In mortgage originations they said that they can't compete with others on hybrid programs. As hybrid loans (5/1, 7/1) are the most popular basically their reply was "we can't compete".

I didn't listen to the WAMU call, but that sounds to me just like the big pile of horsehocky depositories always serve up, and WAMU in particular. They decided a couple of years ago that they "couldn't compete" on good old vanilla hybrid ARMs with a long enough initial fixed period to keep the borrower out of the soup--and I grant them that competing in that market is extremely difficult--so they solved the problem by originating the biggest pile of Option ARMs history has ever seen. (They might be second to Golden Worst. I can't remember today. Anyway, they led the charge into that product.)

"We are working with the regulators to clarify some issues." I bet they are. Like how much trouble they're in for "discovering" that they had been "accidentally" using the wrong payment to qualify Option ARM borrowers for 18 months--the same 18 months that now turns out to look like the top of the RE market.

Never ever underestimate how sloppy a big fat bank can be. I can't believe the market is going to be done beating up on WAMU any time soon.

ild noted that WaMu apparently didn't participate in the recent "business at any cost" push, and that means losses now, but possibly less bad news in the future (as compared to less prudent lenders).

ild might want to check this out: WaMu's New Strategy Raises Credit Risk

I don't think WaMu was one of the worse, but they have plenty of dirty laundry and their share price is only just starting to take a hit. I remember how Yahoo protested that the dot-com debacle would leave them untouched, and Yahoo was a much safer bet then than WaMu is today.

I'd beleieve Citigroup and JP Morgan might get through with a sratch or two, and the big regionals might weather minimal damage, but not one of the biggest lenders POAs, especially one that's admitted that for over a year, they were qualifying borrowers based on teaser rates.

See, what was really happening was the houses were making the loan payments not the people. The owners were just the agents in some mechanical self-perpetuating process offloading the predictable equity increases to the lender.

Now that the house has stopped coming home from work everyday with a big armful of cash, the poor homeowners don't know what to do.

Thanks dr strangelove great post.

Ya trying to fit straight lines where curves should go can get exciting. I started my career as a chemical engineer where there are lots of messy non-linears with hidden or unknown factors & relationships. Pushing those systems to stand in a straight line will get you a whole lot of pookie on the floor - I know for a fact.

But the hedge fund guys are smarter than engineers so we'll all be okay.

Those of us who took physics rather than chemical engineering would say that there are nonholonomic constraints.

dr stangemoney,

Thanks to Black and Scholes, finance thinks it has mastered the mathematics underlying risk...

I think that's the crux of the banks' situation too. They say their risk modeling is so much more sophisticated that subperimes can jump from 8% to 40% of the market in 5-6 years and no change in risk has occurred, likewise the jump in option ARMs, and 100% financing....

I have read up some on the hedge fund situation, but it seems while the possible risks are near limitless, the funds and the industry as a whole are nearly opaque. Plus you can't buy puts on them.

The best argument I've seen that hedge funds aren't as risky as some fear, is that they don't represent an asset class. They are involved in all sorts of bets on all sorts of assets/futures, etc. For instance, Amaranth's pain equalled others' gains. Of course, most of the people sanguine about the hedge fund industry were shocked that Amaranth hadn't managed risk better.... But it did look like the people who had extended them credit came out OK.

I guess the question is how many hedge funds taking similar positions need to blow up before we find out if JP Morgan and Citigroup have managed THEIR risk properly.

Clearly, risk has been discounted all up and down the line, from the person taking out an option ARM assuming they can refinance their way out of it, to the European investor buying subprime mortgage-backed bonds.

Looking at it as an investor, where can you make your bet? Top of the list would have been to been to buy Credit Default Swaps, but that's a little out of my league. Options on publicly traded banks are next. But some aren't available, some are already priced for a fall, some have already fallen, etc.

My feeling about WaMu is that they are definitely going to take a fall sometime over the next couple of years. I think it will be fairly severe, but maybe just moderate. It their share price falls just 6%, my puts break even, if they fall 10%, my puts make 10%, if they drop 20% I make 50%...

Of course, if things turn out rosey and their share price jumps just 5%, my puts are down 50%...

If the big catastrophe comes, with hedge funds exploding, etc., it will only help my puts, of course, that may be small consolation.

vicjim,

One big vulnerability I've read about is the backlog in processing the paperwork for derivatives in general and credit default swaps in particular. The worry is that some large event would trigger a lot of unwinding of positions and the system couldn't deal with it. But they seem to be moving towards automation. In the Financial Times:
Derivatives dealers' tough match

I think WM faces more immediate problems.

Just to save people the effort:

Nonholonomic: "In physics and mathematics, a nonholonomic system is a system in which a return to the original internal configuration does not guarantee return to the original system position. In other words, unlike with a holonomic system, the outcome of a nonholonomic system is path -dependent, and the number of generalized coordinates required to represent a system completely is more than its control degrees of freedom(sometimes called differential degrees of freedom, DDOF). In addition to the motion variables corresponding to the control degrees of freedom,the history of its motion too should be known.

For example, in the case of a vertical wheel which can spin as well as rotate about a vertical axis passing through its centre, the knowledge of these two variables (control variables) need not give a knowledge about its precise position from an inertial frame of reference. Similarly,when riding a two-wheeled cart (often confusingly described as a "unicycle-type vehicle"), a return to the original internal (wheel) configuration does not guarantee return to the original system (cart) position.

Nonholonomic systems exist in at least three cases; Rolling, systems with inequality constraints and systems with constraints on velocity.

Cars, bicycles and unicycles are all examples of nonholonomic systems.

The branch of mathematics dealing with nonholonomic systems is known as sub-Riemannian geometry."

Interesting concept. Chemistry has 'analogs' but I'd never heard that term.

I guess I'd liken it to 'walking cats backward'. Good luck.

These hedge fund types got cats?

dryfly:
It's actually
Dr Strangemoney or: How I Learned to Stop Worrying and Love the Dollar
(think greenspan deep underground with 10 supermodels repopulating the earth)
Ironically (or not?) flouride is bad for the brain.
Fluoride Health Effects Database
And it inhibits nerve growth factor from binding to receptors.
Phenylmethylsulfonyl fluoride (PMSF) inhibits nerve growth factor binding to the high affinity (type I) nerve growth factor receptor

Bob_in_MA:
If hedge funds were just hedging, then I think the fact that they are "diversified" across many asset classes would distribute the impact of any shock like bankruptcy. But instead, they use incredible amounts of leverage, which increases the size of the shock. If I tie myself to N other people and jump off a building it is possible we all survive or we all end up dead. While my downward force is distributed over each rope and therefore reduces the likelihood of death, if there is a little kid on the other end of one of the ropes he may also fall, which might be enough to bring down another, etc. Let's hope that there are no Andre-the-Giant's standing on their tiptoes in stiletto heels.

Another lender confesses: I had to go Google "Andre the Giant." For someone who doesn't get out much, I don't get out much.

if there is a little kid on the other end of one of the ropes he may also fall

Let them eat their young

I try very hard not to inject politics into CR discussions, since it's so refreshing to find a place on the web where pointlessness doesn't degenerate into flame wars faster than you can say "nonholomonic constraint." That said, I am reminded of the Freeway Blogger's Halliburton sign: "Thanks for all the money! Sorry about your kids."

Some days, reading the news and contemplating the federal government debt situation, I find good old bond market cliches like "eating your young" (and "falling on your sword") to be less entertaining than they used to be.

Don't get me wrong: I'd be all in favor of just standing around letting lenders jump off the ledge without a rope--they made their beds, to mix metaphors--if there were no innocent bystanders underneath for them to fall on.

CR, I know it's a lot of work for you, but could we have some Sasha? I know I need it.