Many times we’ve discussed the “toxic assets” held by the banks, and the role they are playing in the global economic meltdown. One of the problems with these derivative securities is this: most of them never traded on any exchange, so valuing them is difficult. The banks had been valuing them at 100% or more of their value, which we now know is laughable. But just how toxic ARE those toxic assets? The Financial Times has some insight today:

“In recent weeks, bankers at places such as JPMorgan Chase and Wachovia have been quietly sifting data trying to ascertain what has happened to those swathes of troubled CDO of ABS. [Ed.: collateralized debt obligations of asset-backed securities.]

The conclusions are stunning. From late 2005 to the middle of 2007, around $450 billion of CDO of Asset Backed Securities (ABS) were issued, of which about one third were created from risky mortgage-backed bonds (known as mezzanine CDO of ABS) and much of the rest from safer tranches (high grade CDO of ABS.)

Out of that pile, around $305 billion of the CDOs are now in a formal state of default, with the CDOs underwritten by Merrill Lynch accounting for the biggest pile of defaulted assets, followed by UBS and Citi.

The real shocker, though, is what has happened after those defaults. JPMorgan estimates that $102 billion of CDOs have already been liquidated. The average recovery rate for super-senior tranches of debt…the stuff that was supposed to be so ultra safe that it always carried a triple A rating, has been 32 per cent for the high grade CDOs. With mezzanine CDO’s, though, recovery rates on those AAA assets have been a mere 5 per cent.

The subprime loans extended in 2006 and 2007 have suffered particularly high default rates and the CDOs that have already been liquidated are presumably the very worst of the pack.

Even so, I would hazard a guess that this is easily the worst outcome for any assets that have ever carried a “triple A” stamp. No wonder so many investors are now so utterly cynical about anything that bankers or rating agencies might say these days.”

Within four years of being issued, two thirds of these CDOs are in default, and their recovery rates are very, very low. We knew it was bad, but the FT analysis is pretty darn staggering. It’s amazing how the banks managed to do THIS badly; they might as well have bundled the assets using the process of tossing mortgages down the stairs and bundling them based on how they landed. Instead, they hired people with advanced math and physics degrees, and paid them handsomely. I’d say a chimp with some rubber bands and a chop-o-matic could obtain better results.

The rating agencies who AAA’d so much of this crap sure weren’t worth the fees they were paid- in fact, they are HIGHLY complicit in the whole disaster. Without those super ratings, banks couldn’t leverage the “securities” as much as they did, exacerbating the problem immensely. They’d have done a better job using a Magic 8-Ball to rate the CDOs. (“Signs point to junk!”)

The bigger, more terrifying picture for the banks and brokers is the consequence of the leverage they used. The financial institutions borrowed heavily against those AAA rated pieces of bovine scatology, and, as a result, have created the world’s biggest margin call for themselves (and for us, as it is our money being shoveled into the black hole of the financial abyss.) Don’t let anyone fool you into thinking this crisis was caused by some bad mortgages. It was caused by out of control, Enron-modeled, securitization of assets that infected the global banking system like a cancer.

There is not enough money in the nation to cover the banks’ bets. If we print enough to cover them, it will be “welcome to New Zimbabwe” time. Unfortunately, the party in power right now has that exact mentality. The speed with which they are borrowing to prop up this house of cards is stunning. So, “The Thing That Ate America” is coming to a wallet near you.

Today is the official beginning of The New American Tea Party. Get involved, bang pots and pans, honk horns… peacefully protest while it is still legal. It’s time to be a patriot, and send the message loud and clear to Washington that we are disenfranchised, and that this must end. It is no accident that as of yesterday, 31 states have declared their sovereignty.

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