liquidity: the 3 pressure points

This was discussed in the "Trouble at Mill" series but here is a summary:

Pressure point:
1. Subprime mortgages. Although the damage is substantial unless further measures are taken, this by itself being the starting point of the flow, could be controlled by the Central Banks. If inaction occurs, expect a very deep recession, considering that the US economy has only patches of growth and less consumption and hence less GDP, can be expected.

2. COD's, where mortgages are bundled, rated and sold. The Rating Agencies did'nt do the job properly resulting in COD's being overpriced. Many are held by US Banks who onsold these. Unless FHA takes the bulk, they can't be traded and so cash is locked up in these instruments. The situation is bad in the EEC, where Banks refuse to loan to other Banks if COD's are used as collateral. This reduces liquidity, the life blood of trade and expansion of manufacturing/ takeovers/IPO's.

3. Derivatives.
3.1. The COD's were heavily geared, often at more than 10:1. Many COD's are suspected of overvalued mortgages, which if sold, may only realize 40 cents or less per dollar, resulting in massive losses and a credit squeeze. Often contracts may have dates at which these need to be valued, a big task. Many institutions have a rule which mentions that mortgages must have a certain rating; if not, these need to be sold. This results in additional mortgages coming into markets coupled with decreasing demand.

3.2 The market has about US$400-500 trillions worth of other derivatives. However, holding Banks and companies may also hold COD's or are engaged in transactions which can't go ahead because the demand for many COD's has dried up and so no cash is released.

Summarizing, items 2 and 3 are causing liquidity problems and the scope of these can't be determined as info from the companies concerned is only slowly released and then only partially.

That is my opinion,

Gerry