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Financial Markets: The Fuse Is Lit
The inverted pyramid of credit derivatives, insurances against bond failures, that sit on top of collateralized debt obligation which sit on top of bad loans is now really threatening to crash down on the financial system.
The failure of Lehman Brothers triggered ‘credit default events’ on bonds Lehman had issued. On Friday an auction will clarify what holders of Lehman bonds might get payed out of the bankruptcy assets. The difference of that value to the face value of the bonds will then have to be payed out by those who sold insurances in form of Credit Default Swaps on Lehman bonds to other parties.
As such risk insurances have not only be sold to people who actually hold Lehman bonds, but to anyone who wanted to buy and speculate with them, the amount that will have to be payed out will be a multiple of the nominal bond value Lehman defaulted on.
Writes the Financial Times (behind free subscription walls):
Banks are hoarding cash in expectation of pay-outs on up to $400bn of defaulted credit derivatives linked to Lehman Brothers and other institutions, according to analysts and -dealers.
…
Yesterday, the default of up to $500bn in derivative contracts linked to Fannie Mae and Freddie Mac was settled, the biggest such exercise ever carried out.
The Fannie and Freddie CDS settled at between 91.5 and 99.9 cents on the dollar, reflecting the fact its underlying debt is not in default after the mortgage groups were seized by the US government. The seizure did trigger defaults on derivatives, however.
The next test will be the unwinding of CDS linked to Lehman, which filed for bankruptcy three weeks ago. Michael Hampden-Turner, a credit strategist at Citi, estimates that there could be $400bn of credit derivatives referenced to Lehman.
These contracts will be settled on Friday, and with the recovery value on Lehman bonds currently estimated at about 10 cents on the dollar, the pay-out by banks and other sellers of credit protection on Lehman could reach a gross $360bn.
Anyone who still thinks that the Paulson plan with some $700 billion can safe the world from a crash needs to see a doctor. This was only one bank going under and it triggers payments of half the size of the Paulson plan.
The $360 billion in CDS payments probably triggered by Lehman’s default might well take down some of those who wrote such insurances. That would then trigger additional ‘credit default events’ which would trigger further CDS payments in the hundreds of billions. This could quickly cascade taking down one financial entity after the other.
The numbers involved here are mind numbing. See the tables here for who holds how many of these nuclear time bombs. JP Morgan Chase leads the pack with $8 trillion of CDS in notional value.
Iceland has now seized the last of its three big banks, Kaupthing, and put it into receivership. That will trigger another round of CDS losses, more multi-billions that will have to be payed.
The threat of huge payouts that may trigger more defaults and the threat of additional credit default events is what freezes the interbank credit market and today send the LIBOR-Treasuries spread, the difference between interbank lending risk and the risk of lending to the government, to historic highs.
The fuse is now lit and its is only so long. The only way to stop the danger of an exothermic CDS chain reaction in the financial markets is by executive or legislative means: Declare All Credit Default Swaps Null And Void.
There is court tested precedence for this from the Roosevelt administration. Simply do it.
b,
Frankly, in my opinion — and I quite understand others may disagree — bigger bandaids, or even a bunch of temporary socialist opium bandages or moonshine, ain’t gonna heal the fundamental source’s of the financial tsunami: citizen apathy, ignorance, greed, hateful procreation, consumer zombies, regulators that don’t regulate the current regulations, but instead regulate that the current regulations are not regulated, etc.. etc.. a culture of avoiding personal, family, community, social and ecological responsibility, and following the corporate mantra of externalizing the costs; well the fuse on those externalities were lit by all above and while some nanny goverment FDR socialist political or executive action may help reduce the pain; it — in psychology speak terms — won’t get the culprits to take a good long look in the mirror and confront reality: humans are a virus of death on this planet; and unlike other predators, we don’t just eat down the foodchain when we are hungry, us cannibals eat our own kind, no cannibalistically feast on our own kind, and breed (unconsciously for most) with the express intention of cannibalising and enslaving our children as economic, military and psychological (religious) cannon fodder. If there is any truth to reincarnation; from my observations of current behaviour, then I’d venture approximately 6,8 billion people are going to be making many many many more painful lifetime returns to “wake the F**k up!!!”
My position has always been; why spend the next 40 or 50 lifetimes in ignorance and denial avoiding reality; why not just confront it, and get on with it…
So, in that very blunt radical honesty context; I agree with:
“Mr. Chairman, we have in this Country one of the most corrupt institutions the world has ever known. I refer to the Federal Reserve Board and the Federal Reserve Banks, hereinafter called the Fed.
~ Armigideon Knights: Rep. L. McFadden; Chair: Banking & Currency Committee ~
and
Sadly, we no longer have the will to resist servitude. Our pulpits are too busy preaching a prosperity gospel; newsmen are in bed with the forces they once disdained; statesmen have been replaced with opportunistic, self-serving politicians; and merchants know no god but money. Hence, it is left to a small–and I mean very small–remnant to sound the clarion call for freedom and independence. Unfortunately, few seem to be listening to their cries.
For what it is worth, however, I pledge no loyalty to this emerging New World Order. Neither will I let Lady Liberty die without a fight. I will say it again: the battle today is not between conservatives and liberals or Republicans and Democrats. It is a battle between Americans and globalists. And, Ladies and Gentlemen, I am an American!
~ “To Keep Your Family Safe, and Your Country Free, Go Buy a Gun”, by Chuck Baldwin, Constitution Party 2008 Presidential Candidate ~
and
“A democracy is dangerous because it is a one-vote system as opposed to a Republic, which is a three-vote system. Three votes to check tyranny, not just one. Citizens have not been informed of their other two votes.”
~ Guerrylla Law for Patriots ~
Posted by: JAGCorpSwan | Oct 9 2008 19:09 utc | 7
The tower of private derivatives contracts between financial and corporate entities are all insurance against default, against non-payment of a defined financial outcome.
The “deals” thus contracted upon, well they long ago left off real-world trading like commodities, futures, corporate expansions, and so forth. A great many are simply insurance on outright gambling — certain market positions being at such and such ratio or setting on such and such a date. Or on weather events, like rainfall in North India during the next monsoon. They may have some market-related bearing, to someone. They may not.
If you bet your cousin real money that there will be more goldfish at the north end of the Marriott Hotel koi pond on May 1st of next year, at noon precisely, and you later decide to get a derivatives contract covering you if you lose the bet, hey — it’s your money. Someone will write that contract, for a small fee.
Wall Street, London, Shanghai, Dubai, Frankfurt — every financial outfit in the world has made hundreds of billions in small fees on derivatives over the past decade. Everyone believed they were covered for their losses, if any, which allowed them to put not only ALL their money at risk, but borrow thirty, fifty, eighty times more money than that, and bet it on the market. How could you lose, cousin? How?
In a word, incest. The same people writing derivatives wrote derivatives upon their derivatives positions. The risk of taking on huge derivatives contracts was itself offloaded to others through derivatives contracts.
Derivatives are so intermingled and intermarried and entwined back and forth between financial players that no human being alive can untangle more than one or two levels of a particular contract, especially once it is under duress.
Insolvency cancels the whole orgy in any case. A is obligated to pay B who must pay C who must pay D who must pay E . . . all the way around to A again. If one party in this chain is unable to pay off his contract to another party, the daisy chain is moot, for all practical, real world purposes.
Sure, it’s notional money, paper assets. Except, it is on the books of banks and insurance companies and pension funds and whomever all over the world. They are leaning on this stuff as secured debt, debt that will pay them a bit of money every month for years to come. They are solvent with this stuff considered as real assets. They are way, way bust if it has to be actually, you know, sold on the market, today.
Pumping money into these way, way bust outfits is absurd. You’ll be able to save a mere handful from immolation, but that’s it.
Which is the plan.
Paulson is busy right now pumping up certain banks he likes before the public catches on that this is clearly absurd. The tower of private derivatives contracts is hollow now, and they will all cancel themselves, all over the world. Who the hell are yo going to collect from? No one has the money these things represent.
In the short period of time it takes for everyone to grasp this, the insiders are making off with everything they can.
Posted by: Antifa | Oct 9 2008 20:29 utc | 11
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