Generational Dynamics: Forecasting America's Destiny Generational
 Forecasting America's Destiny ... and the World's


Generational Dynamics Web Log for 30-Jun-07
Bloomberg news accuses S&P, Moody's and Fitch of purposely "masking losses"

Web Log - June, 2007

Bloomberg news accuses S&P, Moody's and Fitch of purposely "masking losses"

This is "the pot calling the kettle black," as my mother used to say of people who blame other people for things they've done themselves.

It's highly deviant for a news organization to make blunt accusations of anyone but out-of-favor politicians, but that's what happened Friday in an article written by Mark Pittman.

The accusatory article refers to the ratings on the credit derivatives (CDOs) that we've been discussing, following last week's Bear Stearns debacle.

Bear Stearns and other financial managers had been able to greatly overvalue their hedge fund products, based on the inflated valuations of credit derivatives. The valuations are based on investments ratings provided by the three major financial ratings services that investors depend on. Bloomberg is blaming them for keeping the ratings artificially high, "masking burgeoning losses" being experienced by the hedge funds themselves, and also by the individuals who have invested in them.

According to the article:

"Standard & Poor's, Moody's Investors Service and Fitch Ratings are masking burgeoning losses in the market for subprime mortgage bonds by failing to cut the credit ratings on about $200 billion of securities backed by home loans.

The highest default rates on home loans in a decade have reduced prices of some bonds backed by mortgages to people with poor or limited credit by more than 50 cents on the dollar and forced New York-based Bear Stearns Cos. to offer $3.2 billion to bail out a money-losing hedge fund. Almost 65 percent of the bonds in indexes that track subprime mortgage debt don't meet the ratings criteria in place when they were sold, according to data compiled by Bloomberg.

That may just be the beginning. Downgrades by S&P, Moody's and Fitch would force hundreds of investors to sell holdings, roiling the $800 billion market for securities backed by subprime mortgages and $1 trillion of collateralized debt obligations, the fastest growing part of the financial markets.

"You'll see massive losses from banks, insurance companies and pension managers," said Joshua Rosner, a managing director at investment research firm Graham Fisher & Co. in New York and co-author of a study last month that said S&P, Moody's and Fitch understate the risks of subprime mortgage bonds. "The longer they wait, the worse it's going to be."

Note the phrase "according to data compiled by Bloomberg."

The lengthy article summarizes a great deal of this data, showing why the rating services should have lowered the ratings of CDOs long ago. The article specifically claims that "S&P abandoned seven-year-old criteria for determining a bond's protection against default in February."

What we're seeing is a continuing trend: increasing demands for retribution. However, these calls for retribution come from people and organizations who are just as much to blame as the people they're blaming.

I've been pointing out for years that a stock market crash is mathematically certain, given that the market is overpriced by a factor of more than 250%, just like 1929. And yet, financial journalists, analysts, pundits and politicians -- Bloomberg among them -- have been crowing about an "underpriced" market for years.

I'm not the only one who's talked about an overpriced market.

Here's what Alan Greenspan said late in 2005, just as he was finishing up his term as Fed chairman:

"To some extent, those higher [stock and housing] values may be reflecting the increased flexibility and resilience of our economy. But what [investors] perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums."

What Greenspan is talking about here is exactly what's happening today. We have an "onset of increased investor caution" that "lowers asset values and promotes the liquidation of debt."

That's what happened last week with Bear Stearns, and it's what's going to happen in the form of "massive losses from banks, insurance companies and pension managers." The processs that Greenspan described in 2005 is EXACTLY what's happening today.

And Greenspan concluded, "This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums."

So take your pick. My web site warned the world, but if you don't like that, then Greenspan also warned the world. You have your choice of the unknown guy and the most well-known financial guy in the world, both saying much the same thing, in different words.

So where was Bloomberg's warning in 2005? Where was Bloomberg's article claiming that S&P, Moody's and Fitch were rating stocks too high, saying that the price/earnings ratio of these stocks had been astronomically high for over ten years? Where was the article pointing out that, by the Law of Mean Reversion, the stock market HAD to have a major readjustment over a period of many years?

Bloomberg has hardly been alone in being a cheerleader for larger and larger bubbles. Greg Ip of the Wall Street Journal and Steve Liesman of CNBC are people I've commented on in the past, but obviously the mainstream media have been full of financial reporters saying stupid things.

And of course the biggest cheerleader of them all has been the new Fed chairman, Ben Bernanke, who doesn't even believe that bubbles exist.

But we don't have to go that far back.

Let's go back to the phrase "according to data compiled by Bloomberg" from the article quoted above.

The data that Bloomberg compiled is hardly new. I quoted much of that data in a series of articles that I wrote in February on the rapid collapse of ABX index, which indexes the value of the mortgage-based CDOs that are currently in question.

Bloomberg is criticizing S&P, Moody's and Fitch for not lowering the ratings of those CDOs at that time, but why didn't Bloomberg write its accusatory article in February? Why didn't Bloomberg write this in February: "S&P is abandoning its seven-year-old criteria for determining a bond's protection against default." Why wait until today, when the horse, as they say, is already out of the barn?

Jack Bouroudijian of Brewer Investment Group gushes over stock market <font face=Arial size=-2>(Source: CNBC)</font>
Jack Bouroudijian of Brewer Investment Group gushes over stock market (Source: CNBC)

In an article I wrote in December, entitled "Financial analysts gush at stock market's meteoric rise," I quoted what Jack Bouroudijian of the Brewer Investment Group said on on CNBC:

"This has been a wonderful six months for the market. And the worst thing about it is that we underperformed the rest of the world. So it's really of question of whether we're at the beginning of a multi-year run in equities. I guess that's the big debate. When you've got these superstar fund managers like the Bill Millers of the world, that are underperforming that are still unbelievers out there, that makes me even more bullish than I am. And we see all this data coming out and this is absolutely everything that you want."

Randall Dodd, director of the Financial Policy Forum <font face=Arial size=-2>(Source: CNBC)</font>
Randall Dodd, director of the Financial Policy Forum (Source: CNBC)

In that same article, I also quoted Randall Dodd, director of The Financial Policy Forum, who gave a much more sober assessment of the marketplace:

"I don't want to be alarming, I'm just trying to raise people awareness about these issues. I would look at the credit derivatives market. We've had some problems in clearing and settlement of those contracts. We've had problems with people trading more credit derivatives than there is underlying debt. And right now there's one big issue we have to look at -- it's that a lot of our major banks and broker dealers are moving their credit risk off their books and into hedge funds. So you have financial institutions with capital requirements reducing the amount of capital they use by moving that credit risk into hedge funds which have no capital requirements and often use very high leverage to manage their credit risk of selling credit protection through this credit derivatives market."

Now tell me, dear reader, which of these two people would you trust in the future? If you're an investor, would you trust your money to Jack Bouroudijian of Brewer Investment Group? I wouldn't, but what do I know?

So it's nice that Bloomberg has suddenly "got religion," but Bloomberg has no one to blame but itself. Bloomberg is just as guilty as S&P, Moody's and Fitch.

But it does show that the trend of retribution is surging. More and more people are panicking and looking for someone to blame, and since so many people and institutions are to blame, it's not not hard to find someone.

Meanwhile, panicking investors are also becoming increasingly risk-averse, less willing to take risks, as we discussed in conjunction with the announcement of multiple SEC investigations on credit derivatives. This risk-aversion is decreasing the demand for investment opportunities and, by the law of supply and demand, reducing the value of investment opportunities. This "lowers asset values and promotes the liquidation of the debt that supported higher asset prices," as Greenspan predicted in 2005.

From the point of view of Generational Dynamics, this is exactly what always happens at the time of a generational panic and stock market crash.

The preceding bubble period is made possible by giggling, giddy, gushing investors, journalists, and politicians who believe that the Laws of the Universe have suddenly changed, and that this bubble "is different," and that everyone should pour money into the bubble, making it bigger.

At some point these giggling, giddy, gushing gushing investors, journalists, and politicians suddenly fear that everything is collapsing around them, and that they're going to be bankrupt and homeless. That's when they panic. And in the case of a generational panic, it's something that they've never seen before, and they overreact, resulting in a level of panic that brings about a new 1930s style Great Depression. That's the process that's unfolding now. (30-Jun-07) Permanent Link
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