Credit crunch: The board game

From this week's issue of The Economist: Credit Crunch, the board game.

Players start with 500m econos each. One player doubles as banker.

Players move round by throwing four coins and progressing as many squares as they throw heads. If a player throws four heads, he moves forward four spaces and has another turn; if he throws four tails, he throws again. When a player lands on a + square, he collects money from the bank; equally, when he lands on a minus square, he pays the bank.

The aim is to be the last solvent player. In order to achieve this, players try to eliminate the competition. Risk cards encourage players to pick on each other.

Players who cannot pay their fines may borrow from each other at any rate they care to settle on—for instance, 100% interest within three turns. They should negotiate with the other players to get the best rate possible. Players who cannot borrow must either go into Chapter 11 or be taken over.

Players may conceal their assets from each other.

There are PDFs of the game board, in-game currency, and related materials at The Economist's web site.

Hat tip: Carrie

The biggest Ponzi scheme of all?

Wall Street trader Bernard Madoff allegedly defrauds the rich and famous out of tens of billions of dollars. Minnesota businessman Tom Petters allegedly fleeces hedge funds out of $3.5 billion. And socialite New York lawyer Marc Dreier may have duped some hedge funds into giving him hundreds of millions of dollars for an apparently bogus real estate scheme.

All of these scams are a big [sic] and all appear to be some kind of Ponzi scheme, designed to take in money from new investors to pay-off earlier investors. A Ponzi scheme is one of the oldest financial frauds around. And many are referring to the Madoff caper as the biggest Wall Street fraud ever.

But derivatives consultant Janet Tavakoli may be onto something. In a note to her clients, she says the biggest Ponzi scheme of all may be the one that brought the world financial markets to its knees. And that’s the scheme that united Wall Street bankers with mortgage lenders in a bid to funnel more and more money into the market for supbrime homes loans. She says the packaging of iffy home loans into securitized bonds that could be sold to insitutional investors—many of them relying on borrowed money—was a system born to fail.

“The largest Ponzi scheme in the history of the capital markets is the relationship between failed mortgage lenders and investment banks that securitized the risky overpriced loans and sold these packages to other investors—a Ponzi scheme by every definition applied to Madoff,” says Tavakoli. “These and other related deeds led to the largest global credit meltdown in the history of the world.”

Ponzi Nation - BusinessWeek Investing Blog (14 December 2008)

Loans built to self-destruct

If you'd like a preview of Michael Lewis's upcoming book on the global financial meltdown, look no further than this article in Portfolio magazine:

...[T]he scarcity of truly crappy subprime-mortgage bonds no longer mattered. The big Wall Street firms had just made it possible to short even the tiniest and most obscure subprime-mortgage-backed bond by creating, in effect, a market of side bets. Instead of shorting the actual BBB bond, you could now enter into an agreement for a credit-default swap with Deutsche Bank or Goldman Sachs. It cost money to make this side bet, but nothing like what it cost to short the stocks, and the upside was far greater.

The arrangement bore the same relation to actual finance as fantasy football bears to the N.F.L. Eisman was perplexed in particular about why Wall Street firms would be coming to him and asking him to sell short. “What Lippman did, to his credit, was he came around several times to me and said, ‘Short this market,’ ” Eisman says. “In my entire life, I never saw a sell-side guy come in and say, ‘Short my market.’”

And short Eisman did—then he tried to get his mind around what he’d just done so he could do it better. He’d call over to a big firm and ask for a list of mortgage bonds from all over the country. The juiciest shorts—the bonds ultimately backed by the mortgages most likely to default—had several characteristics. They’d be in what Wall Street people were now calling the sand states: Arizona, California, Florida, Nevada. The loans would have been made by one of the more dubious mortgage lenders; Long Beach Financial, wholly owned by Washington Mutual, was a great example. Long Beach Financial was moving money out the door as fast as it could, few questions asked, in loans built to self-destruct. It specialized in asking home­owners with bad credit and no proof of income to put no money down and defer interest payments for as long as possible. In Bakersfield, California, a Mexican strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy a house for $720,000.

The End of Wall Street's Boom - Portfolio (11 November 2008)

How convenient!

So Carrie and I were discussing, just the other day, how we might transform ourselves into a bank holding company, in order to benefit from the TARP money that the US government is throwing around.

She and I are absolutely prepared to make reckless, ill-considered loans using other peoples' money to any applicant with a pulse, so we've got all the intellectual and moral firepower needed to operate as a modern banking institution, clearly.

Chow Bella is already very good at begging for treats, so we've got our government liaison right there.

But how to get our application for aid in front of the right people? Anyone have Neal Kashkari's cell phone number?

Oh, wait -- we can just download this form and fill it out (PDF link to ustreas.gov website).

Be right with you.

So, uh, the rest of the world economy... how's it doing?

As the hullabaloo of the banking crisis fades, it seems increasingly to have been a kind of distraction from the wider topic. Investors are now once more contemplating the non-financial corporate world. It is not a pretty sight.

As an apparently minor sign of distress, take the Baltic Dry Index, which measures bulk shipping rates. It has halved this month, and is down more than 90 per cent from its peak in May.

[...]

The main reason, apparently, is that shippers cannot get trade credit. This is the time-honoured procedure where exporters get a guarantee of payment from a bank, for a fee, until the end customer settles.

[...]

It is also part of a wider issue. As Ian Harnett of Absolute Strategy Research points out, the entire model of global industry over the past 20 years has been based on the premise of cheap, abundant credit. Take that away, and what happens, for instance, to outsourcing? Indeed, what happens to globalisation?

[...]

According to the latest Merrill Lynch fund managers’ survey, the danger least preying on global investors’ minds at present is geopolitical risk.

They might perhaps ponder the fact that derivatives markets are now pricing in some quite startling probabilities of sovereign default: 90 per cent for Pakistan, 80 per cent for the Ukraine and so forth.

The idea of the already tottering Pakistani state defaulting is not reassuring. The fact that China apparently offered last week to underwrite Pakistan’s overseas debt payments is not necessarily comforting either.

The view isn’t pretty as the banking crisis dust settles (Financial Times, 19 October 2008)

The TED Spread

Initially, the TED spread was the difference between the interest rates for three-month U.S. Treasuries contracts and the three-month Eurodollars contract as represented by the London Interbank Offered Rate (LIBOR). However, since the Chicago Mercantile Exchange dropped T-bill futures, the TED spread is now calculated as the difference between the three-month T-bill interest rate and three-month LIBOR.

[...]

During 2007, the subprime mortgage crisis ballooned the TED spread to a region of 150-200 bps. On September 17, 2008, the record set after the Black Monday crash of 1987 was broken as the TED spread exceeded 300 bps.^[3] Some higher readings for the spread were due to inability to obtain accurate LIBOR rates in the absence of a liquid unsecured lending market.^[4] On October 10, 2008, the TED spread reached another new high of 465 basis points. The longterm average of the TED has been 30 basis points.

The TED Spread (Wikipedia)

Related:

• Understanding the TED Spread (Econbrowser)
• Current TED Spread (Bloomberg)

Jim Cramer's famous rant, one year later

Cramer Day is upon us. This weekend marks the anniversary of former hedge fund manager Jim Cramer’s outburst on CNBC that the Federal Reserve was “asleep” and that there was “Armageddon” in the fixed income markets.

It was possibly the most entertaining five minutes of financial television ever broadcast. Those who do not work in a Wall Street trading room and have not watched the excerpt repeatedly over the past year, can watch it on YouTube, where it is a popular view.

[...]

The outburst signalled for the first time to the general public in the US that the largely technical problems for the credit market could have serious repercussions for them.

[...]

Reviewing the rant, we can see it set the template for all that followed.

[...]

Finally, Cramer wanted to pin the blame on Alan Greenspan, who had left the Federal Reserve with an impeccable reputation early in 2006. He pointed out, correctly, that Greenspan had encouraged borrowers to take out mortgages at low “teaser” rates and then proceeded to raise rates.

Those comments have become the new orthodoxy. The easy money with which the Greenspan Fed responded to the bursting of the tech bubble at the beginning of this decade is now deemed a mistake.

This was the first crisis to afflict the YouTube generation. The “Rant That Shook The World” as CNBC called it, will be an important item in financial history years from now.

Long view: Jim Cramer’s TV outburst that will last for ages (Financial Times, 1 August 2008)