Saturday, October 4, 2008

What a hell happening in Wall Street? - Part 2

In the earlier posting, we talked about list of investment banks and how they were affected by subprime mortgage crisis and what happened to them.

Before getting into this further, i am going to explain what is subprime mortgage crisis and about bear stearns, which was missed in the earlier posting and then followed by sequence of events happened after that.

Mortgage backed securities(MBS) are investment instruments available in the financial market through investment banks, which are nothing but bond by owner of the home to repay the home/mortgage loan to the lending institution(commerical bank) along with interest rates. There is no collateral to be submitted by borrower and the home bought buy him going to act as collateral and taken over by the bank in case if he forecloses(not able to pay back) the loan. This kind of securities are classified based on loan defaulting risk of the borrower and available in the stock market. Higher the risk, higher the return.

Sub-prime mortgage investment instruments are the ones with higher risk. During the year 2005-2006, there was a housing bubble in the US (i.e) Value of housing assets were overpriced and the price correction for the same happened latter resulted in fall of the asset value. This made the owner of the asset to default the loan since their asset value is less than loan payback value. So ,commerical banks and investment banks who owns these asset in one form or another(collaterals/securities/infrastructure funds/real estates), ran into deep problem called sub-prime mortgage crisis.

One among the investment banks, 85 years old Bear stearns ("Most Admired" securities firm in fortune's "America's Most Admired Companies" survey)who had high exposure to this crisis, started collapsing during march 2008 and went for filing bankruptcy. It was then bought by JP Morgan chase for $10 per share(initial quote was $2 per share and latter it moved to $10 to save the bear stearns investors)

Next, Fannie Mae and Freedie Mac are the liquidity(funds) providers for the mortgage based lending institution and added to that they were selling MBS to investors. So ultimately they had the exposure to this crisis and they are now under the control of government who took the major portion of the preferred stocks in these company as collateral and provided them $100 billion to each as bailout(funds as loan) to go ahead with their operations.

Next, AIG, one of the biggest insurer in the world who have clients across 130 countries who insured consumers, business, MBS, hollywood movies etc.. also got affected by this mortgage crisis. They got $85 billion as bailout by providing around 80% stake as collateral and they need to pay 12% interest on bailout. If this insurer was not saved as Lehman brothers by FED then lot of business insured by them would had got affected resulted in global economic meltdown.

Next, Washington Mutual(WaMu), 119 years old savings and loan bank closed by the government, the largest bank failure in the US history and its asset were sold to JP Morgan Chase for $1.9 billion on the same day of closure.

Next, Wachovia securities, the bigger one in the U.S east coast with around 3,400 branches. Citi who was ready to take over only securities division for $2.2 billion with guarantee from the government for the $312 billion wachovia mortgage asset. But Wells fargo & co who have huge client base in the U.S west coast comes up with $15 billion bid for the entire wachovia includes brokerage, securities and investment banking division. Citi or Wells fargo?
Lets see what happens..

What about to recently turned bank holding companies such as Goldman sachs, Morgan stanley. Whats happening with them? They are right now busy, looking for national banks with troublesome mortgage assets and taking them at cheaper price. Recently, Goldman took ohio national bank and looking for somemore troublesome assets.

Watchout for more here with respect to $700 billion bailout from government and US economy now.

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