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April 2010: We’re Glad It’s Over
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(May Day, 2010) April saw gold up nearly 5%, Greek bonds greased, Goldman Sachs under attacks, Iceland in the news again (that’s never good), an oil slick the size of Vermont spreading in the Gulf of Mexico, and Arizona taking a stab at the immigration situation.

With all that bad news, we can thank heavens that we’re said to be in an economic recovery: stocks are up sharply in the past twelve months, housing prices have at least slowed their skid, and the consumer is now out spending again. That is, if he or she can find any business still in business to take their money or plastic.

If you don’t happen to have personally been bamboozled into believing that a genuine economic recovery is underway, then you've come to the right place. Let’s admit it, the economy is the pits. The American public is up to its ears (or just plain upside-down in most cases) in over-mortgaged real estate, real income and job creation have made no measurable gains in the past how-many years, and in general, people are feeling the pain.

No wonder there has been a populist clamor over the past couple of years about the king’s-ransom sized rewards doled out to captains of industry, primarily the financial types who are most popularly blamed for our continuing economic and business woes. And who seem to have been at the heart of the bubble in residential real estate.

Recent SEC hearings starred two obvious targets: mighty and famous Goldman Sachs’ CEO Lloyd Blankfein, and only recently famous 31-year old Goldman executive director Fabrice Tourre.

Sen. Levin accuses Goldman Sachs of betting against the US housing market. Goldman Sachs maintains that it was hedging its large bets, the profitable performance of which depended on a steady US housing market.

The Economist of May 1, 2010, in an article entitled “Sachs and the Shitty,” described Mr. Blankfein’s turn at the microphone before the SEC hearings:

“Mr. Blankfein gurned incredulously at some of the senators’ question, doubtless baffled that they would characterize as immoral profiteering what he views as prudent risk management. (He must have wondered whether Goldman would have been better off politically had it incurred giant losses, like Citigroup) He argued that criticism of Goldman’s motives rested on a misunderstanding of the market-making business. Market-makers owe no fiduciary duty to clients, and offer no warranties; their responsibility, he argued, is to make sure that those they serve are getting the risk exposures they seek.”

Whatever Goldman’s true position on housing was, they enabled John Paulson to pioneer an insurance derivative which allowed him to profit from falling house prices. We first wrote about Mr. Paulson in our November 2009 in our article "Exciting Frontiers in Insurance Pricing:"

“In the year 2006 he came to a conclusion that would make him incredibly rich: the US residential housing market was overvalued, by his reckoning, by about 40%.”

“After several false starts during which he was turned down by many money managers who told him that his idea would take him nowhere, he finally managed to ‘place his bet’ against housing by purchasing then-cheap residential mortgage insurance through the use of derivative CDOs. Paulson found a way to trade against the cult of residential real estate, and took advantage of the market’s blind complacency about ever-rising housing prices. His firm went on to make $15 billion in 2007 alone. His cut of that: about $10 million per day for the year.”

What Mr. Paulson did was convince Goldman Sachs to create a ‘derived’ financial instrument whose performance would track that of a particular mortgage-backed bond. Goldman sold these CDOs (many of them to German banks), and found counterparties who would allow Mr. Paulson to purchase insurance on the CDOs performance. In the midst of a seemingly unstoppable housing bubble, that insurance cost Paulson very little. Months later, as nonperforming loans and foreclosures grew, that insurance skyrocketed in value. Paulson cleaned up.

A thorough treatment of his exploits can be read in Michael Lewis’ fascinating new book ,“The Big Short, Inside the Doomsday Machine.”

Whether Paulson and Goldman’s treading in the mortgage bond market actually helped bring down housing prices, we will never know. But enormous profits were made peddling CDOs and the like to the over-optimistic. The suspicion is that Goldman saw it coming, and made a bundle selling these ersatz mortgage pools to fools.

The SEC somehow obtained Fabrice Tourre’s email in which he spoke rather candidly about the mortgage-backed securities that he was peddling for Goldman Sachs in London. His famous quote, complete with archaic spelling, bears repeating:

“The whole building is about to collapse anytime now…Only potential survivor, the fabulous Fab... standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!”

Ah, Youth! Ah, Hubris! Ah, there goes the neighborhood…

Iceland was in the April news also, this time not about its financial collapse, but instead because it is the site of an underwater volcano that blew its top and spewed debris all over the Atlantic and much of Europe, canceling thousands of scheduled airline flights due to fears of the effect of airborne ash on jet engines. Later, it was claimed that jets fly just fine through ash, and perhaps hundreds of thousands of travelers were stranded without good reason. Well, better safe than sorry, we imagine. And just think of all the foreign language skills that those ‘travelers’ got to brush up on while they were stuck flightless.

Also in April, British Petroleum drilled a large hole at a depth of some 5,000 feet, in the middle of the Gulf of Mexico, from which oil started to flow. An explosion followed, killing eleven workers on the offshore platform, and oil continued to flow, even over BP’s protestations

The United States has over 2,000 miles of shoreline on the Gulf of Mexico, and the BP oil catastrophe is unfortunately located south of Louisiana, a point almost equidistant from the Texas and Florida coasts. Thus, the growing millions of gallons of oil, depending on wind, waves, and weather, could potentially ruin beaches, fisheries, inlets, fragile marine environments, and pricey real estate over a huge swath of the coastal US.

Comparisons with damage to Prince William Sound by the Exxon Valdez spill are laughable – that tanker spill involved a finite amount of oil, confined to one bay in Alaska. BP’s gusher in the Gulf cannot at this time even be measured as to the potential quantity of crude which will contaminate the waterways and shorelines – it seems to be increasing every day, and there is no assurance that the technology to stop this flow even exists. Tens of millions of people live on or within a few miles of the Gulf of Mexico. It is also the source of about one-third of the seafood consumed in this country.

But as April events go, the Gulf filling with oil hasn't drawn quite the attention that has been focused on our home state of Arizona lately. A bill was passed in the Arizona legislature, and signed by Governor Jan Brewer, that has the effect of making being an illegal immigrant in this state…actually illegal according to Arizona law. Since Arizona is the center of both drug and human smuggling from Mexico, it’s no wonder that there was a general will in this state to take matters into our own hands.

But not without controversy, of course. Let’s admit it: our nation is deeply divided over this issue. In a nutshell, we need the cheap labor, but it infuriates us when a robotic voice tells us to “Press 1 for English.” Any further commentary on this subject, we will outsource to the true believers on both sides.

In short, April had its issues. But this month, we have good news. A young woman, unexpectedly stricken two weeks ago, in critical condition and in a coma since, lying horizontal and intubated in an Intensive Care Unit, opened her eyes on May 1st, picked up a whiteboard and wrote the words which were her first communication since she went under: “I want a Dunkin’ Donuts iced coffee and blueberry muffin.”

For that reason alone, we think May will be a much better month for this world.


 

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