Con-tango

US government commitments

Reading the comments on this excellent Brad Setser post, I found this amazing NYT graphic depicting the US government commitment to the crisis so far, which stands at $1.5 trillion, guaranteeing an additional $3.6 trillion in investments and deposits. Wow!

US Government Financial Commitment

Courtesy of The New York Times

What’s most amazing to me, is to see the progression from a non despicable initial $8 billion loan to banks, to what appears to be an unfathomable sum of money, maybe: $5,100,000,000,000.

And according to the same NYT article,

Under the plan, the government is seen as a “silent partner” in the banks, without board seats. But analysts expect the government to be more quiet than silent, operating as an adviser that must be consulted.

Should the bank sell these mortgage-backed securities for 10 cents on the dollar today or wait a few months and hope to get 40 cents on the dollar? A discrete call to the Treasury or the Fed, analysts say, would
seem in order.

Now, what is really being asked here is a much larger question: will banks risk taking us all under to save 30 or 40 cents on the dollar?

If banks do not buy their way out of their CDS soon, mistakenly thinking that the government support will avoid being dragged into hot waters again, then, they may be taking us all under with them, $35 trillion in outstanding CDS only, which doesn’t include the potential black-holes in the remaining derivatives.

I would advice the government to put a little pressure on the idiot bankers to hurry and clear their wrong sided CDS trades, their assumptions may be wrong once again!

Let me be very clear, the weakness remains, and the temptation is huge, as long as the CDS on the $35 trillion are not cleared from the system.

Idiot bankers

I found this wonderful piece in the FT, which confirms my remarks from my previous post “Lehman was killed by Sharks”.

And, although calling bankers idiots is quite a harsh thing to say, I’m sure bank shareholders, and most of us that got hurt with the banking fiasco, would certainly agree.

But, they’re not my words, but Andrew Lahde’s, a high rolling hedge fund manager with a 1,000 % return record, making tens of millions for himself playing the other side of the banks trades, who has decided “to spend more time with his money”, taking a permanent leave of absence from the markets.

Indeed, he was not nice to bankers, here are some highlights of his remarks, in his must read goodbye letter:

“The low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA, was there for the taking.

These people who were (often) truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government. All of this behavior supporting the Aristocracy only ended up making it easierfor me to find people stupid enough to take the other side of my trades. God bless America.”

Like I mentioned before, banks —like Lehman— stupidly exposed themselves, mostly through the unbridled selling of CDS. But, some noticed this weakness, and acted accordingly, good for them!

Is GM next in line to default on its debts?

But there’s more, he has some dire predictions:

“I have no interest in any deals in which anyone would like me to participate. I truly do not have a strong opinion about any market right now, other than to say that things will continue to get worse for some time, probably years.

I am content sitting on the sidelines and waiting. After all, sitting and waiting is how we made money from the subprime debacle.

I now have time to repair my health, which was destroyed by the stress I layered onto myself over the past two years, as well as my entire life – where I had to compete for spaces in universities and graduate schools, jobs and assets under management – with those who had all the advantages (rich parents) that I did not. May meritocracy be part of a new form of government, which needs to be established.”

And some advice… in reference to Soros and the government:

“My suggestion is that this great man start and sponsor a forum for great minds to come together to create a new system of government that truly represents the common man’s interest, while at the same time creating rewards great enough to attract the best and brightest minds to serve in government roles without having to rely on corruption to further their interests or lifestyles.

This forum could be similar to the one used to create the operating system, Linux, which competes with Microsoft’s near monopoly. I believe there is an answer, but for now the system is clearly broken.”

And some very interesting remarks on marijuana…

“The evil female plant – marijuana. It gets you high, it makes you laugh, it does not produce a hangover. Unlike alcohol, it does not result in bar fights or wife beating. So, why is this innocuous plant illegal? Is it a gateway drug? No, that would be alcohol, which is so heavily advertised in this country.

My only conclusion as to why it is illegal, is that Corporate America, which owns Congress, would rather sell you Paxil, Zoloft, Xanax and other addictive drugs, than allow you to grow a plant in your home without some of the profits going into their coffers.”

In conclusion, an independent thinker. I like that.
Wish you well Andrew.

Volatility

I wanted to show this amazing volatility chart. Almost two years ago, I showed a chart with volatility VIX of 12, which is synonymous to tranquil waters with a certain uneasiness, they were uncharted waters. The current reading of VIX 70+ is not encouraging either, it’s quite unusual, and worse of all, stock indexes align themselves inversely to changes in the VIX, confirmed by the direction of the major indices.

But, the movement has been fast and extreme, which tells me two things: there should be a regression to the mean, but, the momentum has been too strong in the bear direction, hence, the bleeding should continue for quite some time…

How long?

Paul Krugman. Economist
Courtesy of The Rolling Stone Magazine

Congrats to Paul Krugman on his Nobel prize. Now, this is his view of what’s coming:

Just this week, we learned that retail sales have fallen off a cliff, and so has industrial production. Unemployment claims are at steep-recession levels, and the Philadelphia Fed’s manufacturing index is falling at the fastest pace in almost 20 years.

All signs point to an economic slump that will be nasty, brutish — and long.

How nasty? The unemployment rate is already above 6 percent
(and broader measures of underemployment are in double digits). It’s now virtually certain that the unemployment rate will go above 7 percent, and quite possibly above 8 percent, making this the worst recession in a quarter-century.

How long? It could be very long indeed.

I also have a pretty dim view of what’s coming…

It’s only natural that if credit liquidity dries up, economic activity slows down. And, we are coming down from the most expansive credit peak that history has ever known, fueled by the exuberance of some derivatives, but, of one ‘credit default swap’ gem of a financial instrument, in particular.

I can’t get myself to shoot the CDS bastard in the head, as my feelings demand. Unregulated, uncovered insurance, exerting unbridled exuberance bank lending, all the way to $62 trillion USD. This wretched financial contraption brought out the worst from traders, bankers, insurance companies, and why not, mongrels of all sorts that must’ve taken insurance on their companies debts with full knowledge that their companies were doomed.

The criminal possibilities involved are better understood if you think of a CDS as an insurance on a house mortgage debt, –which by the way, do exist.

First, since nobody had ever offered this kind of insurance before, it was one hell of a profitable business to collect premiums at an average 2.5% of the value of the debts, or $1.5 trillion premiums off a $62 trillion debt. And, the cherry on the cake: there was no collateral requirement to sell this type of insurance.

Second, it’s one hell of a payback to take an insurance on a house, pay the premium, light it up, see it burn to cinders, and collect the insurance. And, as I’ve explained, this was the weakness of the banks involved in selling CDS, which attracted shark attacks, whom shorted bank’s stock as well as bought its CDS to collect the huge insurance involved in a bank debt default, as in the Lehman case.

I also want to stress that the insurance of debts has a wonderful side, it makes credit cheaper. So, CDSs are in fact a gem of an instrument, within the regulations and oversight of an appropriate exchange.

But, I’m getting sidetracked. The underlined issue is that world
liquidity is contracting from dizzying heights, so economic activity
must contract accordingly.

Although, there is the question of how far will the waters rise as a consequence of the central banks spigot opening?

My first thought is will the US consumer purchase of Chinese low price exports, and Chinese buying of US Treasuries cycle stop? I don’t think so, because the original low Chinese labor price condition persists.

If this is the case, then a good percentage of this CB infussion of liquidity should end in places like China, India, Malasya, Thailand, Vietnam and alike countries; where there’s still plenty of this cheap resource, without the western companies entanglement in expensive legacy union negotiated labor contracts –where GM and Ford are good examples.

So, deterioration in the west should continue, through periods of inflation and depression, till the arbitrage in the east-west labor prices adjust to equilibrium. In the meantime, we build houses… I’m sorry, we repair roads and infrastructure funded by the government…

Lehman was killed by sharks

Cramer: Breaking Capital Destruction
Courtesy of The Street.com

Wow! I’m amazed, Cramer has these wonderful days. I usually hit the remote button to change the channel to avoid his shouting… But, I take my hat off to the guy this time, you have to watch him on this video clip.

And, I have to admit that I still haven’t developed the killer instinct of these sharks!

Let me explain. In essence, these sharks, as they’ve done in the past in Mexico and Thailand, smelled the weakness in the credit default swaps’ short positions, which are mostly held by investment banks, —and recognized that there was a huge amount of money to be made if the origination debts defaulted.

A long CDS position allowed more leverage at default than ever before.

I have estimated that they made $4 trillion USD with the Lehman default (10x Lehman’s debt). But, the beauty of it all, is that they only needed about $5 million to do it ($5 million = 4% conservative good faith deposit on 3% average cost of outstanding CDS to debt of $4 trillion).

An unbelievable 833 times profit in less than 2 months, conservatively.

What can I say, live and learn.

The subprime mess

From The Last laugh:

CDS ramblings

Central banks supply $$ brooms
to remove toxic waste

As we learn from the DTCC that CDS total volume has been clearing at an average $5 trillion monthly pace over the last 4 months, it makes me wonder in awe at the incredible pain that must’ve been exerted on the sellers, since their out was to buy what I assume (from the Lehman auction) outrageously expensive CDSs.

Although I read that bond payouts have ranged from 60 to 91 % of the debt insured, I’m sure there must’ve been some wild and crazy transactions going on over the last few days, which spilled and also fed themselves from the underlying bonds and stock prices.

Apparently, the bleeding in the stock markets has stopped, which should also give a breather to the credit default market participants, by reducing the CDS prices, which coupled with the unabated support in credit from central banks worldwide, should remove at yet a more hastily  pace the unwanted culprit CDSs.

I would also assume that the most worrisome or potentially harmful $27 trillion in CDS outstanding were removed first (since the December $62 trillion). So, it may well be, that if we see a pause in market deterioration, a good percentage of the remaining $35 trillion CDS outstanding may be recategorized as healthy debt and not prone to seller payouts.

In other words, the credit bleeding could be a trickle, if not ending soon, altogether.