Thursday, December 20, 2007

Too Good To Be True

I have often been told that if it sounds too good to be true, it probably is. I mainly got that lecture after signing my father up to win cars at the mall when I was younger. Well, this phrase can certainly apply to business and investments. I have been told a couple times to get in on the ground floor of the next Google and both times rejected it. This isn't to say that I will never accept risk, but some things are too risky or far fetched for me.

This brings me to the recent banking meltdown. I read a recent article in Fortune magazine that really shed some light onto how banks were caught. Carol J Loomis did an interesting piece on part of the issue that is plaguing Citigroup. Citi used solid safe investments (is there such a thing?) to get some easy cash. This process came back to bite them:
Citi started then to have ominous dealings with CDO's [Collateralized Debt Obligations] that carried a "liquidity put." What Citi did a couple of years ago was insert a put type of option into otherwise conventional CDOs that were backed by subprime mortgages and sold to such entities as funds set up by Wall Street firms. The put allowed any buyer of these CDOs who ran into financing problems to sell them back - at original value - to Citi. Last summer, with the whole world suddenly unwilling to finance CDOs, the holders of the liquidity-put CDOs began to return them to Citi. And that's where they now reside - $25 billion of them
Now CDOs were considered very safe and Citi did some creative accounting to get them off their balance sheet. Well now it is coming back to bite them. Selling puts on safe items will never come back to haunt you...

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