Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Strategies & Market Trends : John Pitera's Market Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: John Pitera who wrote (9928)	9/10/2008 8:14:17 AM
From: Terry Whitman	1 Recommendation Respond to of 33421

You missed the highlighting on this one: -g- >Fannie Mae and Freddie Mac were the epitome of the capitalism for-the-poor, socialism-for-the-rich policies that have been pursued by financial authorities in this country< As for the clownbuck- I think it's aptly named that. It just so happens that there is NOWHERE else to hide at the moment, since now: real estate, equities AND commodities are in a nose dive, and commercial bonds are shaky. In the long run, the clownbuck is still headed to Zero, comparitavely speaking, to real assets, IMHO.. I am long Gold Miners and short Oils here, will probably add a Gold short position to it since: Message 24927735

To: John Pitera who wrote (9928)	9/10/2008 1:59:55 PM
From: The Ox	1 Recommendation Respond to of 33421

Message 24933547 Fannie and Freddie's New Derivatives Cliffhanger The bailout triggers settlement of $1.4 trillion in unregulated credit-default swaps. Do the hedge funds have the money? by Ben Levisohn 9.9.08 In taking over Fannie Mae (FNM) and Freddie Mac (FRE), Henry M. Paulson Jr. and the U.S. Treasury Dept. cleared up uncertainty surrounding the companies' common stock, preferred shares, and senior and subordinated debt. But Uncle Sam's intervention also triggered a default event, according to the International Swaps & Derivatives Assn., and now roughly $1.4 trillion in outstanding credit-default swaps, a type of derivative contract, must be settled. You remember the credit-default swap (CDS). It began life as an "insurance policy" that big players such as hedge funds took out to hedge investment risks. Over time, however, the CDS became a tool that big funds, financial institutions, and others used as a way to place bets on whether a company would go bankrupt. They're contracts negotiated between two parties and—unlike insurance policies—there's no regulator verifying that companies can actually make good on the $62 trillion of swaps outstanding. Ever since Warren Buffett described derivatives as "financial weapons of mass destruction" in 2003, the market has been waiting for signs that the Oracle of Omaha's vision may come true. That's why the federal government's decision to take over Fannie Mae and Freddie Mac could turn out either to demonstrate that the auction system to unwind such contracts works or to set loose financial Armageddon. In a worst-case scenario, the default swaps could lead to monumental writedowns and overall financial gridlock as companies bicker over prices and unpaid obligations. A default like no other Still, while Fannie and Freddie sit technically in default, theirs is a default unlike any other. Neither has filed for bankruptcy or stopped doing business. Nor have they missed payments on their bonds. Instead, both companies now have the full—rather than implied—backing of the U.S. Government. In most default cases, the bonds are worth much less than face value. Fannie and Freddie's senior debt is currently trading even, and its subordinated debt is trading at around 97¢ on the dollar. "In most cases, if you bought protection and you go to make your claim, you would expect that the company in default to be trading below par," says CreditSights analyst Richard Hofmann. "Here, it's going to be reverse." That doesn't mean, however, that there won't be problems. First, there are technical issues. An auction system exists to untangle the complex web of transactions that make up the swap market. But to date, it has been tested merely a handful of times, and only by relatively small companies. This process essentially involves a blind auction, where companies enter what they perceive to be the value of the bonds and that information is used to establish a price. The entire process usually takes about a month. No one, however, knows if this auction will work because there's never been a CDS liquidation approaching the size or complexity of Fannie and Freddie. Despite the size of the market for them, relatively few swaps have been subjected to the settlement process. Bankrupt commercial printer Quebecor World was the most recent. The Montreal company had roughly $2 billion in debt outstanding, which was priced at around 41¢ on the dollar; Fannie and Freddie have around $1.6 trillion. The typical failed company has four to eight different bonds; combined, Fannie and Freddie have over 6,000. Nearly 600 CDS holders signed up for the Quebecor World auction; many more should materialize for the great unwinding of Fannie and Freddie. Pennies could cost billions The mechanics of this auction—and whether it will work smoothly—are very much up in the air. "The paperwork that's involved will be huge, and the process has never been tested before," says Ezra Zask, a financial-services expert at consulting firm LECG (XPRT). "There will be delays and missed specifications." But the dangers extend beyond technical issues. It's unlikely, but sellers of credit default swaps could run into trouble. It's possible that cash-strapped hedge funds have been selling insurance on Fannie and Freddie debt as an easy way to make money—while operating under the assumption they'd never have to pay. But near par isn't the same as par: Even a few pennies below face value could add up to billions of dollars. The hedge funds who wrote insurance might not be able to pay, forcing institutions to write down the value of their swaps. "Hedge funds unfortunately are not insurance companies," says Chris Whalen, a risk analyst at Institutional Risk Analytics. "That's why we're worried." Still, the low-stakes nature of the auction could be a blessing. With so many institutions under stress, it may be only a matter of time before a major bank fails without the government stepping in to back up claims. By then the process will have been tested and a track record established of how financial firms settle up. Then the government can turn to the next task at hand: unwinding the derivatives contracts held by the institution itself, a much more complicated task.