Experts Explanation PDF

Reading Two:
The Subprime Crisis Is Just Starting

(A Mortgage Derivatives Risk Primer)
Copyright 2008 by Daniel R. Amerman, CFA, All Rights Reserved.
MortgageSecretPower.com
Turning Inflation Into Wealth Mini-Course Page 2
Overview
As a $700 billion proposed bailout of the American financial

sector is implemented, there are many instant “experts” telling the
nation that $700 billion is excessive, the risks aren’t that bad, and that
bailout may even be lucratively profitable for the federal government.
As the author of three books on mortgage finance and related
derivative securities, and speaking as someone who first turned
mortgages into rated securities in 1983, let me suggest, respectfully,
that even the most basic actual knowledge of mortgage securitizations
is enough to show that market losses may get much worse.
Below is an easy-to-understand mortgage derivatives risk

primer, titled “The Subprime Crisis Is Just Starting”. As you will see,
in the months since publication in March of 2008, one of the three risk
factors I wrote about, a further decline in housing values, did occur.
The decline in housing values did substantially increase subprime
mortgage losses, which then led to the effective collapses of Fannie
Mae and Freddie Mac, and the near collapse of Wall Street as a whole.
As predicted in the primer, this is leading to a massive bailout, which
is leading to the predicted assault on the value of the dollar. However,
two of the three major risks explained have not yet hit the market –
though there is good reason to expect that each may do so within the
year. If either risk factor hits, or worse, they hit in combination, then
mortgage losses may get much, much worse than what we are seeing
today.
A1008 MortgageSecretPower.com
Most of the primer below is just as written below six months

ago, however comments and updates have been added in italics, as
well as an extensive new discussion and update at the end.
The Subprime Crisis Is Just Starting
I’m going to let you in on an unfortunate little secret – the real

subprime mortgage securitization crisis may not have even started
yet. But, there is a good chance the real crisis will arrive soon.
This assertion that the crisis could just be getting started may
seem absurd and extraordinarily out of touch. What about the
approximately 45,000 homeowners losing their homes to foreclosure in
the United States every month? What about the 8.9% plunge in
nominal housing prices in 2007, the largest decline in over 20 years?
What about Bear Stearns losing 94% of the value of its stock in 2
days, with even the remaining 6% in value being based on an
unprecedented loan from the Fed before JP Morgan would agree to the
acquisition? How much worse could it get? (Unfortunately,
September 2008 provided the answer, or at least, the first stage.)
To understand the full extent of the danger requires moving

beyond current headlines to take a brief and simple look at how
mortgage securitizations actually work. These securitizations are
based on what are known as “stress tests”, or the ability of a security
to withstand an adverse economic change and still pay principal and
interest on schedule. The heart of the subprime problem is that no
major stress tests happened in 2007 – and the market still blew up.
Which brings up the question of what will happen to subprime and
other mortgage derivative securities in 2008 if actual stress tests do
occur in such possible forms as recession, increases in interest rates,

or a further plunge in housing values? Given that the safety margins
have already been stripped bare? As we will explore, should one of
those stress tests occur – or worse, if two or three occur together –
then we may look back at 2007 as being a mere stroll in the park in
comparison.
The Lack Of A Problem
To explain what I mean about nothing going wrong, let’s review

a bit of ancient history, and talk about how ratings and securitized
mortgages used to work. You started with a creditworthy borrower,
and a significant piece of equity invested in the property. The
assessment of “creditworthy” was not a guess or an experiment, but
rather the result of decades of underwriting experience on a national
basis, through good times and bad. With single family mortgages, you
had a large pool of such creditworthy borrowers, each having equity in
their properties.
Then, you applied what are known as “stress tests”. A stress

test is the assumption that something goes wrong. For instance, you
might assume that there was a recession that would lead to
homeowners losing their jobs, and then their homes. If rising interest
rates hurt the security, you would check out some rising interest rate
scenarios, and if falling interest rates hurt the security, you would
check out some falling interest rate scenarios. Essentially you would
push on the security until it fell over (using financial modeling).
The rating was simply a description of how hard you had to

“push” before the security fell over and was unable to make
contractual principal and interest payments to investors. If the ability
to make payments was a bit shaky under the current economic
environment, then the rating was junk. If the ability to repay
investors was pretty good with a decent economy, but possibly grew
problematic with a mild recession – then maybe you got the lowest
investment grade rating, that of “BBB”. The highest rating, “AAA”,
was reserved for those securities that had such powerful coverage and
reserves built into them that they could withstand another Great
Depression, and still make investor payments in full and on schedule.
(Or so the theory went until Wall Street got collectively “brilliant” a few
years ago.)
The Theory Of Turning Subprime Mortgages Into Wealth
To understand how the subprime debacle came about, we need

to understand the reasons why supposedly prudent lenders would lend
money to people wanting to buy houses, who, unlike our examples
above, had neither equity nor a good credit history. The essence of
the theory is that you charge a high enough interest rate, then you
can cover the losses, and still walk away with way more money than if
you had been doing ye olde traditional and boring strategy of lending
to credit worthy borrowers with actual equity in their homes. A simple
version of the numbers is something like what is illustrated in Scenario
A, “The Way It Was Supposed To Work”:
Scenario A: The Way It Was Supposed To Work

Changes: None From The (Flawed) Theory
Initial Teaser Rate: 6.0%

Full Rate After Adjustment: 10.0%
Assumed Losses:
Annual Foreclosure Rate: 8.0%
Loss Per Foreclosure 30.0%
Foreclosure Losses: 2.4%
Interest Rate After Foreclosure Losses 7.6%
AAA Rate For Investors, Plus Expenses 4.8%
Incentive To Do Transaction 2.8%
Size of Market: $1,200,000,000,000
Annual Incentives: $33,600,000,000

Total Incentives (7 year average life): $235,200,000,000
This Chart is for illustration purposes only, and contains MANY simplifying assumptions!
Copyright 2008 by Daniel R. Amerman, CFA, InflationIntoWealth.com
The theory was that if you lend to people who don’t have
particularly good credit, and who didn't put much equity (if any) into
their homes, then sure, foreclosures were going to happen, and at
rates well in excess of national averages. In this case, for illustration
purposes (there were many kinds of subprime mortgages securitized
over the years, this is just one round number example), we are
assuming that 8% of the mortgages go into foreclosure every year,
and we assume that the loss per foreclosure is 30%, so there is an
annual loss of 2.4% on a large pool of mortgages. If you were lending
at the same low rates that a highly creditworthy borrower can get,
then this 2.4% annual loss would be a bad thing. But, if you are
lending at a rate that is much higher than the market for "good" loans,
and through securitization, you can get most of your funding at “good”
loan rates, (the 4.8% for “AAA rates” plus expenses in our example) –
then that 2.4% annual loss is no big deal, and in fact leaves a lucrative
amount of money for you and others to keep.
In our example of how things were supposed to work, that 2.8%

annual incentive with a $1.2 trillion market worked out to over $33
billion a year in incentives to securitize subprime mortgages. This was
money that would be split many different ways: mortgage banking
fees, investment banking fees, high yields on junior classes for hedge
funds and other aggressive investors, bond insurance payments, and
some of the most lucrative rating agency fees (to assure investors the
whole thing would work) that have ever been seen in the capital
markets. Multiply times seven for an average mortgage life, and we're
looking at almost a quarter of a trillion dollars to be split, much of it
just for massaging some numbers on a computer.
That was the theory, but there proved to be some complications

in practice. The sources of these problems were myriad, including:
underwriting people who could barely qualify for the teaser rate (while
ignoring whether they could handle the full rate when the reset
occurred); taking the thinnest of statistical histories, and creating a
huge new market from the selective interpretations that allowed the
deals to get done; ignoring the due diligence reports if you didn’t like
them, and a number of other reasons that could all be summed up as
the intersection of hubris and greed. The reasons are not our focus in
this article, but a simple illustration of a general result is included
below (this is an illustration, and does not purport to be an accurate
statistical summary of the current market):
Scenario B: What Happened (Oversimplified)

Changes: Higher Foreclosures & Losses

Assumed Losses:
Incentive To Do Transaction -2.3%
Size of Market: $1,200,000,000,000
Annual Incentives: ($27,600,000,000)
As illustrated in Scenario B, if it turns out that foreclosures are

15% instead of 8% for a particular grade of subprime, and foreclosure
losses rise to 50% from 30% because so many people are getting
foreclosed upon that it drives home prices downwards – then instead
of splitting 2.8% of the excess profits in each mortgage pool, the big
financial players are splitting a 2.3% loss. Meaning $27 billion in
annual losses instead of $33 billion in profits (in this illustration, which
does not purport to be an industry summary). While bad enough on
its own, the losses showed that the securitization didn’t work, the
ratings didn’t work, and the bond insurance might not work either.
Which then collapsed the prices in the market to a far greater extent
than mere foreclosure losses to date would justify alone, as discussed
in the “Leveraging Up The Losses” section of this article.
The higher than expected losses did something else as well,

something that truly made sophisticated investors nervous. Because
the system failed with no genuine stress tests, and the layers of
protection that were intended to insulate investors against adverse
economic changes melted down – investors were left naked and
exposed. Vulnerable to any adverse changes, as we illustrate in the
next four charts below.
(Fall 2008 update: this principle is crucial to understanding the

current risks, as the safety margins are now gone with not only the
$1.2 trillion subprime mortgage derivatives market, but are now paper
thin or gone altogether with the overall mortgage markets. According
to the Federal Reserve, the current total amount of US residential
mortgages outstanding is about $12 trillion. So, to roughly convert
the increase in risk, multiply the negatives time ten for the rest of the
article.)
Scenario C: Recession
Changes: Double Foreclosures, Higher Losses

Assumed Losses:
Interest Rate After Foreclosure Losses -8.0%
Size of Market: $1,200,000,000,000
In Scenario C above we assume that a recession hits, something

that is almost certainly already happening. People in marginal
economic circumstances tend to be the most vulnerable to recessions,
and there are already a surplus of properties on the market. So if we
assume that a recession doubles subprime foreclosure rates, from
15% to 30%, and increases the loss per property from 50% to 60% as
still more homes hit the market, (banks lose far more money in a
foreclosure than just the decline in overall property values would
indicate), then because we have no safety layers left, all the negative
results go straight to the bottom line. Meaning that losses just went
up by a factor of five, with over $154 billion in losses in the
first year. In other words, what we saw in 2007 was nothing
compared to what 2008 may hold for investors if a recession hits the
nation. (Please note these are illustrations rather than precise
predictions, a mild recession might inflict less losses – and a severe
recession much worse.)
Scenario D: Higher Interest Rates

Changes: Double Foreclosures, Lower Losses

Assumed Losses:
Size of Market: $1,200,000,000,000
Recession is not the only danger. We just experienced the

highest inflation rates in 17 years with an official annual CPI rate of
4.1% in 2007, and a 12 month PPI rate of 7.4% through January of
2008. Substantial inflationary dangers remain, and the Fed has
effectively abandoned its (already weak) defense of the dollar, in order
to try to avert recession. In Scenario D we look at what happens if
recession is (miraculously) averted – but the price is a surge in
inflation and rapidly increasing interest rates. Let’s say that indexed
subprime mortgage rates jump from 10% to 13% -- and the result, for
a group of people who barely qualified at 6% interest rates, is that the
foreclosure rate doubles, going from 15% to 30%. With this scenario,
rising inflation alleviates the fall in property values, so we assume that
the average loss declines from 50% to 40%. Nonetheless, our bottom
line is that our overall losses from subprime mortgages have
tripled, from $27 billion up to $81 billion. The very effort of

avoiding or minimizing a recession (if possible at all), may trigger a
loss that is almost as bad as the recession driven loss would have
been.
Scenario E: Falling Property Values

Changes: 33% Higher Foreclosures, Much Bigger Losses

Assumed Losses:
Size of Market: $1,200,000,000,000
OK, let’s be optimists. Let’s say that the Fed somehow balances
on the tightrope and dodges major recession through pumping the
system full of new money, without triggering higher levels of inflation.
This will be amazing if they can pull it off – but stranger things have
happened. However, there is the separate issue of another powerful
economic force at work, and that is housing prices that probably got
way too high in a number of areas, and which many economists think
might be in for a prolonged fall. If this happens, then two major
problems occur for subprime mortgage collateralized securities
investors: the foreclosure rate rises, because the more negative home
equity becomes for someone who is struggling to make payments, the
more likely they are to say “forget it” and walk away from their
property; and, following that (of course), the greater the losses per
foreclosure for investors. As illustrated in Scenario E above, if we say
that the foreclosure rate rises from 15% to 20%, and in a market of
falling values where few want to buy, the average foreclosure loss
rises from 50% to 70%, then our annual total losses increase to $105
billion, or almost four times the current loss level under current
conditions.
Scenario F: Three Tsunamis Hit Together

Changes: Triple Foreclosures, Much Higher Losses

Assumed Losses:
Size of Market: $1,200,000,000,000
So, recession pushed our losses up by five times in our

recession illustration (Scenario C), rising interest rates pushed up
our losses by three times in Scenario D, and falling home prices
pushed up our losses by four times in Scenario E. What if all three
scenarios happen at the same time? What happens if: 1) a
significant recession does hit despite the Fed pumping the system full
of money; 2) inflation does increase thanks to the Fed’s recession
fighting efforts, meaning we now have stagflation; and 3) the drop in

property values accelerates with the double whammy of people losing
their jobs even while mortgages grow less affordable in markets that
are still falling?
Or, if we want to look on an individual level, what happens to the

chances of someone making their mortgage payments, when: 1) they
lose their job; 2) their mortgage payments more than double in two
years (since the initial teaser rate); and 3) they owe $50,000 more on
their mortgage than the market value of their home?
Troubles can arrive in threes, and the triple whammy of

recession, rising interest rates and falling property values can indeed
come ashore one after another, like three great tsunamis hitting a
beach, as illustrated above in Scenario F. Let’s assume this three way
combination means that foreclosure rates triple from 15% to 45% --
which may be a bit conservative for subprime borrowers, none of
whom ever really had the money for the home in the first place, under
conventional lending standards. Let’s further say that the glut of
distressed homes on the market, even as unemployment is spiking
upwards and mortgages are growing both less affordable and less
available, means that the fall in property values accelerates, and
average investor foreclosure losses rise from 50% to 70%. As shown
in Scenario F – just making those two (reasonable) changes to our
assumptions means that subprime losses climb from $27 billion to
$315 billion, an increase of almost twelve times!
Should stagflation slam into an overpriced housing market after

investor safety layers have already been stripped away, then we
haven’t even begun to see the full extent of the damage to investors,
to the housing market, and to the financial system as a whole.
Leveraging Up The Losses (Banking Dominos)
The scenarios shown herein may seem overly optimistic,

particularly when compared to such numbers as the $600 billion in
industry losses which UBS is predicting, or the $160 billion in losses
which they estimate to have already occurred. The reason for the
discrepancy is that we have been sticking to just the mortgages and
mortgage securities – and these securities are generally not bought
with cash, rather they are bought with borrowed cash. Highly volatile,
short term borrowings which carry major risks of their own. As an
example, when Bear Stearns fell 94% in 2 (weekend) days, there was
no change in the mortgage market that precipitated the fall – it was
the fear that Bear Stearns would lose their ability to borrow. An event
that can make the capital of just about any seemingly solid looking
major bank or investment bank disappear in a flash.
The bigger issue is that all the big financial players are highly
leveraged. Now, just for round numbers, let’s say that a big financial
firm has $100 billion in assets, $94 billion in liabilities and $6 billion in
capital. We will assume that it owns $6 billion in questionable
mortgage securities directly, with another $6 billion in loans to highly
leveraged hedge funds that have their own questionable mortgage
security holdings. Something drops the value of questionable
mortgage securities by 25%. So the big financial firm takes a $1.5
billion hit directly – and a 50% hit on the hedge fund loans when the
hedge funds collapse and the creditors are left with illiquid and
distressed collateral that they don’t dare sell. The big financial firm
just lost $4.5 billion, and the key number isn’t that it lost 4.5% of the
value of its assets – but that it lost 75% of the value of its $6 billion
capital base. With the remaining 25% being considered highly
questionable.
Meaning the financial firm now has to unload $75 billion in assets
to maintain its 6% capital ratio (assuming it can survive at all), or else
be recapitalized by a foreign investor, with the Fed possibly propping it
up in the meantime, when no one else will lend to it. In a market
where everyone else has their own problems, and don’t have the
money to buy the assets. Which drops the prices of everything.
Which multiplies the losses upwards. Which brings us to the real
problem.
If real subprime losses climb by 6 times or 12 times – then

system wide financial losses likely climb by 24 times, or 36 times, or
more. Because everything is linked, and the math that links all the
dominos is multiplication, not addition. If you want a mental picture of
how banking dominos work, don’t think of one domino hitting another
domino, hitting another domino in a long line. Rather, think of one
domino hitting two dominos, hitting four dominos, and so forth.
Understand this, and you will understand the desperation in the
current moves by the Federal Reserve.
Taking Actions
First, you need to very seriously think about cutting your

ownership of financial assets. The type of disaster scenario we are
talking about could devastate stock and bond markets for a

generation. If you are investing for retirement and your portfolio gets
taken down by just such a scenario, then you may never have the
chance to replace it. For these reasons, there is a powerful, powerful
case for moving a substantial portion of your assets into tangible
assets.
The next thing you should very seriously think about is whether
crisis leads to opportunity, in ways that go well beyond a simple
strategy of only buying tangible assets. John Paulson saw the crisis
that was coming in subprime mortgages, researched and educated
himself on this area (which had not been his field of expertise), and he
turned the crisis into a $3-$4 billion personal payday in 2007. If
you're not a hedge fund manager like Paulson, you may not have the
tools that he used to turn a market crisis into personal billions. That’s
OK, because Paulson didn’t start with the tools either. He started with
educating himself, learning about a new area, until he came up with a
novel way to profit from disaster. A method that wasn’t in the
financial textbooks, and that he didn’t find by reading a financial
columnist in the paper.
You have more tools than you may think, some of which may
surprise you. Tools which can give you the opportunity to turn
financial disaster into personal net worth. There are ways you can use
those tools to turn the destruction of the currency into perhaps the
greatest real wealth-building opportunity of your life, on a long-term
and tax-advantaged basis. But, if you want this to happen --you will
need to start with learning. You are going to have to educate yourself,
and work to not just understand, but to master some of the financial
forces and methods in play here. You will have to learn how to turn
the destruction of paper wealth into real wealth. With Turning
Inflation Into Wealth being the first key step. My best wishes to
you for turning this challenge into an extraordinary personal
opportunity.
Fall 2008 Update
Let me suggest that if you want a simple of understanding of

what happened in September 2008 – and how it was not only entirely
predictable but perhaps even inevitable – then reread the preceding
section. We came within a couple of hours of potential complete
meltdown, not just on one day, but on several days, as covered in the
next reading.
What happened between March and September is that housing

prices reached a new low, a full 20% below where they had been two
years before. This led to the negative feedback cycle described above,
where falling real estate prices led more people to walk away from
their mortgages, which increased foreclosures, which further
depressed housing prices, which further increased foreclosures, and so
forth. It was that double increase in both the number of losses and
the severity of each loss, as illustrated in Scenario E, that then pushed
subprime mortgage losses to whole new level. This then nearly set off
the domino effect described above, which has been averted (so far)
only by rapid government interventions on a massive scale.
Actual housing losses are much worse than many commentators

seem to understand. As demonstrated in my article “Real US Housing
Losses Are $6 Trillion”, when we take the loss of value in a dollar due
to inflation, the full extent of US housing losses is already $6 trillion.
That is a number that is so large that it is difficult to understand, but
as illustrated in the graph below, that amount is already equal to total
Boomer retirement investments (held in retirement accounts and
pensions), and nearly twice the official size of the Chinese economy:
How Much Is Six Trillion?

$0 $1 $2 $3 $4 $5 $6 $7
US Housing Losses, 2006 to 2008
Total Boomer Retirement Assets
GDP of China
Subprime Mortgage Securities
(from “Real US Housing Losses Are $6 Trillion”, Amerman, 2008)
Properly put into perspective then, a $700 billion dollar bailout is

not a gargantuan overkill – but only about 12% of actual, inflation-
adjusted real estate losses to date. It does not take that much more
movement, to go right past the $700 billion amount either. The
difference between the $6 trillion and the $700 billion is that US
taxpayers are already bearing the brunt of the losses in the value of
their home equity, even as they get to pay for the bailout of Wall
Street.
That further downward pressure on real estate prices could very

well arrive sooner rather than later. As credit continues to become
more difficult to obtain, the chances of a sharp and fast deepening of
the nation’s current recession rise substantially (those believing the
current government line that we are not in a recession, are
encouraged to read my article “Inflation Index Manipulation: Theft By
Statistics”). This then potentially brings into play Scenario C from
above – which further increases foreclosures, which further depresses
housing prices, accelerating the negative feedback cycle.
The other wild card is of course the real source of the

government’s bailout – and it isn’t through taxes, not really anyway.
The federal government can’t pay for the bailout, anymore than it can
pay for impossible retirement promises made to Boomers. Anymore
than it could pay for the $170 billion “tax rebate”. Just as the US can’t
pay for the goods it consumes everyday, and the oil it imports, as
expressed in the trade deficit. Those real goods that the current
United States day to day standard of living depends upon are
dependent upon foreign nations accepting that the dollar is valuable
and that the value of our debt is solid.
As the United States government makes ever more extravagant

dollar promises, even while our real economy suffers, then despite the
many advantages to our current trading partners of the current
arrangement – the time arrives when enough is enough, and they stop
buying our debt. And we stop getting the oil and goods we need.
Until we raise the interest rates on our debt to make it attractive
enough for debt and dollar purchases to resume, and bring the oil and
basic consumer goods back.
Which means that mortgage rates just soared – and our third
risk factor kicks in, that of substantively rising mortgage rates as
illustrated in Scenario D above. Inflicting major damage on it’s own, it
then further depresses property prices, which further raises
foreclosure rates, even as the 1-2 combination of the little credit
available carrying an even higher interest rate, pushes the nation
deeper into a stagflationary recession (or worse).
Bringing us to the full perils of Scenario F, with three tsunamis

together hitting an already bankrupt banking system, with reserves
long gone, that is able to survive only on continuous infusions of
financial assistance, from a government that is effectively bankrupt,
dependent upon the value of its ability to create money at will in order
to fund each successive stage of emergency bailouts.
Everything is connected, and without seeing the connections – it

is impossible to see what the risks in a situation are. This is
particularly true when we consider that mortgages and mortgage
derivatives are only one part of the picture – with much smaller risks
than those found in the far larger credit derivatives market, as covered
in the previous reading.
With your next reading we will dive into the story behind the
story, and explore the repeated hidden bailouts that have been
occurring inside the public bailouts.
If A Link To This Reading Was Given By A Friend
If you found this article because of a friend’s recommendation,

then you should know that it is part of a free mini-course on Turning
Inflation Into Wealth. Much more information on the course and the
benefits of the course to you are available by following the link below.
http://mortgagesecretpower.com/Mini%20CourseB.htm
This website contains the ideas and opinions of the author. It is a conceptual
exploration of financial and general economic principles. As with any financial
discussion of the future, there cannot be any absolute certainty. What this website
does not contain is specific investment, legal, tax or any other form of professional
advice. If specific advice is needed, it should be sought from an appropriate
professional. Any liability, responsibility or warranty for the results of the application
of principles contained in the website, sample chapter and book, either directly or
indirectly, are expressly disclaimed by the author.

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Reading Two:

The Subprime Crisis Is Just Starting

Copyright 2008 by Daniel R. Amerman, CFA, All Rights Reserved.

As a $700 billion proposed bailout of the American financial

Below is an easy-to-understand mortgage derivatives risk

Most of the primer below is just as written below six months

The Subprime Crisis Is Just Starting

I’m going to let you in on an unfortunate little secret – the real

To understand the full extent of the danger requires moving

occur in such possible forms as recession, increases in interest rates,

The Lack Of A Problem

To explain what I mean about nothing going wrong, let’s review

Then, you applied what are known as “stress tests”. A stress

The rating was simply a description of how hard you had to

The Theory Of Turning Subprime Mortgages Into Wealth

To understand how the subprime debacle came about, we need

Scenario A: The Way It Was Supposed To Work

Initial Teaser Rate: 6.0%

Annual Incentives: $33,600,000,000

Copyright 2008 by Daniel R. Amerman, CFA, InflationIntoWealth.com

In our example of how things were supposed to work, that 2.8%

That was the theory, but there proved to be some complications

Scenario B: What Happened (Oversimplified)

Full Rate After Adjustment: 10.0%

Annual Incentives: ($27,600,000,000)

Copyright 2008 by Daniel R. Amerman, CFA, InflationIntoWealth.com

As illustrated in Scenario B, if it turns out that foreclosures are

The higher than expected losses did something else as well,

(Fall 2008 update: this principle is crucial to understanding the

Full Rate After Adjustment: 10.0%

Annual Incentives: ($153,600,000,000)

Copyright 2008 by Daniel R. Amerman, CFA, InflationIntoWealth.com

In Scenario C above we assume that a recession hits, something

Scenario D: Higher Interest Rates

Full Rate After Adjustment: 13.0%

Annual Incentives: ($81,600,000,000)

Copyright 2008 by Daniel R. Amerman, CFA, InflationIntoWealth.com

Recession is not the only danger. We just experienced the

tripled, from $27 billion up to $81 billion. The very effort of

Scenario E: Falling Property Values

Full Rate After Adjustment: 10.0%

Annual Incentives: ($105,600,000,000)

Copyright 2008 by Daniel R. Amerman, CFA, InflationIntoWealth.com

Scenario F: Three Tsunamis Hit Together

Full Rate After Adjustment: 13.0%

Annual Incentives: ($315,600,000,000)

Copyright 2008 by Daniel R. Amerman, CFA, InflationIntoWealth.com

So, recession pushed our losses up by five times in our

fighting efforts, meaning we now have stagflation; and 3) the drop in

Or, if we want to look on an individual level, what happens to the

Troubles can arrive in threes, and the triple whammy of

Should stagflation slam into an overpriced housing market after

Leveraging Up The Losses (Banking Dominos)

The scenarios shown herein may seem overly optimistic,

If real subprime losses climb by 6 times or 12 times – then

First, you need to very seriously think about cutting your

talking about could devastate stock and bond markets for a

Fall 2008 Update