Investment Landfill: The Ability To Market Toxic Bonds

Paul Tustain - Fri 06 Jul, 2007

It all starts with the mortgage. About six million people in the United States who have no money have borrowed about 100% of the value of a house, right at the top of a housing market which has since fallen sharply. These are the subprime borrowers. But it is not always easy to sell a package of these Mortgage-Backed Securities (known as MBS for short). Selling such a product demands that the credit quality is assessed; and because the underlying mortgages are subprime they are quite likely to go into default...In the market for CDOs, the investment bank will find it relatively easy to sell the investment grade bonds. They go mostly to respectable institutions. But the mezzanine and particularly the equity tranches can be trickier to dispose of. The effect of concentrating the risk, as well as the upside, in these tranches is to make them "hot" so hot, in fact, that investment insiders sometimes call them toxic waste. How can these toxic bonds be sold off? There are several ways.

THIS IS NOT the idle chatter of permanent bears. The
subprime mortgage collapse now hitting Bear Stearns may
be just the start.

Serious analysts from big investment firms are talking
ominously about "the big one". It will make you angry
to learn just how the investment industry has got
you involved.

If you can understand what's happening, you should have
time to move. So let’s get to the bottom of it now, and
in plain English.

It all starts with the mortgage. About six million people
in the United States who have no money have borrowed
about 100% of the value of a house, right at the top of a
housing market which has since fallen sharply. These are
the subprime borrowers.

The lenders, however, did not have to worry very much
about the risk of default, because they rolled these
mortgages into bonds called Mortgage-Backed Securities,
which they then sold. They got to be off-risk within a
few weeks, because by then these re-packaged mortgages
belonged to other financial organizations.

But it is not always easy to sell a package of these
Mortgage-Backed Securities (known as MBS for short).
Selling such a product demands that the credit quality is
assessed; and because the underlying mortgages are
subprime they are quite likely to go into default.

So a credit-ratings agency will only give the subprime
MBS a low credit score, which means it is not considered
investment grade. That disqualifies it from the
portfolios of many professionally managed funds.

This is where it pays to get a bunch of smart investment
bankers involved.

The investment bankers slice the MBS into several
“tranches”. These are known as Collateralised Debt
Obligations, or CDOs for short.

The idea is to create some higher risk assets and some
much safer ones by slicing up the MBS into what are
called equity (high risk), mezzanine (middle risk) and
the much sought-after investment grade bonds (low risk).
Higher risk equals higher returns, of course, so the
equity tranche of the MBS will earn the highest profits
if things go well. But if things start to go wrong, the
equity is lost first, and then the mezzanine. Even then,
the investment-grade bonds could still get fully paid
out. This persuades the credit ratings agencies to give
the lowest-risk tranche a high enough credit rating to
qualify for the critical investment grade rating.

In this way the investment bank has created a decent
proportion of highly marketable bonds out of a package of
low-quality mortgages. Fairly standard, for example, is
to convert a large package of MBS into perhaps 80%
investment-grade bonds, 10% mezzanine, and 10% equity.

The original mortgage lender is in a hurry to get
the whole MBS sold off, because this raises cash
which can then go to fund fresh mortgage loans to
new subprime borrowers.

The investment bank is well motivated to slice up the
MBS, because selling investment products is what it does
best. It won’t want to keep much, if any, of the newly
created CDO tranches, because investment banks earn their
money primarily by deal-making and distribution, rather
than by taking risks with borrowers.

In the market for CDOs, the investment bank will find it
relatively easy to sell the investment grade bonds. They
go mostly to respectable institutions. But the mezzanine
and particularly the equity tranches can be trickier to
dispose of. The effect of concentrating the risk, as well
as the upside, in these tranches is to make them "hot" —
so hot, in fact, that investment insiders sometimes call
them “toxic waste”.

How can these toxic bonds be sold off? There are
several ways.

The investment bank might choose to set up a hedge fund,
possibly even using some of its own money to get the fund
started. The hedge fund’s objective is to trade in the
high-risk equity and mezzanine CDO instruments.

Let’s imagine that the investment bank puts up the
first $10 million. The hedge fund then buys the
equity tranche of the CDO from the investment bank.
In effect, the investment bank is actually buying the
equity from itself.

With a bit of luck — and this is what happened over
recent years — the housing market then goes up. Now the
CDO equity is floating higher in the water, because
there’s a cushion of higher house prices preventing those
original subprime borrowers from defaulting. This rather
obscure equity instrument, which is not traded on any
open market, and so is not a liquid asset that can
readily be bought and sold, should now be worth more
than it was at issue.

It gets marked up in value, and it gets marked up much
faster than the underlying house prices, because all the
price volatility is concentrated in this thin slice of
CDO equity. The hedge fund is now a real performer! And
that means it will be rewarded by further investment from
outside. So what started as a vehicle with a little
investment bank cash can grow the funds it manages under
its own steam.

Next, and this is what hedge funds are all about, it will
leverage its risk, too. The hedge fund goes out to an
unrelated lending bank, holding its high-performing but
illiquid toxic waste in its hand, and it asks to borrow
money using the waste as collateral. The lending bank has
access to cheap money, and so it has the prospect of
lending for spectacular profits.

Now the MBS wheel is fully in motion. With a little co-
operation from the investment bank, to which it is
closely related, the hedge fund loses no time in marking
up the value of its equity CDOs, on the basis of rising
house prices. There is an overwhelming pressure to do so,
not least because the hedge fund managers are rewarded on
performance. Alas, in the absence of a genuine open
market, it is too easy to manipulate the CDO's price up
to an unrealistic value.

The lending bank can see its collateral floating higher
and higher in the water, and so it lends ever more cash
against it to the hedge fund, and it picks up the new
CDOs bought by the hedge fund as further collateral on
new loans. Naturally, as with all collateral, the bank
claims the right to sell the bonds if the underlying debt
gets into trouble. But it doesn’t look like a real danger
at this stage.

So the money lent by the bank against the CDO equity goes
back to the hedge fund, which buys more CDOs from the
investment bank, which buys more MBS from the mortgage
lender, which provides more money to subprime borrowers,
who then buy more houses, pushing real-estate prices
higher again.

This solution only gets into trouble when house price
turn sharply down. The lending banks ask for their money
back, but the hedge funds haven’t got it. All of it has
been invested in CDO tranches. So the collateral needs to
be sold. No problem, surely. It’s in the books at a few
billion dollars after all.

But with its concentration of risk in a falling market,
the equity slice has been haemorrhaging value, without
ever being bought or sold in an open exchange. It’s
incredibly painful for the investment banker to mark down
a paper price in these circumstances. First, he doesn’t
actually know for sure that the price is falling any more
than he knew it was rising when he marked the price up.
But he does know that marking the price down will
immediately be bad for him, his team, his bank, his
customer and everyone else. He doesn’t have to be totally
evil to put off marking down the price until tomorrow —
or maybe the next day.

That’s why the lending banks which later get hold of
their collateral can be presented with a very nasty
surprise when they finally try to redeem the situation
with a sale. It simply won’t fetch anything like the
price it was last marked at.

Something like this is what happened to Bear Stearns’
hedge funds. Its two funds were leveraged 5 times and 15
times respectively. That’s the number of times they went
round the financing wheel of leverage.

The smaller, more cautious fund had 5 times as much money
invested in CDOs as it had received from its hedge fund
investors in cash. This means that its balance sheet
may have looked like this:

Assets Liabilities

$5bn CDOs $1bn hedge fund investment
$4bn bank loans

Whereas the bigger fund was 15 times leveraged. So its
balance sheet could have looked like this:

Assets Liabilities


$15bn CDOs $1bn hedge fund investment
$14bn bank loans


So far, only the smaller hedge fund has been rescued and
we await developments on the larger one.

The picture that is emerging is that the providers of
the bank loans became increasingly nervous as US house
prices turned down, and they wanted their money. Clearly,
there were no cash assets in the hedge funds. So the
banks took hold of the CDOs — their collateral — and went
to sell them.

The first out of the door, rumoured to be Merrill Lynch,
mostly got the collateral it was owed, but it exhausted
the CDO market of buyers. The rest found no bids and
quickly stopped trying to sell for fear of advertising
the rock-bottom prices of something which currently sits
in many portfolios at funds all over the world.

Worse still, we are advised that the Bear Stearns funds
were not actually invested in the toxic waste. They had
bought the investment grade bonds. That clearly means the
toxic waste and the mezzanine bonds have no value. We do
not know who owns these.

“If it’s not these failing hedge funds who own the toxic
waste who does?” we asked another banker in a closely-
related business.

A core competence of investment banks in this market is
the ability to market the toxic waste, so it’s one of
their most sensitive commercial secrets. Our sources
would only hint at where the mezzanine and equity CDOs
are now sitting. We learned that at least some of it goes
into tame, largely unsuspecting, and almost always
“institutional” portfolios — the type of investment fund
which looks after your money and lazily signs an
indemnity to confirm to its brokers and banks its own
professionalism and awareness of risk.

The same source smiles wryly when asked how these
“investment landfills” get their daily value for the un-
marketable sludge. They phone their investment bankers,
and dutifully record in their bond valuation package
the numbers they receive back. They have no motivation
to do better.

That means some fund managers out there are habitually
reporting asset values which are a fiction, and we don’t
know who they are. It’s worth understanding that they are
giving us the chance to get out, provided we move fast.

Often the exit price of such a fund is based on the asset
value, and they have not yet recorded the worthlessness
of their CDOs. For the time being, therefore, this would
create the opportunity to do a Merrill Lynch, and get out
ahead of the crowd.

Method Two is frowned on, however, and rightly so.
Arguments of “moral hazard” demand that the investment
bank should hold on to some, if not all, of the riskiest
equity class.

The third method on the face of it seems to resolve this
question of moral hazard. It leaves the equity and
mezzanine tranches with their creator (the investment
bank) and thus exposes them to the possibility of being a
victim of their own poor judgment.

But we’ll see that it doesn’t quite work that way. You
didn't expect it would, did you?

To explain what happens, we need to delve deeper into the
workings of the credit derivatives market. It’s not hard
to understand, provided we stick with plain English.

We need to get to grips with the “synthetic” CDO; and for
that we need to understand its building block, which is
the Credit Default Swap (known as a CDS for short).
Here's how it works.

The investment bank is now the owner of the hard-to-sell
and risky mezzanine and equity tranches. Rather than
dumping them into landfill, it decides to retain them,
along with all the cash flows that they generate. But the
investment banker managing these CDOs also decides to
take out an insurance policy — just in case the home
loans go into default.

The investment bank pays an insurance premium to another
investment institution for underwriting the risk of the
underlying home-loans defaulting. Apart from a bit of
legal drafting, that's all there is to a Credit Default
Swap. In return for a cash payment, you swap the risk
of default.

These insurance premiums, paid to the underwriter of the
CDS, appear to the receiver as income - just like bond
interest payments. But unlike a standard bond, they are
paid without the receiver having to part with any cash
himself. It's income received without putting your money
at the disposal of the person who pays you. You are being
paid for accepting risk, not for lending money.

So you see, the investment bankers have been very clever.
They have said there are two components in a bond-
interest payment: a fee for the use of your money, and a
fee for the risk of default. The CDS simply separates out
the element for the risk of default.

The investment bank can have still more fun with this.
Because what the underwriting institution would see is
just a stream of income payments. And just like the
boring mortgage streams that we started with, these CDS
streams can be aggregated into a pool...then divided into
tranches with different risk profiles...producing the
magic of higher credit ratings for lower-risk
tranches...plus concentrated risk in new toxic waste.

If you can get a credit rating agency to assess these new
tranches you have created, then you have something which
looks like a CDO — and smells like a CDO — but which is
not now based on cash flows deriving from borrowed money.
Instead it is based on cash flows deriving exclusively
from insurance premiums that are paid to cover the risk
of mortgage default.

That’s how CDSs get packaged into what is known as a
"synthetic CDO", and the investment bank can sell them
for what appear to be fantastic yields. Here is their
pitch to investment funds that might be prospective
buyers:

"You used to have to give me all your money to buy a
boring old cash flow CDO, and then you were both lending
your money and accepting the potential risk of the
borrower defaulting. What I have for you today is the
ability to accept only the better half of that deal.

"This new instrument means you can keep your money where
it is, earning great returns in the stock market or
wherever you're currently chasing performance, yet you
will still receive income in return for underwriting the
risk on a package of credit default swaps in the
mortgage-backed security market.

"Look, I've got a great credit rating on this thing, and
because we have eliminated the cash-borrowing aspect of
the deal, I can sell you $1 million of synthetic CDO
income for just $200,000.

"You get no extra risk above what you’d ordinarily
accept, and a huge yield on your investment. You want
in?"

It's a really neat deal. The investment bank is selling
what the institution was already buying before - a steady
income, in return for underwriting the total loss if
there's a default. But now the risk of default is
dissociated from interest cash-flow. The buyer doesn't
need to give anyone the underlying cash lent. He can earn
part of the income those assets pay simply by promising
to stump up if there’s a default.

Meanwhile, the investment bank is now holding onto the
original CDO toxic waste. So to the untutored eye it
looks thoroughly responsible. But we now know better.
The important part of what it was supposed to hold onto -
the risk of default - has now been parked in the broader
financial markets.

Remember Lloyds of London?

The yield meanwhile looks irresistible. Of course it
does! The synthetic CDO packaging has allowed the
investment bank to sell something which previously it
would have had to buy.

It is selling to the highest bidder the right to
receive its mortgage default insurance premiums - so
the buyer is just another "investment landfill". He ends
up with what’s called a “contingent liability", a
prospective claim on other valuable assets in his
investment portfolio.

Why would any investment fund possibly fall for this
scheme? The modern fund manager has a powerful short-term
incentive to get a strong performance out of your
invested savings. If he gets 2% more than the next guy he
is a genius, and he will get more money under his
management, more fees, and bigger bonuses.

But do you remember Lloyds of London? It used to be the
world’s biggest insurance underwriter. The way it worked
was that rich individuals were allowed to keep all their
money invested in their favourite stocks and shares, but
they could also earn a second income from those assets by
pledging that same wealth to underwrite commercial
insurance risks which were sliced and diced by syndicates
on behalf of their members.

Many Lloyds members lost absolutely everything - houses,
furniture and indeed their life — when a series of
vicious insurance losses hit the world's insurance market
through the early ‘90s. Acquiring synthetic CDOs is the
modern professional money manager’s equivalent of being a
Lloyds member.

So you can see now how through the use of synthetic CDOs,
fund managers can underwrite credit default risk and
increase their income accordingly, without outlaying any
fund capital. But they are placing their fund capital at
risk. Your fund manager is a genius while there are no
claims. But if it goes wrong, your fund gets hammered.
These styles of risk expose whole portfolios, so a loss
to a subprime synthetic CDO could cost a fund its entire
holding of US Treasury Bills.

Now, just in case you thought the CDS and its packaging,
the synthetic CDO, were as ethereal as a financial
product could get, let’s fill in a few details and
take a few more steps along the road of infinite
credit expansion.

It was not long before the investment banking industry
had a “eureka” moment. They realised that actually
holding the toxic waste was unnecessary. By offering CDSs
and synthetic CDOs based on the worst possible companies
they could make fantastic profits. In effect they could
short-sell the bonds of the world's flakiest borrowers.

With it? These bright sparks started insuring against the
default on CDS which they didn’t even own! It’s like
noticing your friend is looking a bit ragged and taking
out insurance on his life for your benefit, without him
having anything to do with it.

When Delphi Corp, a large motor parts spin-off from
General Motors, got into serious trouble last year, its
bonds fell into default. Incredibly, more than 10 times
the nominal value of its bonds were then claimed from
investment institution underwriters, by bankers who had
insured against the default of bonds they didn’t own by
issuing Delphi CDSs.

This shows the perverse logic of the markets, which here
dictate that the synthetic CDOs which will be found in
the greatest numbers are the ones least deserving of the
credit rating they've been given. And as long as there is
demand for easy income there’s no limit to how many of
them may have been created.

The synthetic CDO market has shown truly remarkable
growth in recent years. Probably the most respected
issuer of statistics in international finance is the Bank
for International Settlements. On this link
http://www.bis.org/publ/qtrpdf/r_qt0506.pdf it says that
“credit-related derivatives rose by 568% in the three
years ending June of 2004.” That growth was nearly 5
times as rapid as the overall growth in over-the-counter
derivatives. By now you should be getting some idea of
why this incredible growth rate occurred.

During 2001-2004 interest rates around the globe were
deeply depressed as the world's central bankers tried to
reflate after the Dot Com bust and 9/11. Fund managers
were desperate for yield and the slump in equities had
destroyed stock-market portfolios everywhere.

Governments began trying to enforce investment prudence.
One of the things they did was require retirement funds
to make a better attempt to match their long-term
liabilities to their assets. Equities had suddenly and
spectacularly failed to do this. So legislation was
introduced which forced funds to buy investment grade
bonds. Offering a regular income with a very low risk of
default, investment-grade bonds looked to be the perfect
vehicle for institutions that must make regular payments
to the world’s pensioners.

It would have been thoroughly wrong of the investment
banking industry not to do its utmost to find a source of
top-grade bonds to satisfy this demand. Equally, it would
have been naïve of them to allow their competitors to
have the CDS and CDO market space all to themselves,
unchallenged.

So in essence, it was government interference in the
market which helped trigger the nascent CDS/CDO boom.
Banks were soon queuing up to create investment grade
instruments, and the income starved fund managers were
gobbling them up. They had to — because we, the public,
don't buy underperforming funds.

Want proof of what has been going on? One of the
mysteries of recent years (to us anyway) has been the
progressive narrowing of credit spreads.

Four years ago, dodgy bond issuers would have to offer a
much higher yield than US Treasury Bills to get people to
buy their debt issues. On average, since 1970, Fairly
Flaky Debts Inc. — with a credit rating of BAA
investment-grade — would need to pay almost exactly 3%
more than T-Bills each year to its bond holders.

This difference is known as the “credit spread”, and that
extra income of 3% covered the fact that once every
thirty-five years or so, companies like Fairly Flaky
would fail and cost the bondholders 100% of their money;
that's your money if the bondholder happened to be your
fund manager.

Yet by November 2006 bonds issued by Fairly Flaky Debts
Inc. were yielding less than 1% above US Treasury bills.
The risk premium had disappeared. Why?

The reason is that it had become easy to distribute
default risk to income-hungry institutions. Investment
banks had a risk-free bet, known as a credit arbitrage.
They could borrow cheap money from Japan (that’s another
story, but there’s plenty of cheap money about outside
Tokyo too) and buy Fairly Flaky’s bonds. They would then
issue new CDS to income-hungry funds to offload the risk
of default.

After checking the credit rating the income hungry fund
would accept a rock-bottom premium of about 1%, so the
bank would be silly not to keep buying Fairly Flaky bonds
yielding 3% above T-Bills until the yield dropped to T-
Bills plus 1%. It works as long as they can dump the
credit risk into landfills by selling more CDSs.

That’s why the Credit Spread, otherwise known as the risk
premium, has now shrunk to a third of its long-run value.

The credit ratings agencies were obeying their standard
model of evaluating risk on the basis of recent historic
rates of default. That skewed the results, because of
course there were almost no defaults in the previous 20
years. Nobody leaves their debt unpaid when the securing
asset has risen in price much faster than the value of
the debt.

That meant that the rating would be unlikely to fully
factor in the risks of a housing price correction such as
the one we have seen recently in the US.

Who is going to fail next?

We have hit upon a very rough and questionable method of
identifying the next big failure in the CDO/CDS market.
It may be coincidence, but if we had used this method a
few months ago, it would have shown us to look first at
Bear Stearns.

Why? Our sources indicate that Bear Stearns only has
problems with those CDOs issued in respect of Mortgage
Backed Securities created in 2005 and 2006. This is
logical. Those CDOs were issued nearest to the peak of
the US housing market, so they have the least float.
Older CDO issues should have more headroom before
defaults become a problem.

This would suggest that it is those firms who were late
to the CDO party who should be in the deepest water. The
following data was published by Standard and Poors in a
2005 report entitled “CDO Spotlight: Update To Sizing
Collateral Manager Participation In The US Cash Flow
CDO Market.”

This table shows the ranking — by size of liabilities —
of CDO managers at the end of 2004 and in the autumn of
2005. Bear Stearns jumped from nowhere to 13th place.
It was late to the party, in other words. But it got
busy very fast.

Overall Largest Managers by Size of Liabilities

Year-end Sept. Manager Liabilities
2004 30, 2005 (bil. $)

1 1 CW Group Inc. 22.00
2 2 Babson Cap Man LLC 12.53
17 3 Duke Funding Man LLC 10.45
6 4 Credit Suisse Alt Cap 9.97
5 5 BlackRock Fin Man Inc. 9.49
3 6 Brightwater Cap Man 9.10
4 7 Pacific Inv Man Co. LLC 8.84
13 8 Vanderbilt Cap Advisors 6.57
8 9 Prudential Inv Man 6.53
12 10 Deerfield Cap Man LLC 6.05
7 11 GMAC Inst Advisors 6.03
9 12 ACA Capital Holdings 5.87
— 13 Bear Stearns Asset Man 5.77
23 14 Sankaty Advisors LLC 5.54
11 15 Fortress Inv Group 5.46
14 16 Highland Cap Man L.P. 4.98
10 17 Structured Credit Ptnrs 4.96
16 18 INVESCO Snr Scrd Mgt Inc 4.89
15 19 Western Asset Man Co. 4.73
18 20 RiverSource Invs LLC* 4.67
— 21 Aladdin Cap Man LLC 4.28
— 22 Paramax Cap Group 4.27
20 23 C-BASS 4.27
— 24 Declaration Man & Res LLC 4.14
25 25 Ares Management LLC 3.94

We do not pretend to understand these statistics fully,
and we strongly advise anyone to look at the original
report. What is of interest is that the data seem to
illustrate how Bear Stearns aggressively sought market
share starting in 2005, which could be why it found
itself one of the first to be in some trouble.

If that is true, then the data might point to some other
coming failures. It would be a remarkably prescient
analysis by Standard and Poors if that were to be the
case. But of course it might be complete coincidence,
too. Maybe Bear Stearns has better risk management, and
so it is first to see where things are going wrong.
Maybe other providers adopted different measures to
protect their exposed funds. Who can tell?

By the way the data only concerns cash-flow CDOs. The
synthetic part of the CDO market is not included. The
synthetic market is bigger.

Long Term Capital Management failed in 1998. It was the
last truly serious financial collapse which threatened
the financial system. When LTCM went under, the bail-out
fund required was $3.65 billion. The fund itself was
leveraged to about $125 billion of assets using a similar
style of wheel financing to the one described above for
Bear Stearns’ hedge funds.

There was also the presence of off-balance sheet devices
called interest rate swaps — not so different in
principle from the CDS described above.

Last week’s rescue package announced for Bear Stearns
smaller fund has been announced at $3.2 billion. We are
awaiting the figures for the larger and more serious
case. We believe the overall liabilities of both funds
are in the $20-$25 billion range.

Back in 1998 LTCM was ploughing a lonely furrow. Its
investment view was something to do with Russian bonds
and the Japanese Yen. It was off the main investment
spectrum, and there were few copy-cats putting the same
market view into action in the same way.

That is where things are very different this time. The
data produced by Standard and Poors above show just how
conventional a strategy Bear Stearns has been following -
all of it trailing the worldwide boom in housing markets.
Many banks and funds are involved. Perhaps they are not
quite so exposed as Bear Stearns, but it is only a matter
of degree. This makes the size of the problem potentially
much larger, and of much greater risk to the whole
financial system.

How large? Well - the equity lost can be very roughly
estimated from first principles. There are about
6,000,000 subprime mortgages in the USA. They typically
result from re-financing deals - topping up to utilise
whatever equity has accumulated in a house usually to pay
off credit card debt; so they stay near 100% outstanding.
The average house price in the USA is about $190,000, but
we can reduce that to $150,000 on the assumption that
we're at the lower end of the market. That gives us a
principal sum of $900,000,000,000, which is 7 times the
size of the LTCM exposure. But the more serious figure -
the housing equity lost to falling prices - is currently
estimated at approaching 8% which is $72 billion, not
including an adjustment for synthetic CDOs created by
investment bankers to short the weakest MBSs – as they
did with Delphi.

Now you can see the difference in scale between LTCM and
the subprime bust. This may be 20 times worse than LTCM.
And it's getting worse - daily.

At a time like this, we should not underestimate the
skill of people like Ben Bernanke at the US Federal
Reserve in underpinning the financial system. They have
been remarkably effective at organising the lifeboats
over many years and many crises. On the other hand the
Bear Stearns episode could be the beginning of wider
systemic difficulties.

Here at BullionVault we think the Bernankes of this world
will one day fail.

The result will be a credit squeeze. Bond issues will be
pulled, bank loans recalled, and business activity will
sharply decline for lack of funding. The first two of
these have certainly started — with a rash of failed
issues at the end of June. Will these risks be
contained? We don't know.

We don’t seriously expect that by some fluke we will
identify the tipping point as it happens; that would be
too lucky. Yet we feel compelled to share our views on
the current situation with you. Clearly we’re biased
against excessive leverage, and against too much
financial ingenuity, too.

That’s why we’re in the physical gold bullion business.
We believe that real physical gold is a sensible
insurance against today's increasingly weird financial
system. It has been astonishingly reliable in that role
in the past.

But this time, who knows?

Regards

Paul Tustain
For The Daily Reckoning 

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