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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: ild who wrote (478)	8/25/2003 10:26:58 PM
From: Haim R. Branisteanu	Respond to of 110194

to be prosperous and young Goethe's Faust also sold his soul to the devil .... we know the end Part Two begins with Faust recovering through the power of Nature from the emotional buffeting he has undergone in the disastrous episode with Gretchen. With his constant companion Mephistopheles, Faust attends the Emperor's court. The empire is in financial ruin through the extravagance of the court, but Mephisto and Faust offer a solution to these problems. Till now the currency of the empire has been Gold, but there is not enough to support the extravagant spending. Mephisto suggests an easy answer - since there is undoubtedly much gold as yet undiscovered beneath the land, which belongs to the Emperor, then surely a promissory note can be made for the value of such gold. He showers the Court with the new paper money. The foundation of the empire has been moved through Mephisto's cunning from the solidity of metallic gold to insubstantial promises on paper. Faust acting the role of magus is asked by the Emperor to conjure up the spirit of Helen of Troy. Goethe is here drawing upon the story about Johannes Trithemius conjuring spirits before Emperor Maximilian. levity.com

To: ild who wrote (478)	8/26/2003 8:23:36 AM
From: russwinter	Respond to of 110194

Should we be surprised about this? Nah. Reuters WORLD BONDS-Echoes of LTCM in recent U.S. swaps market storm Monday August 25, 12:27 pm ET By Eric Burroughs NEW YORK, Aug 25 (Reuters) - For what is often billed as one of the deepest and most active markets in the world, the recent bout of heavy mortgage bond hedging revealed the U.S. interest rate swaps market is perhaps not so sturdy after all. That means that a key gauge for judging the value of investor bond holdings across the world, from agency debt to Asian corporate bonds, is prone to exaggerated moves that could lead to huge paper losses for speculators and investors if another wave of hedging hits, as many fear. It could even be a threat to the banking system and hurt the economy if taken to the extreme, such as nearly happened during the crisis following the Russian debt default and troubles at the giant hedge fund Long-Term Capital Management in 1998. This time, much of the trouble for the swaps market came from the recent massive hedging needs of mortgage portfolios that led to one of the worst bond market sell-offs in the past decade. As rates kept racing higher, swap spreads exploded in one of their worst weeks since the LTCM crisis. Not only did it impair liquidity in the U.S. swaps market -- with $79 trillion of outstanding contracts easily the world's largest derivatives market -- but also in the U.S. government bond market and linked fixed-income markets around the world. The irony is that heightened risk aversion by investment banks during times of severe volatility constrains markets and leads to even more volatility -- and potentially heftier losses for everyone. "There was a pure lack of liquidity, it was absurd," said one senior swaps trader at an investment bank. "Nothing was trading and no one was standing in the way." At its worst on Friday Aug. 1, the 10-year swap spread blew out 10 basis points on very little trade to around 71 basis points, with frantic dealers simply pushing out spreads on almost no trading. It had stood near 41 basis points a week earlier -- an almost unprecedented move that sent volatility measures skyrocketing. Most of the pressure came from portfolio managers trying the $4.9 trillion in outstanding mortgage-backed security market, which now dwarfs even the Treasuries market. Luckily the crisis quickly calmed, and swap spreads raced lower as quickly as they had blown wider. But such a large move in spreads could conceivably cause crippling mark-to-market losses for hedge funds and other investors that they would have to post more collateral and exacerbate any cash crunch. The stocks of big investment banks like JP Morgan Chase (NYSE:JPM - News), Lehman Brothers (NYSE:LEH - News) and Bear Stearns (NYSE:BSC - News) that deal in the mortgage-backed and derivatives markets started taking a hit at the height of the turmoil. If those stocks had fallen even more, the danger could have been magnified. "What I had on the screen on the Monday after that episode was not swap spreads, it was the financial component of the S&P 500. If we had started to see the market feel that financial firms were suffering dramatically from this, that would have been a much more worrisome sign," said Lou Crandall, chief economist at Wrightson ICAP, a consulting firm. What the huge move revealed is that Wall Street dealers, perhaps still smarting from the LTCM crisis and the resulting losses, were quick to pull back from making markets actively as risk levels rose. Rumors swirled that one dealer told its interest rate options desk to stop trading for a few days. A few weeks ago Crandall summarized in his weekly newsletter how in the most extreme of circumstances these market breakdowns can spread beyond to the economy. "When everyone has the same risk-management constraints (and the same month-end balance sheet sensitivity), the combination of rate volatility and spread blow-outs that the market has experienced lately can become lethal," he wrote. "Large numbers of players are forced to reduce their exposures simultaneously, slashing the financial sector's capacity to absorb risk. In a system built on leverage, this sort of retrenchment hurts prices across the board, regardless of the underlying fundamental outlook," he said. "And while it starts out as a bond market problem, the deleveraging can eventually become everyone's problem if it begins to impair the financial intermediation process." One problem is that these markets are not hosted on exchanges but traded over-the-counter. If the dealers who make the market pull back, trading can be severely hobbled. While investment banks threaten to upset and lose customers, it was clear many were backing down during the peak of the volatility. Traders reported that during the worst of the swaps storm it was increasingly difficult to get trades done as desks pulled back. While some traders said they were still able to make markets for customers, others said the problems were evident and troublesome. As one head trader said at the time: "This can't go on for much longer because the market can't take this. Someone is going to get into trouble."