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Tuesday, November 25, 2008

Subprime Mortgage and Credit Crisis (2007 - )

Background: To understand the ongoing subprime mortgage and credit crisis, let's go back a few years. The end of the Dot-Com Bubble was the start of another, even larger bubble: the housing bubble.
From 2000 to 2005, the median sales price of existing homes increased year over year and speculative investment in properties skyrocketed. "Flipping" or buying a house, doing some quick renovation or repair, then selling it for a handsome profit, became sort of a national pastime, with cable TV shows dedicated to it. In 2005 we saw the launch of not one but two shows, one called Flip This House and another - completely unrelated - called Flip That House.
When property values kept on increasing, home loans became very easy to get (after all, if the borrower defaulted on the mortgage, then the bank got the house - which value kept on increasing anyway!). New mortgage products became popular: subprime loans for borrowers who otherwise wouldn't qualify for loans because of their lack of creditworthiness (hence the term "subprime") and adjustable-rate mortgage, which, as its name implies, have a variable interest rate. In addition to ARMs, there were also interest only loan - which let the borrower pay only the interest and not the principal on the loan for a period of time, and negative amortization loan (or NegAm) which let the borrower pay a portion of the monthly payment (the rest got added to the total amount borrowed - in this type of mortgage, the amount you owe gets larger year after year!).
How easy was it to get a mortgage? One mortgage provider, HCL Finance (motto: "Home of the 'no doc' loan" - no doc refers to no documentation of income required) had a product called the NINJA loan. It stood for No Income, No Job (and) no Assets! (Source)
In 2006, home prices started to go down and a year or so later, borrowers of subprime mortgages started to default on their loans. In 2007, almost 1.3 million properties were being foreclosed - a jump of 75% over the year before. (Source) As late as March 2008, it was estimated that 8.8 million homeowners (about 10.8% of total homeowners) have zero or negative equity in their homes, meaning they owe more than their houses are worth. (Source)
Had that been it, the crisis probably would've been isolated. Sure some banks would undoubtedly fail because they made bad loans, but the subprime crisis had since spread to the credit markets and created a massive credit crunch that is larger and far more dangerous than the subprime crisis.
Securitization: To understand the current credit crisis, it's important to understand something called "securitization." Securitization is an old process by which an asset that generates a cash flow can be converted into a security (like a bond), that can then be bought and sold in the market just like any other security.
A great example is the Bowie Bond. In 1997, musician David Bowie issued a bond (basically a loan note) secured by the current and future royalty revenues of his first 25 albums (a total of 287 songs … here it was the "asset"). The 10-year Bowie Bonds were bought for $55 million by Prudential Insurance Company, who then would collect on the royalties for ten years. So David Bowie got $55 million up front, and Prudential could either keep the bond (and get the song royalties) or sell the bond for profit. (Source)
Back to the topic at hand. Traditionally, banks hold mortgages until maturity, with profits being interest of the loan. But Wall Street had an idea: why not do to mortgages what David Bowie did to songs? So they (and by they, I mean Freddie Mac, Fannie Mae, and 12 Federal Home Loan Banks) pooled together mortgages and bundled them up into asset-backed securities (ABSs) and sold the package to get up front money (the investor would get the monthly mortgage payments from all of the homeowners whose mortgages got bundled).
But wait - these mortgages all had different risks. Some were safe, stodgy 30-year mortgages whereas others were subprime loans that though were more risky, also had higher interest rates and thus were more profitable. Not to worry: Wall Street split the ABSs into "tranches" (just a fancy word meaning sections or classes): the safest were rated AAA (by rating agencies whose sole job was to gauge how risky something was … and got paid by those whom it rated - talk about a conflict of interest!), the rest were medium and low-rated tranches.
The logic was this: one borrower might default on his loan, but if you bundled them together, there's safety in number: it's unlikely that ALL borrowers would default all at once.
But wait - there's more. The medium and low-rated tranches were riskier investments, but it's unlikely that all of them would default at the same time. So let's take all those medium-to-low rated ABSs and pool them together to create something called collateralized debt obligations (CDOs). And through the magic of rating, we once again could turn some of these risky securities into - tada! - A-rated securities fit for pension funds. Repackage these CDOs a few more times and pretty soon you wouldn't know how much subprime loans were actually in them. (Source)
The Credit Crisis: So how did the housing downturn infect the credit markets? Well, when the housing price dropped, a large number of borrowers began to default on their mortgages. Suddenly, ABSs and CDOs looked very suspicious as no one knew how much exposure to the subprime mortgage mess these securities actually had. The market for ABSs and CDOs dried up and holders of these securities couldn't sell them. In many cases, these companies leveraged their purchase of these securities, which really amplified their losses.
Just as the market worsened and investment firms and companies found that their holdings of ABSs and CDOs were worth far less than they had paid for them (and thus had to write off that loss in their books - causing a number of hedge funds to collapse), another domino fell: Credit-default Swaps (which took down AIG).
Credit-default Swap: Credit-default Swap (or CDS) is basically insurance on debt. Say that a bank buys a large amount of bonds from a company. As with any debt, there is a risk of the debtor fail to pay the money back. To protect against the company defaulting on its bond payments, the bank would buy CDS. In case of a default, the bank go to the insurer and cash in its CDS.
American International Group or AIG was the creator and the largest seller of CDS. It thought that CDS was an insurance product just like a homeowner's policy, but obviously it was wrong. "Any one house burning down doesn't increase the likelihood that lots of other houses will burn down," explained Adam Davidson of NPR, "That doesn't apply to bond insurance." (Source)
In case of bonds, a default can create a domino effect: as investors lose confidence and sell, the price of bonds go down and the interest rates go up. Borrowers who can't find capital to meet their obligations would start to default on their bonds and the cycle deepens. (Photo: Gone-Walkabout [Flickr])
To make sure that AIG would actually pony up and pay the CDS in case of a bond default, it had to post a collateral. This collateral depended on their credit ranking - as their credit was downgraded, it had to post more collateral. Because of its worthless mortgage-backed securities assets, AIG's creditworthiness would be downgraded - which meant that it would need to post as much as $250 billion, which of course it didn't have laying around, in collateral in a matter of weeks!
Why Bail Out AIG? Over the years, the CDS market has grown into a $70 trillion a year business. And since no one knew who has CDS from AIG, the failure of AIG would mean that a lot of companies are holding bonds that are significantly riskier than they first thought. Companies that had "hedged" their bets by buying CDS would find their books suddenly unbalanced, which means they have to sell off assets to cover their risks or they would become insolvent. This failure would propagate throughout the entire economy and create a "systemic failure." That, by the way, was what the government was trying to avoid by bailing out AIG. (Source)
The Credit Crunch: The basic essence of the credit crunch is this: banks won't lend because they can't be sure that they'll be paid back. Companies with excellent credit ratings found themselves unable to get a loan (after all, all those ABSs and CDOs had excellent ratings, so who's to say that the ratings are worth anything?). Even some banks find themselves unable to borrow money from other banks!
The Solution? As you well know by now, the White House requested, and the Congress passed a $700 billion bailout program. The idea is to for the government to buy distressed asset, especially mortgage-backed securities, from the nation's banks, which would inspire banks to lend again. The bailout remains unpopular with the general public, who perceive it as bailing out Wall Street, who caused this mess in the first place.
Whether the bailout will work or not remains to be seen.

Monday, September 29, 2008

Multiplication

I am sure you would love the new way of multiplication. 

video

Friday, September 26, 2008

उगवला चंद्र पुनवेचा !


If you love Shankar Mahadevan's Music, here is a treat !
http://in.youtube.com/watch?v=Eq3V-93diXE
उगवला चंद्र पुनवेचा !
मम हृदयी दरिया ! उसळला प्रीतिचा !
दाहि दिशा कशा खुलल्या,
वनिवनी कुमुदिनी फुलल्या,
नववधु अधिर मनी जाहल्या !
प्रणयरस हा चहुकडे ! वितळला स्वर्गिचा ?

गीत - प्रल्हाद केशव अत्रे
संगीत - श्रीनिवास खळे
स्वर - बकुळ पंडित
नाटक - पाणिग्रहण (१९४६)
राग - मालकंस (नादवेध)

First Venture - in Kody's Words

Forrest Gump's mom famously said, "Life is like a box of chocolates, you never know what you're gonna get"....

As we draw curtains on the historic and emotional-Land Sharks project, just thought that it wouldnt be such a bad idea to travel back memory lane...and so, here's this message !

An hour after registering the property in the buyer's name and driving back home with a bag full of cash, and yet, it still hasnt sunk in - that we've successfully closed out our first venture, and whats more, made money out of it too ! As the three of us - me, lamba and
papa felt a sense of victory, a feeling that perhaps Sachin had when he scored his first run in international cricket, it was, in our own small way - "a history being created". Yes, it was a feeling of - "We have arrived...and how !"

This is a real sweet victory and what makes this victory sweeter is the journey itself. I vividly remember when the architect of this project - lamba, discussed the exciting investment opportunities in Kerala realty around Aug/Sept 06, and it wasnt long before we took a plunge into the hot and volatile realty space. A-Smooth-Ride is the last thing that strikes us when we look back at those 20 eventful months. It pretty much has been a mixed bag. Executing a plan so quickly gave us tremendous joy in November, and ensuring we raised sufficient funds to register the property in our name gave us an equal amount of anxiety in the following January. To top it, the way we've managed to share the EMI burden despite all of us going through a cash crunch just cannot be forgotten. Who can forget Papa signing the POA at the Tuticorin Airport and getting it dispatched to Lamba in double quick time !

And boy, did we celebrate the culmination in style ! The only way that the final celebration could have been better was the presence of kaku, mythri,
papa, shweta and shravani. Folks, we really missed you guys that night !!

Through all this, we stood by each other, weathered many a problem, and our bond only grew stronger with each passing day. Am I going overboard with all this ? Perhaps, not ! The underlying idea is - when, after 3 decades, on a rainy evening, sipping a cuppa' tea, we turn back time, this sweet albeit small experience doesnt get lost in the dust, but brings a smile on our faces. This is a tribute to our resolve and the spirit of partnership !

We rock !

Cheers !

P.S - Did not have Kamya bhabhiji's ID...Dangy, could you pl. forward it to her !

10 Startling Facts

1) Coca-Cola was originally green.
2) The most common name in the world is Mohammed.
3) The name of all the continents end with the same letter that they start with.
4) The strongest muscle in the body is the tongue.
5) TYPEWRITER is the longest word that can be made using the letters only on one row of the keyboard.
6) It is impossible to lick your elbow.
7) People say "Bless you" when you sneeze because when you sneeze,your heart stops for a millisecond.
8) The "sixth sick sheik's sixth sheep's sick" is said to be the toughest tongue twister in the English language.
9) Each king in a deck of playing cards represents a great king from history. Spades - King David . Clubs - Alexander the Great, Hearts - Charlemagne Diamonds - Julius Caesar.
10) 111,111,111 x 111,111,111 = 12,345,678,987,654,321 (BEST fact)

Munar Trip - Narrated by Kody

Caught up in daily routines and professional pressures, there was hardly any opportunity to meet up with friends. The only way to communicate with friends, both near and far, was through the cellular technology. Seems like it was not long back since we passed out from college, but, time is running like there is no tomorrow. The trip to Munnar was a welcome break and a refreshing one at that. I hadn’t met Vindy after coming out of Manipal. It had been close to three months meeting suppy, dangy and nussy as well, so I was really looking forward to this trip down to the God’s own country. A hard-thought out itinerary, bowl full of pranks and a perfect execution is how our vacation in Munnar can be described. The disappointment of missing a reunion at Homecoming in Manipal due to various professional commitments was in a way compensated by this trip, though not completely as some junglees couldn’t make it even this time around.As soon as our program was finalized, I couldn’t wait for 23rd October to come. It was great travelling from the flash of the NE monsoon in Hyderabad to the height of the humid kerala. I arrived in Cochin on the afternoon of 24 th October and was received by Vindy at the railway station. Suppy, nussy and dangy were all waiting at home for me to come, but as always, I reached late for the party. Amidst all these, the most heartening thing was that each of us were as excited to see each other as much as we’ve ever been. We had a quick lunch, and then, we set out for Munnar in a stylish Qualis on the Friday afternoon.

It was a wonderful journey with each of us finding it hard to remain silent. No matter what we talked, we used to invariably end up discussing about "whatchya"There was a lot of singing and leg-pulling [esp.
papa’s] on our way upto Munnar. Papa was appointed the Finance manager of the trip. We had a short-break half-way up the hills. It was about 9.30 in the night by the time we reached the guest house on the hills. [by the way, the guest house was sponsored by HDFC]. We started boozing at around 10 pm and continued till 4 am, early morning. We shared our experiences and had dollops of fun during this. We didn’t realise when we slowly slipped into sleep. Next morning, we set out for sight-seeing on the hills. Saw the lush green forest with clouds moving like they do in a movie, and boy, was it beautiful!Then we stopped over at the lake for a boat ride. It was a speed boat and it was a lottov fun. There was a femalus horribulus, who vindy aptly described as "good from far, far from good..!" We also found one for dangy… The boat driver drove the boat with many twists in the water and it was like another exciting water sport.We had lunch in a restaurant which took us just about a coupla’ hours…. and even that was because we had a mallu with us…had it not been for vindy, we probably would have completed our lunch by the dinner time. We then moved on to see the tea estates.

All through Munnar, you drive for miles and miles in any direction and you are guaranteed to be surrounded with tea plantations. You will be amazed at the amount of labour that has gone into building these plantations (and also into destroying the forest). But I have to admit that neatly trimmed tea plants spread like a lawn all over the hills does look really beautiful. We had clicked a few snaps there and then were on our way back to the guest house. A day had passed off, completely unnoticed by us.The next morning, we left for kochi as I had an early train to catch. It seemed as if time was running at the rate of knots. In the afternoon, I was on the train heading back to hyderabad, ending what was a fantastic vacation, even if it was short.Time in kerala moved so swiftly that I hardly realised that it was three days up, and now I’m back to work. That’s for my travelogue….FYKIU guys take care… So, till next time that we meet in papa’s wedding…its me,

Vinay/Kody

Leveraged Bust Option - Sep'2008

Up until 2003, all investment banks in US were allowed only 12 to 1 leverage. Then in 2004, the SEC basically gave 5 banks (and only 5 banks) the ability to lever up 30 or even 40 to 1.
Bet you can guess the names...

Bear Sterns, Lehman Brothers, Merrill Lynch, Morgan Stanley and Goldman Sachs.

3 down... 2 to go!