News from the Zona

An excellent article in the NYT
on the little worldwide web woven within the Greenspan system that is now going down a stitch here, down a stitch there – you in the corner can’t have your retirement, and you in the other corner can’t have your education. The vast game of tag in which you, my friends, my friends, are It – now, try to run for cover!

The article takes up a move by a Wisconsin school district to take advantage of what it was assured was easy money in the highflying world of international finance:

“Mr. Noack told the Whitefish Bay board that investing in the global economy carried few risks, according to the tape.

“What’s the best investment? It’s called a collateralized debt obligation,” or a C.D.O., Mr. Noack said. He described it as a collection of bonds from 105 of the most reputable companies that would pay the school board a small return every quarter.

“We’re being very conservative,” Mr. Noack told the board, composed of lawyers, salesmen and a homemaker who lived in the affluent Milwaukee suburb.

Soon, Whitefish Bay and the four other districts borrowed $165 million from Depfa and contributed $35 million of their own money to purchase three C.D.O.’s sold by the Royal Bank of Canada, which had a relationship with Mr. Noack’s company.
But Mr. Noack’s explanation of a C.D.O. was very wrong. Mr. Noack, who through his lawyer declined to comment, had attended only a two-hour training session on C.D.O.’s, he told a friend.”

It is a lovely story, full of the pathos that will tug at your heartstrings or at least make you violently ill. It is a story that will replace our celebrity breakdown stories in the next year, assuredly. The word, lately – amongst all the financial columnists – has been “bottom”. A Melvillian word, a word from the infantile word, a word from sex games – bottom bottom bottom. Has the stock market bottomed? Is the bottom coming up? It turns out that a little word like that can land like a giant flyswatter in the country that elected the Giant Fly as Pres, oh so many years ago it seems, and much crushing will be involved.
Well, last word I’ll leave to the article:

“In Mrs. Velvikis’s classroom at Grewenow Elementary in Kenosha, students have recently completed a lesson in which each first grader contributed a vegetable to a common vat of “stone soup.” The project — based on a children’s book — teaches the benefits of working together. The schools have learned that when everyone works together, they can also all starve.”

PS - And I should link to myself, right? This is my review of a recent book on Iran. Many will jump down my throat about it.


roger said…
I should have ps-ed this post with a link to IT's photomontage of Manchester , very zona-esque.
ed said…
If the CDO was rated investment grade (BBB or better) by one of the established rating agencies, Mr. Noack was within his rights in believing it was a safe investment. The default rates on these securities are very low, and the ratings are put there as a guide to investment managers who don't have the time, training, or information need to do a thorough analysis on the bond. If the article puts the blame on the Noacks of the world there is a problem with it.

He was also close in understanding what a CDO was. The security is little bits of debt, though not all from reputable companies though the stronger ones will be mostly reputable companies or the debt will be secured in some ways. However the reputable companies have been going bankrupt and the security is often a guarantee from a more repubtable company.
roger said…
Ed, good points. However, the article isn't blaming Noack - it is pointing to how people like Noack were being told, by banks seeking revenue from fees, to go out and sell CDOs in preference to instruments upon which the banks would take lesser fees, but which, in reality, paid out close to the amounts paid out by CDOs. Here is, I think, the gotcha graf:

"If just 6 percent of the bonds insured went bad, the Wisconsin educators could lose all their money. If none of the bonds defaulted, the schools would receive about $1.8 million a year after paying off their own debt. By comparison, the C.D.O.’s offered only a modestly better return than a $35 million investment in ultra-safe Treasury bonds, which would have paid about $1.5 million a year, with virtually no risk."