Sunday, November 11, 2007



We now turn our attention to the current crisis affecting the financials. Much of the story may well be old-hat to those that follow the fundamentals of the market, some might actually surprise you.

I actually follow the fundamentals quite closely, yet, the scope of the problem had eluded me, therefore, a hat-tip is due Mr. Sierra Water for uncovering the data that will provide some of the referenced data provided.

The problem started in MBBS, specifically, sub-prime mortgages. With deteriorating employment, rising interest rates, overpriced housing stock, lax, to no lending standards, incredible greed and stupidity, fraudulent business practices, it was simply a matter of when, not if, there was a crisis.

The players


*Ratings Services


*The Fed.

First off, just how big is the problem? From the chart below we can easily see that the problem is large.

The banks loaned to consumers, who could not afford a mortgage, and then securitized the loans via MBBS, CDO’s etc and sold them to all and sundry.

They were aided and abetted in this undertaking by the ratings Agencies, Standard & Poor, Fitch and Moody’s, who accepted large fees for granting AAA grades, based on the principal of diversification.

Not being satisfied with simply this set of fees, the Banks then issued derivatives, Credit Default Swaps on the MBBS.

This is where the problem has escalated a couple of notches.

Worldwide derivatives are valued at some $400 Trillion or 30x the entire worlds GDP. US Bank exposure is circa $150 Trillion in notional value.

The vast majority of this exposure is concentrated within; JP Morgan, Bank of America, Citibank, Wachovia and HSBC.

The CDS exposure is circa $12 Trillion.

Now of course as the default rate starts to escalate, so there is movement within these derivative contracts. As the exposure is so leveraged, the Balance Sheets of these Banks is called into question.

Although the majority of the exposure is hedged, the fear is that a failure somewhere in the system might cause that exposure to move down the line and cause a bankruptcy to a First Tier Bank, Citibank for example.

The catalyst for the August meltdown, based on credit fears, was the downgrading of billions of dollars worth of MBBS securities.

One Hedge Fund that evaporated had purchased securities at $0.05 on the dollar and was required to provide margin to $0.80 on the dollar, needless to say, they passed on this generous offer.

We have two catalysts brewing for the next stage in the credit crisis. The first is an accounting change that takes effect I believe November 15 and that is Rule 157. This rule requires Level 3 assets to be more accurately valued, hence, the Merrill implosion, Citibank and Chuck.

The second of course are your corrupt Ratings Agencies again, from Fridays Wall St Journal;

"As of Nov. 1, S&P had lowered ratings on 381 tranches of residential mortgage-related CDOs. It still had a "Credit Watch negative" on 709 CDO tranches, meaning the bonds face a good chance of a downgrade.

Fitch has 609 CDO tranches on negative watch and plans to act on them by later this month. Through the end of October, Moody's said it had downgraded so far this year 338 CDO tranches worth $13 billion, backed primarily by mortgage-backed securities. It was still reviewing for downgrade another 734 tranches worth $48 billion.

Moody's says it hopes to finish its current crop of CDO downgrades in the next few months. Further downgrades could happen depending on the rating firm's assumptions about the underlying economy, where the outlook could be changing fast."

So it would seem that there remains much market volatility into the future.

"So it would seem that there remains much market volatility into the future."

Truly enlightening.
Grant, where is the non-directional or arb. trade for the financials? I ask because what you suggest is bankruptcy for a tier 1 bank.
Do you really think employment is deteriorating? 4.7% unemployment is bad? Hmm.. Odd but I think that may not be terrible, I mean yeah we still have 4.7% lazy fucks out there not working but I would not say its deteriorating. Full employment would not always be a good thing.

I suggest that there is a distinct possibility.

It however of course depends on their hedge book and if there are any blow-ups in the system that impact their placed hedges.

This is why Bernanke is dropping rates and sacrificing the dollar, he needs to protect the financial system.

The non-directional or market neutral play[s] are very simple....I'm sure you can figure one out.

Goldman Sachs has been a goldmine since August.

jog on

I suppose that depends if you buy into the BLS figures, in particular the noxious Birth/Death statistic.

jog on
Scarlet Poltroon,

I stand in semi-awe of your intellectual unerringly manage to miss the trees in the forest.

jog on halfwit
Fly baby...

What happened to the chart?
Lost in translation I guess.

jog on
Has your suggested 1st Tier Bank BK theory taken into account news that has been coming out all weekend about a "bailout"?

From NYT:
The country’s three biggest banks have reached agreement on the structure of a backup fund of at least $75 billion to help stabilize credit markets, a person involved in the discussions said yesterday, ending nearly two months of complicated negotiations against a worsening economic backdrop.
Lots of rapid fire posting. Ducati is having a Blogasm.

It really depends if you believe two things;

*That the bailout will work
*That there is enough money to cover the losses and where is it coming from

jog on

Once all hypothetical assumptions regarding the market/economy are negative, consumer sentiment sitting at a 6 year low, I feel safe putting large sums of money into the long camp.

The sector analysis was not hypothetical....fact.

Derivative exposure and Balance Sheet weakness ....fact

Market valuations....fact

But, hey, be my guest, your money....who knows, you might be right.

jog on
Cheese, as much as it pains me to agree with Ducati, I think he makes some valid points.

75 billion is not near enough to cover the exposure.

If the 75 billion comes from the Fed, then greater inflation, weaker dollar, etc.

Plus, how will the banks "bailout" each other? Are they agreeing to limit or throw out the credit derivatives that they are holding with each other?

God I sound like a conspiracy theorist/bearshitter. However, this level of stupidity has happened before in the markets and it is certainly possible that it is happening again.
If the world economy is as dependent on dollar strength as it appears from the daily rhetoric we hear from France,China,etc, it wouldn't be surprising to see some of the bailout money come from Asia/UAE/Euro/etc.

There's a crisis evry 4-6 months.


When looking at economic figures it's very beneficial to look to job growth (166K) GDP Trends (+3.9%) and core inflation (low).

If some Kiwi wants to drum up fear and shake some of the weak hands so be it. I personally don't care about 3 year time frames, nor do many of the traders on this blog. His long term business cycle reasoning may make some sense.

I find it more suitable for a bathroom wall.

Obviously your blue collar diet is causing you some flatulence.

Traders are a law unto themselves.

jog on
Cheese, look at a 5 year employment chart. Also, compare the ADP employment situation revisions against the gov's data. If the revision of the gov's data to meet the ADP picture continues the way it has been since March of 07, the gov's data will eventually be revised lower. If you follow the ADP employment picture, it will be getting revised much lower.

Click on that link, and it is chart #6.

I have not put a lot of study into the GDP data so I cannot speak to whether there is any suggestion of weakness or strength.

Also, I agree PCE is okay.
When the fuck did you start looking at fundamentals? Is this now an economics blog? What's with the fucking font? I leave for a few weeks, and shit hits the fan!
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