November 14, 2007
The SubPrime Pain: The Big Lie
Much of the roiling in the markets has been caused by a very simple lie: Many investors hold positions that were advertised as bankruptcy proof (very low risk) and found out, much to their anger and surprise, that the low risk promise may have been untrue. Their response is to flee the questionable positions and no wait for assuring claims of insurance or guarantees. There are several examples. First and foremost are those holding money market accounts who have found out that some of the commercial paper in the accounts was from SIVs issuing asset back securities. Surprise! They thought that commercial paper came from blue chip operating companies and that the default risk was negligible (only Penn Central has defaulted on its commercial paper). The response? Withdraw from money market funds and refuse to buy, even through, intermediaries, any asset back commercial paper. It is a rational response to having been misled. Similarly, E*Trade now has people moving deposits and investment accounts to other banks and to other brokers respectively because they have discovered that E*Trade has lost a boat load of money in CDO investments. Surprise! You might have to rely on SDIC insurance or on SIV insurance against losses. They do not want to claim insurance proceeds, they want their money in secure accounts as they were told they would be. So they flee. Those who offer the utmost security and then disappoint get severely burned, as they should.
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