Oct 6, 2010

Why is gold and silver price going to rocket even further?

Collateralized debt obligation is now effectively worthless because the collateral behind the debt can no longer be collected. The banks cannot go and get it.

Let’s say you have 10 mortgages at $1 million a piece, the sum total of those mortgages are $10 million. So, the banks took the 10 mortgages and bundled them together into a collateralized debt obligation or CDO with a face value of $10 million.

They then sold that new entity that they created to an investment group of some sort, a pension fund, hedge fund, etc. promising them a yield of let’s say 7%. The sales pitch would emphasize the fact that this CDO was backed by real collateral. In the event of loan defaults by the borrowers, the banks would tell the buyer of the CDO that the collateral behind the loan could be sold to recapture any potential losses on the part of the purchaser.

Everything seemed to work fine until the defaults began and the foreclosure process kicked into high gear. The foreclosure process has exposed fatal flaws in the system and the flaw is that the banks cannot prove clear ownership of the mortgage.

Consequently, they are then barred from foreclosing on the property. Because they can no longer foreclose on the properties, the CDO is now effectively worthless.

The hedge funds and the pension funds cannot now sell these CDO’s on the open market, so how are they going to recover their original investment? Perhaps you may say that won’t be a problem because these instruments were insured. The problem is now the credit default swap or the insurance policy that was purchased to protect against default assumes that the insurer has the financial wherewithal or resources to make good on the claim.

If there were only a small number of these problem CDO’s this would not be an issue. But as the number of the foreclosures continue to skyrocket, and more and more banks are prohibited from seizing the collateral behind the property, the sheer magnitude of the number of claims presented to the insurer will overwhelm their balance sheet.

In effect what you have is an insurance company which doesn’t have enough money to pay off the claims. Compounding the problem is the fact that the CDO’s and credit default swaps related to these claims form a mass network of interdependence. This then ripples through the entire system and creates a domino effect which can cause the failure of entities creating the next financial crisis.

Ultimately the Federal Reserve will be asked to step in and buy up the now worthless CDO’s and put those on its balance sheet. In order to do this the Federal Reserve will have to engage in massive quantitative easing, taking onto its balance sheet the worthless CDO’s in exchange for newly issued treasuries.

This of course will have a horrific effect on the US Dollar which is why gold and silver are heading much higher.

Dan Norcini (JS Mineset)

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1 ΣΧΟΛΙΑ (COMMENTS):

Anonymous cash for gold UK ΕΙΠΕ (SAID)...

The Golden Rule is of no use to you whatever unless you realize that it is your move.

December 20, 2010 8:56 AM  

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