In the months to come it’s likely this past Monday will be called Black Monday on Wall Street. Where do I start with the big three stories of the day.
But first things first: I wish I had five more minutes to give you a brief history of how we got here, because it affects us Canadians in huge numbers of ways.
Suffice it to say that in Canada, banks hold mortgages on their own books and keep them in-house. In the U.S. they’re packaged and sold in blocks called Collateralized Debt Obligations, or CDOs. They’re all pieces of thousands of mortgages, good stuff, bad loans, subprime and kinky ones all put through a blender and packed nice and neat. Everybody wanted them and nobody could get enough on their books for years.
The huge investment firms were making billions in fees gathering them, packaging them and re-selling these CDOs. It turns out that they started to fall in love with the product they were selling. First, they put a ton into their own accounts, because it was a great return. When things slowly started going sour and they didn’t want to admit it and to keep making the market think everything was just fine, they got stuck with billons more they couldn’t sell.
Now back to Monday: First was the huge and well established investment firm Lehman Brothers filing for bankruptcy. They were done in, or finally dragged under, by over $60 billion of bad mortgage loans on their portfolio. And, gee – their CEO got $22 million in pay just this past year. Nice money for guiding his company into bankruptcy…
Then came the announced sale of Merrill Lynch to Bank of America. Same story in a way, since Bank of America is buying the firm in an all-stock deal. That’s kind of like me buying your house for no cash, but only paying off your credit card bills.
Lastly was the insurance giant AIG filing for re-organization. It’s not that the insurance business is bad. It’s just that AIG invested their clients’ premiums in mortgage loan portfolios, instead of GICs, because they were getting a better return. Lesson number 780 for all of us: If you want a higher return you have to take a higher risk!
And a month ago, we were told that the worst was behind us. Yea, right. Banks and investment firms are the oxygen of the economy and this isn’t helping.
Added to the Monday list is the government takeover of Fannie Mae and Freddie Mac last week who hold over $5 TRILLION of mortgage loans. There isn’t really a Canadian equivalent unless you kind of think of CMHC holding half of all Canadian mortgages on their books!
Until home values stabilize we can keep using the quote from Lily Tomlin: Things are going to get a lot worse before they get worse.