Monday, August 20, 2007

Where's Waldo?

Via Calculated Risk, Bill Gross of Fortune describes the subprime mess as a huge game of Where's Waldo:

The bond and stock market problem is the same one puzzle players confront during a game of "Where's Waldo?" -- Waldo in this case being the bad loans and defaulting subprime paper of the U.S. mortgage market.

While market analysts can estimate how many Waldos might actually show their faces over the next few years -- $100 billion to $200 billion worth is a reasonable estimate -- no one really knows where they are hidden.

First believed to be confined to Bear Stearns's hedge funds and their proxies, Waldos have been popping up with regularity in seemingly staid institutions such as German and French banks, and that has necessitated state-sanctioned bailouts reminiscent of the Long-Term Capital Management crisis of 1998.

IKB, a German bank, and BNP Paribas, its French counterpart, encountered subprime meltdowns on either their own balance sheets or investment funds sponsored by them. Their combined assets total billions, although their Waldos are yet to be computed or even found.

Those looking for clues to the extent of the spreading fungus should understand that there really is no comprehensive data to allow anyone to know how many subprimes actually rest in individual institutional portfolios.

Regulators have been absent from the game, and information release has been left in the hands of individual institutions, some of which have compounded the uncertainty with comments about volatile market conditions unequaled during the lifetime of their careers.

Also many institutions, including pension funds and insurance companies, argue that accounting rules allow them to mark subprime derivatives at cost. Default exposure, therefore, can hibernate for many months before its true value is revealed to investors and, importantly, to other lenders.

The significance of proper disclosure is, in effect, the key to the current crisis.

News comes today that Deutsche Bank tapped the Fed's discount window over the weekend for a loan.

Have we found another of Waldo's hiding spots?

The Financial Times says Deutsche Bank was simply trying to show support for the Fed's move to combat the credit squeeze.

Maybe that's so.

Probably it is.

But as Bill Gross notes, with little regulation, no transparency, and information release left up to the the same institutions who have made billion-dollar mistakes, it's hard to say.

And that's the real problem.

BNP Paribas said one week that they had little exposure to the subprime mess.

The next week, they had to be bailed out because several of their funds had melted down from the subprime mortgage mess.

IGiven the amount of hidden Waldo's out there, it's hard to believe anything you hear from any of these institutions.

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