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To: rich4eagle who wrote (253103)	5/6/2002 7:07:34 PM
From: D.Austin	Read Replies (1) \| Respond to of 769670

In the contemporary environment where “money” is little more than electronic IOUs (liabilities) from financial institutions and intermediaries, I believe a more applicable “law” would hold that “bad lending drives out good.” Certainly, we have seen exactly such a situation develop over this protracted cycle as Wall Street has grabbed the reins of the money and credit creation process. While traditional finance sought to profit from lending prudently, today’s game is all about voluminous fee-based security issuance, sophisticated vehicles and structures and, of course, lots of derivative products. Quality was been completely sacrificed for quantity. In the process, the investment banker and “rocket scientist” derivative specialist has come to dominate the monetary system, supplanting the local loan officer. And while lending for investment into cash-flow- generating enterprises was the business of the local banker, the volume seeking Wall Street banker specifically pursues enterprises with negative cash flows that will require continuous financings. After all, the “best” clients are those that “keep coming back to the trough.” Besides, as Wall Street thinking goes, if the marketplace does become nervous about the soundness of securities (as it is today) doesn’t that just provide more opportunities for “our derivative department down the hall” to peddle credit insurance? Why has it not been absolutely obvious that this was no way to run a financial system?

To: rich4eagle who wrote (253103)	5/6/2002 7:10:34 PM
From: D.Austin	Respond to of 769670

“Chase and Bank of America were the top two lenders to telecommunications companies, accounting for more than half the amount borrowed. Goldman Sachs & Co. and Toronto Dominion Bank were third and fourth with 8.6 percent and 7.1 percent market share respectively. Almost 400 companies with low credit ratings organized high-yielding loans in the fourth quarter. High yield, or leveraged, loans jumped to $112 billion from $86.3 billion.”

To: rich4eagle who wrote (253103)	5/6/2002 7:11:10 PM
From: D.Austin	Respond to of 769670

“High-yield loans are popular among companies that can't sell bonds or stock to raise money. The loans, which are less risky than junk bonds, are also growing in popularity among funds and insurance companies looking for high-yielding investments. The number of investment vehicles buying loans rose from 64 in 1997 to 149 in 1999, according to (Portfolio Management Data’s (PMD)) research. They include collateralized loan and debt obligations, or CLOs and CDOs -- securities backed by corporate debt -- which have grown from 19 in 1997 to 42 last year, according to PMD.”

To: rich4eagle who wrote (253103)	5/6/2002 7:11:48 PM
From: D.Austin	Respond to of 769670

I also saved the January 10th American Banker that included an article titled, “Syndicated Lending closes Out ‘90s on a Tear.” “What a year 1999 was for the U.S. syndicated loan market. Lending topped $1 trillion for the third consecutive year. Leveraged lending, the most profitable kind of syndication soared 19% from 1998, to $391 billion, and the industry recorded its biggest deal ever: a $30 billion loan for AT&T Corp.” Pulled from this article, “It was also the year Wall Street woke up to syndicated lending’s potential. In May, PaineWebber published “The Biggest Secret of Wall Street,” a 44-page report that labeled syndicated lending ‘the largest, highest fee generating, and most profitable corporate financing business” on the Street.” The American Banker also quoted a Wall Street analyst: “Syndicated lending is changing the way the banking industry provides loans – period. It’s the most flexible form of financing there is and the quickest way to raise money.”

To: rich4eagle who wrote (253103)	5/6/2002 7:12:20 PM
From: D.Austin	Respond to of 769670

Numbers that will come back to haunt the U.S. financial system, total issuance of syndicated bank loans surpassed $1 trillion during 1999, making two consecutive years of trillion dollar loan syndications. Chase Manhattan $349,154,000,000, Bank of America $217,237,000,000, Salomon Smith Barney $93,304,000,000, JPMorgan $57,459,000,000, and Bank One $48,118,000,000. Comparing to 1998, Chase increased syndicated loan issuance by 28% and Bank America by 23%. In the midst of an historic speculative run throughout the technology sector, Bank of America issued $123 billion of syndicated loans and Chase Manhattan issued $113 billion. And while Chase was ranked #1 in total loans, Bank America had the most loan packages at 794. Year 2000 got off to a big start, with almost $120 billion of syndicated loans made during January. Closely associated with the unprecedented boom in risky lending has been the proliferation of credit derivatives and credit insurance. It’s been quite a game – create the risk, and then develop and market products that supposedly protect against it. As such, we took note of a recent Bloomberg article by David Wigan and Tom Kohn “Credit Derivatives Boom as Bonds Dip.” The article stated that “sales of credit derivatives may increase by 50 percent this year as investors try to protect themselves…” A head of a Wall Street derivative shop was quoted as saying, “for holders of (corporate) loans and bonds, they could be a real life saver in this environment.” This same individual estimated that the market for credit derivatives has actually surpassed $1 trillion.

To: rich4eagle who wrote (253103)	5/6/2002 7:12:47 PM
From: D.Austin	Respond to of 769670

Wow! Why does this so remind us of the proliferation of derivative products and sophisticated strategies in SE Asia and Russia (at the peak of their booms!)? Derivatives were major factors in the absolute fiascos created with the inevitable collapse of all the leverage and acutely fragile structures? As we have stated in the past, derivatives in no way reduce risk for the system as a whole (they actually increase systemic risk!), but only shift it to other parties. And, importantly, in the midst of boom-time speculative markets, risk is often shifted to parties (speculators) with little wherewithal to deal with losses in the event of a major market disturbance. That was certainly the case in SE Asia and Russia, where great risk was shifted to highly leveraged financial speculators who were quickly destroyed when liquidity faltered and markets buckled. There is just no doubt that the enormous amounts of derivatives and associated dynamic hedging strategies played an instrumental role in collapsing markets. Yet, amazingly, no lessons were learned from the spectacular counter party defaults in Asia and, particularly, in Russia.

To: rich4eagle who wrote (253103)	5/6/2002 7:13:17 PM
From: D.Austin	Respond to of 769670

So, today we are looking at a market for credit derivatives estimated to now surpass $1 trillion, as well as the thinly capitalized GSEs that have guaranteed “timely payment of principle and interest” on more than $1.8 trillion of mortgages-backs. Add to this, a truly staggering amount of credit insurance written by a host of aggressive financial institutions. The two largest credit insurers are MBIA and Ambac Financial. MBIA now has net (gross insurance less amount reinsured) insurance written – “Net Debt Service Outstanding” – of a staggering $670 billion. These policies are supported by a “capital base” of $4.4 billion, thus creating a “capital ratio” of 152:1. At Ambac, net insurance – “New Financial Guarantees in Force” – of $402 billion is supported by “capital” of $2.7 billion, or 149:1. So, for these two credit insurance behemoths, over $1 trillion of credit insurance has been written, supported by a capital base of $7 billion. I will leave you to ponder how valuable all of the credit derivatives, guarantees, and credit insurance will be in the event of the type of major financial and economic dislocation that I believe is the inevitable consequence of truly unprecedented excesses. And while we are on the subject of derivatives, Joe Niedzielski, of Dow Jones newswire, penned an excellent article today “Xerox In Talks With Counter party on Derivatives.” Niedzielski’s piece highlighted how the company is faced with “constrained access to the capital markets and is essentially shut off” from the commercial paper market. At the same time, “…Xerox may also be on the hook for $240 million of derivatives if its credit rating falls to junk status. On that score, the company’s fate is in the hands of Moody’s investors Service and Standard & Poor’s.” In Xerox’s filing with the SEC, it disclosed that it might be required to repurchase these derivatives from counter parties if it loses its investment grade ratings. A Xerox spokesman stated that the company is currently negotiating with its counter parties. The article also stated that Xerox has “drawn down $5.3 billion of its $7 billion bank credit line.” The company anticipates that it will need “another $1.1 billion during the rest of the year to refinance its commercial paper, medium-term notes and maturing bank debt.” This is a particularly poor position to be in, especially considering the unfolding market environment. Xerox should be a loud wake-up call to the complacent.

To: rich4eagle who wrote (253103)	5/6/2002 7:13:53 PM
From: D.Austin	Read Replies (1) \| Respond to of 769670

Over the coming weeks and months, it will be interesting (and critically important) to see if market confidence wanes regarding the mountains of credit derivatives and credit insurance. If and when sentiment turns, we would not want to be left holding asset-backed securities, asset-backed commercial paper, or any of the sophisticated “paper” created during this bubble. With the very poor initial quality of so much boom-time lending, and with the dramatic deterioration in the general credit environment, there are enormous quantities of securities in the marketplace backed by weak (and weakening) underlying loans/collateral. It may be triple-A, but “buyer beware.” A few weeks ago I wrote a commentary (September 29, 2000-A Tale Of Two Bubbles) underscoring the extraordinary circumstance where the bursting of the technology bubble was occurring concomitant with a continued expansion of an historic real estate bubble. This unfortunate dynamic clearly continues. This week, Fannie Mae reported that it increased its mortgage portfolio by $12.6 billion during October, an annualized rate of almost 27%, and the largest growth since August of 1999 (which, by the way was a month where liquidity faltered within the credit market!). Interestingly, the average balance of “other investments” increased $4 billion to $59 billion. Average “other investment” balances have increased $9 billion (18%) in the last two months. Once again, it is the ironic and dangerous circumstance that heightened stress in the U.S. financial system leads only to greater excess from the mortgage finance superstructure. The real estate bubble grows by the month, greatly increasing the risk to the U.S. financial system and economy.