Jim so many thanks for your opinion here ... I keep asking one of my great friends who was at the center of the storm down at one of the biggest firms on Wall Street ..."When will they ring fence the CDS modality?"
This is at the absolute center of the storm as of this moment.
I think where this discussion has gone with my friend is this discussion and it's result entail a US "bank holiday".
My own thoughts are that this time NOW - as opposed to the the 1930's - a 2009 bank holiday won't just take down the banks but it will take down a number of "bank like" companies involved essentially in Ponzi finance as well. GE, Sears, etc. along with posssibly the financial empire of the great investor of Omaha. Who knows what his CDS are? Are they even swap-like instruments?
An interesting article today in The Asia Times with links to what must be "our creditors" dismay ... of the never heretofore promised but lately given.... "promises" of dear Fannie and Freddie's solvency.
Please. Let's do investigate the when and the what will possibly cause repudiation of CDS modalities and the ring fencing of their crazed offspring.
My own thoughts .... cf. Mike Shedlock .... who is more ontop of this than anyone I have seen writing.
"The credit bubble that just popped exceeded that preceding the great depression, not just in the US but worldwide. Thus, it is unrealistic to expect the deflationary bust to be anything other than the biggest bust in history. Those looking for hyperinflation or even strong inflation in light of the above, are simply looking at the wrong model." Shedlock
Best, as ever my friends,
Clark
US Fed's move is the bigger problem Asia Times, 3.21.09 By Julian Delasantellis
What we are gradually learning is just how central CDS became to the great expansion, and now deflation, of the credit bubble. As the securitization craze deepened and expanded, as everything from loans for houses, cars, office buildings and credit cards got rolled up and then sliced off into ever- and ever-larger successive rounds of debt issuance, CDS were always there, providing the participants in this market the false sense of security that whoever was on the other side of the debt security they had just bought or sold could fulfill their commitment to make good on their obligation. In essence, the $62 trillion market in CDS became the enablers of the entire shadow banking system that provided the liquidity for the whole real estate and other asset boom.
But it's not like there was not even more opportunities for mischief. CDS betting on a company's decline could be bought for very little, if any, initial investment in this non-exchange traded market. Many are saying that much of the crashing decline in the shares of the financial system occurred when people bought CDS that would increase in value if a company foundered; whoever was the market maker on that side of the trade would, if at all prudent, enter the market to either short the stock or buy its puts - thus, a very small initial investment could have a large and wholly disproportionate effect on the stock price.
On the other side of the trade, the selling of CDS has a payoff profile much like that of selling options - an up-front payoff received for the seller bearing risk. If you do this on an established exchange you either have to put up an initial margin to prove that you can fulfill your part of the deal if it turns against you, or have an underlying ownership of the stock that roughly corresponds to your covered call option position.
CDS were totally unregulated; one could sell and sell and sell them for premium - as AIG did with CDS on the mortgage-backed securities that came out of the subprime boom - and just hope that the prices of the underlying mortgages, and the real estate that backed them up, held up.
If they didn't, it's (now) a mad dash to find Ben Bernanke's phone number.
The free-market advocates of this system, most prominent among them former Federal Reserve chairman Alan Greenspan, blessed this system, for it seemed to allow risk to be transferred from those who didn't want it to those who were comfortable with it.
However, once this system was utilized to make it appear that it was much safer to issue and hold much higher levels of debt than was previously considered prudent, that logic was turned on its head. As risk got shuffled and dealt around like playing cards, what financial regulators did not realize until it was too late was that the total amount of risk the system was bearing was, if anything, exploding.
At the center of it all was AIG. The essence of insurance is the measurement of risk - that's why a teenager with a Corvette pays a lot more in car insurance premiums than a grandmother with a station wagon. AIG thought that this experience provided background in pricing CDS risk.
They weren't even close. In exchange for premium, and not necessarily a lot of premium, they sold every CDS they could beg borrow or steal. As Gillian Tett put it in the Financial Times:
On paper, banks ranging from Deutsche Bank to Societe Generale to Merrill Lynch have been shedding credit risks on mortgage loans, and much else. Unfortunately, most of those banks have been shedding risks in almost the same way - namely by dumping large chunks on to AIG. Or, to put it another way, what AIG has essentially been doing in the past decade is writing the same type of insurance contract, over and over again, for almost every other player on the street. Far from promoting "dispersion" or "diversification", innovation has ended up producing concentrations of risk, plagued with deadly correlations, too. Hence AIG's inability to honor its insurance deals to the rest of the financial system, until it was bailed out by US taxpayers. "
In other words, risk, far from being diversified across the world, was highly concentrated, in AIG's computers. This would be a far more productive focus for the public's outrage than the bonuses, but there's no investigation of this, as opposed to the bonuses, which all have a face and, probably a very exclusive address.
The issue of who loosed the shadow banking/CDS financial system onto the world is mostly uninvestigated. There was the Commodity Futures Modernization Act of 2000, pushed through the Congress with no debate in either chamber, mostly by Republicans such as Phil Gramm of Texas, and signed into law by president Bill Clinton a month before the end of his term. It removed private party derivatives from regulation by the US Commodity Futures Trading Commission; as applied to CDS, that was what allowed one to hold so many of them without posting a margin.
On April 28, 2004, the US Securities and Exchange Commission approved a rule that permitted major investment banks to operate with much higher leverage ratios, allowing for up to $40 in loans for each dollar in capital. Explaining his vote for the change, SEC commissioner Rod Campos is heard on the tape of the meeting saying that "I keep my fingers crossed for the future".
Asking how the shadow banking system grew these past years is like asking why plants grow in highly fertile soil; no one in authority had to take a lot of positive action - it just did.
Specifically, the conception of government as a negative, inhibiting force, and the freedom of private finance to dream up and create just any financial product they could think of, led to this circumstance. Those who knew, like the Greenspan Fed, and the bankers themselves, were either profiting from the experience or expected to profit from it once they left government service. If you knew what was going on and objected, you were a veritable spoilsport at the orgy; if you came all this way to understand what was going on, why not go one more penultimate step, take off your clothes and morals, join the fun?
AIG used to be a pure insurance company. General Electric used to sell good toasters, Sears clothed the backs of Middle America. In one way or the other, all three staid-and-true American commercial names have recently allowed themselves to roll down the road to ruin and turn their companies into hedge funds.
That, the recent obsession over manipulating leveraged finance instead of actually producing something to be successfully sold in the markets of commerce, is something that aches for a public debate it will never see. (Consider Sears: majesty to hedge fund dust, Asia Times Online, May 14, 2008.)
But if the public is getting the AIG story wrong, it's also now getting an even bigger story wrong.
An addicted cigarette smoker might deny that his nagging cough and scratchy throat was the onset of the lung cancer or emphysema he was so often warned about; "It's just a cold or allergy, right, Doc?" So seems to be happening with America's addiction to foreign capital.
The first article I ever wrote for Asia Times Online, (US living on borrowed time - and money" March 28, 2006), introduced readers to the US Treasury's monthly Treasury International Capital (TIC) report, a compendium of how much investment or short-term capital the US receives from foreign sources every month. Back then, the US was quite the popular parking spot for foreign capital, frequently drawing in over $100 billion a month.
That worm has certainly turned; the US in January, the last month data is available, was actually net drained of foreign capital, to the tune of $150 billion. On his blog at the Council of Foreign Relations, economist Brad Setser interpreted the data this way.
Today's TIC January data was a disaster. $150 billion in (net) capital outflows (negative $148.9 billion to be precise) cannot sustain even a $40 billion trade deficit.
Obviously, the concern is that those with still the capital to lend to the US, primarily China, seeing the huge increase in US government demand for borrowed funds with its now huge and ever-burgeoning budget deficits being used to finance the economic crisis recovery programs, will fear that the US dollars they use to buy US debt will depreciate in value, devastating the value of their investments.
Previously, China has tried to give messages that slowly pulling out of its dollar positions was exactly what it wanted to do, but America's cherished habit of ignoring anything that foreigners say to it had it lending a stone-deaf ear to the warnings.
Last week, as detailed on this site with W Joseph Stroupe's three-part series (see Dollar crisis in the making Asia Times Online, March 14-18, 2009) and by Olivia Chung's article on Chinese Premier Wen Jiabao's warning to the US to maintain the value of its currency as a matter of national honor, (see Wen puts US honor on the debt line Asia Times Online, March 14, 2009) the message seemed to be being sent as loudly and clearly as possible. Still, the US stockmarket ran true to form - it ignored Wen's warnings, and continued its recent bounce off the lows.
So Ben Bernanke decided to give America's Chinese and other foreign investors a good swift kick in the keyster as they headed out the door.
Meetings of the US Federal Reserve's interest-rate setting Open Markets Committee used to be a lot more interesting back when there were actually interest rates to set. Now, with rates at zero, the Fed has to work extra hard to get the markets to take notice. At Wednesday's meeting, they did.
After committing another $750 billion for purchases of mortgage-backed securities as part of its program of adding liquidity to the system through "quantitative easing", the Fed had this for those foreigners who apparently think that they can put America over a barrel by refusing to buy its debt.
To help improve conditions in private credit markets, the committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.
In other words - foreigners, we don't need your money; we'll print our own! That's what's essentially been done with the short end of the Treasury yield curve since the Fed's rescue operations from last September; it was probably only a matter of time before they would attempt the same with longer-term securities.
What will this do to the Fed's balance sheet? It will cause it to grow - a lot. From being virtually non-existent a few years ago, the Fed has it soon growing to almost $4 trillion - more than 25% of the country's gross domestic product.
That's supposed to inspire confidence?
The potential drawbacks to this approach are obvious. Does Bernanke really think he can convince foreign investors to make new investments in US government securities by threatening the dollar value of their existing securities? The last thing the recovery effort needs is long-term interest rates in an uncontrolled rise.
A key factor currently holding down inflation in the face of the incredible monetary expansion recently has been a decline in what is called monetary velocity, the rate of which money circulates in the economy. Nothing will ramp up velocity faster than a falling dollar; people will want to get rid of that accursed green thing as soon as possible, before it falls even further.
In the markets, the effect of the Fed announcement has been entirely predictable. Although yields on 10-year US government securities fell to 2.5% from near 3% before the announcement (entirely expected, what with $300 billion of new buying to hit this market) they were back on the rise by late Thursday.
With the US dollar, there's been no such ambiguity of effect. The euro rose from 1.31 against the dollar to 1.37 immediately after the announcement, its highest level against the greenback since early January. The dollar also fell five cents against the yen, to under 0.93 cents/yen. Other inflation-sensitive markets also fell in line: crude oil broke above $50 per barrel for the first time since the New Year; gold takes the cake for sounding the alarm bell, up over $77 per ounce just since the announcement.
But this collective 5% impoverishment of America drew no notice on Capitol Hill. The House of Representatives, in the very rare mode of considering themselves and acting as servants of the plebeians, overwhelmingly voted to seize the AIG bonuses through confiscatory taxation; to have a similar beneficial effect with the currency markets might require a repeal of the laws of gravity.
I almost get the impression that, like a child with too many toys and who has become bored with his most recent one, the public is tiring of AIG rage. Will they now turn their focus to an actually important public issue?
Doubtful. "Next, on PowerCableNews, we'll have the experts debating President Barack Obama's NCAA basketball picks!" |
