Debt Views

As the tangled tentacles of this latest investment mania slowly unwind, the details that have made the contagion so far reaching are beginning to ooze out to the public. And the details are quite amazing–with complex investment pyramids built on the back of a corporation’s or consumer’s promise to pay, the debt leveraged over and over again. Billions of dollars are gambled on this rather unstable structure, a pattern that has played out time and time again within the financial markets over the years.

Generally these cycles begin with a reasonably stable investment vehicle that earns investors a bit more than the average yield with a slightly higher risk level. As these early investors turn a tidy profit, the word begins to spread about the latest investment opportunity. Then, as demand grows, the speculators arrive on the scene and the mania begins.

Above average returns are no longer enough, as speculators seek to bid prices up for a higher profit margin as they buy and sell these investment vehicles. Investment funds of all types with ever more creative configurations appear. Soon, these investment vehicles are inflated in price, and the complex manipulations of speculators have multiplied the risks of investment. Of course, profits are inflated as well during this period, blinding many to the building risk.

Everyone involved is making money, and so, the bubble rises. Naturally, seasoned speculators realize that these bubbles are not sustainable, and bail out as the bubble nears the bursting point, leaving the profit drunk investors that came after them to lose their shirts as the market collapse begins.

Of course, this pattern is evident in the recent housing and sub-prime lending events, as speculation drove both of these markets to the breaking point. Mortgage backed investments are no longer just a fairly low risk bet that Uncle Joe will pay the mortgage to keep a roof over the family’s head, now involving notes that are sliced and diced, then packaged with riskier loans and passed through multiple layers of investors, the profit and risk growing as they move further and further away from their original source. Meanwhile, these investments are traded as if they were currency, permeating nearly every area of the American economy, as well as spreading throughout the global economy.

Hybrid securities, the endless acronym laden varieties of mortgage backed bond and funds — PCs, CMOs, REMICs, ETFs, and so on, into infinity it seems — and other mortgage related investment vehicles have evolved into such a tangled web that no one seems to know for sure who owns what and what it is all worth these days. Hedge funds and investment banks either don’t know or are not admitting how much exposure they have to devalued mortgage investments. Investors who try to foreclose on mortgages they thought they owned have run into trouble, as they find their investments have not been properly documented, as sloppy bookkeeping flourished during the frenzy.

Now, at the end of the road, there is a great show of head scratching and bewilderment that all has gone so wrong, as if we hadn’t built these paper pyramids and watched them collapse many times before. The obligatory hot air is blowing in Washington about investigations and new regulations, and of course, the usual unproductive Congressional hearings. And, almost before this crisis became apparent, the speculators were on to the next bubble, replacing debt based investments in mortgage notes with those related to credit card debt, a market which is already showing ominous indications of becoming the next pyramid to collapse into a heap of worthless paper for taxpayers to sweep up.