure, don't breathe too easily. You're going to pay for the schemes of greedy bankers in so many ways. We're just beginning to get a grip on how many.

$$ & Banks Reeling - Recession Looms

I was sitting at lunch last Friday with a number of local bankers and lawyers. They were involved in an animated, half jocular, half serious conversation (as men are wont) about the country's current financial melt-down. Looking to place blame anywhere but in their own policies and practices, most were disparaging stupid consumers who succumbed to "have it all and have it now" messages and the many loan and credit solicitations they've been receiving almost non-stop for a over a decade. Uh huh, that's right. Blame us for your preditory business practices. Typical.

I've posted before about preditory business practices here, and here. The subject is not unfamiliar to me and Pop Impulse readers. It was only a matter of time before the proverbial feces hit the fan in these scenarios, and it has now. Big time. I was struck by a point-on article I recently read in the Asia Times. Doug Noland, who does a weekly financial round-up for the publication, offered some truely alarming predictions - based on some good data and analysis. Read the article here. So let's quickly review.

The sub-prime loan crisis, now well documented and widely understood, is just the tip of the iceberg. Because banks and loan originators got involved in a classic, greed-fueled feeding frenzy they started securitizing their loan portfolios and selling these collateralized debt obgliations to large investors including but not limited to pension funds, school district investment pools, hedge funds and money-market funds. And we sold these mortgage-backed securities worldwide. Now, these securities have gone from an AAA rating to JUNK. That's right, worthless junk. This predictable turn of events has created massive losses in the financial sector that are now spilling over to other sectors, threatening market liquidity itself. This has lead some key financial observers to worry about a system shock to world markets.

Just today, I read in my local daily paper that the auto industry is now threatened by a dramatically rising rate of delinquency and default on auto loans. Makes sense to me as unemployment rises and families struggle to meet higher adjustable rate mortages on their homes. But there's yet another tie-in. Turns out that Chrysler's new owner, Cerebrus (you know, the three-headed dog that guards the gates of hell) Capital Management is also an partner with GMAC in Recap, one of the nation's largest mortgate loan origination and service companies. We're all way too familiar with their subsidiary, DiTech. Could Chrysler be in danger from the sub-prime crisis? Could we all?

The world is watching as we melt-down. And it's not a pretty sight. Vocal critics of US policies like Venezuela's Chavez and Iran's Ahmadinejad have loudly questioned the US dollar's continuing relevance to the world economy. And China, which funds much of our debt, is also re-evaluating its large dollar reserves. Even our allies like the United Arab Emirates are contemplating pegging their currency to a basket of other currencies - rather than directly to our dollar as in the past. Look, I'm not being paranoid here. There's plenty of reason for concern. By this time next year, deep into the presidential election race, I have a sense that the issue will again be: The economy, stupid.