Friday, October 03, 2008

Wall Street's Gaping Hole

CEOs weren't content to dig for gold with a shovel. Wall Street innovation turned financial products into a huge, high tech boring machine, similar to those that clear coal from earthly veins or dig monstrous tunnels, like the one under the English Channel. Leverage ramped up the giant machines RPM's. As long as it went forward, things were great.

But housing prices peaked, the economy lingered, and people began defaulting on loans. The machine stalled, then went into reverse. The blades now cut the other way, shredding instruments previously thought of as safe.

Mortgage backed securities are a real problem, but not the only one. Wall Street packaged other instruments, backed by assets other than home mortgages. Many have the quality of a Las Vegas style bet. Numerous markers have been called, leaving the bet holder with little more than a receipt.

Who invested in these products? Who did the betting? More non Wall Street CEOs than you think. SemGroup, an energy distribution firm, declared bankruptcy due to billions in hedging losses. HCA, the giant hospital company, has a professional liability subsidiary with $1.6 billion in level 2 or 3 investments, including derivatives and $652 million in auction rate securities based on student loans, now untradeable.

Carlyle Capital Corporation combined the two sins, leveraging its investment in mortgage backed securities 39 to 1. It turned into a Phoenix in March, but may benefit from the Federal bailout plan in its roll up. In addition, the Carlyle Group may get to buy back its ManorCare commercial mortgage debt for pennies on the dollar, with Uncle Sam as the middleman.

Sure, pension funds swallowed Wall Street's swill by the trillions. Investment advisers pushed junk on IRA and 401(k) holders. Who will show up at the Treasury window? It may surprise you.

The private equity owners of hospital and nursing home companies could arrive with their hand out. The PEU boys are now posited as saviours for banks and at risk financial institutions. I expected them to arrive with one hand out, but not two.

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