CREDIT DERIVATIVE MELTDOWN IN PROGRESS

From table 1 on page 23 of 34 in this PDF
http://www.occ.treas.gov/ftp/deriv/dq406.pdf

The biggest derivatives players are (pay careful attention to the "total derivatives" column in the pdf):

1 JPMORGAN CHASE BANK NA
2 BANK OF AMERICA NA
3 CITIBANK NATIONAL ASSN
4 WACHOVIA BANK NATIONAL ASSN

Now look who is borrowing money from the FED:

http://www.businessweek.com/ap/financialnews/D8R679MG0.htm
The Associated Press August 22, 2007, 1:37PM ET
Four major banks borrow from Fed
Four major banks said Wednesday they each borrowed $500 million from the Federal Reserve's discount window, lending weight to its efforts to restore liquidity to tight markets.

Citigroup Inc., JPMorgan Chase & Co., Bank of America Corp. and Wachovia Corp. each stressed they themselves have "substantial liquidity" and the ability to borrow money elsewhere.

Is it true that the fed will accept these credit derivatives as collateral against the loans? If so are these guys just taking this opportunity to offload a bit of risk to the FED?

JR

Is it true that the fed will accept these credit derivatives as collateral against the loans? If so are these guys just taking this opportunity to offload a bit of risk to the FED?

JR

ECB Signals Readiness to Raise Rates, Adds More Cash (Update4)

Aug. 22 (Bloomberg) -- The European Central Bank indicated it may still raise interest rates in September and announced an extra 40 billion euros ($54 billion) three-month loan to ease lending between commercial banks.

That was my interpretation of the offer made by the FED when it was all going wrong last week, it was then I knew this would be resolved in a way that was essentially corrupt. How did they value the collateral? The whole reason the market was in such a mess was because these CDO's were struggling to find a value buyer would take!

CREDIT DERIVATIVE MELTDOWN IN PROGRESS

From table 1 on page 23 of 34 in this PDF
http://www.occ.treas.gov/ftp/deriv/dq406.pdf

The biggest derivatives players are (pay careful attention to the "total derivatives" column in the pdf):

1 JPMORGAN CHASE BANK NA
2 BANK OF AMERICA NA
3 CITIBANK NATIONAL ASSN
4 WACHOVIA BANK NATIONAL ASSN

Now look who is borrowing money from the FED:

http://www.businessweek.com/ap/financialnews/D8R679MG0.htm
The Associated Press August 22, 2007, 1:37PM ET
Four major banks borrow from Fed
Four major banks said Wednesday they each borrowed $500 million from the Federal Reserve's discount window, lending weight to its efforts to restore liquidity to tight markets.

Citigroup Inc., JPMorgan Chase & Co., Bank of America Corp. and Wachovia Corp. each stressed they themselves have "substantial liquidity" and the ability to borrow money elsewhere.

These four banks alone are on the hook for more than 120 Trillion USD. If the FED monetized even a small fraction of that much money, hyperinflation would quickly result.

This is just insane. I would urge everyone to have a look at the above referenced table.

I start to wonder whether this is not an interest rate derivative meltdown, rather than a credit derivatives meltdown. The biggest part of the derivatives with these banks are IR derivatives. What has happened recently was an interbank IR shock that the central banks desperately tried to suppress. I don't know much about IR derivatives, but what is more relevant for them: base/funds rates or market rates?

This is just insane. I would urge everyone to have a look at the above referenced table.

See page 34 too.

They look bankrupt to me....c.f. CDS vs. Assets

CREDIT DERIVATIVE MELTDOWN IN PROGRESS

From table 1 on page 23 of 34 in this PDF
http://www.occ.treas.gov/ftp/deriv/dq406.pdf

The biggest derivatives players are (pay careful attention to the "total derivatives" column in the pdf):

Tapping the discount window had previously been seen as a last resort for banks in trouble, a perception the Fed sought to eliminate.
...
"The companies believe it is important at this time to take a leadership role in demonstrating the potential value of the Fed's primary credit facility and to encourage its use by other financial institutions," their statement said. The three added that they hoped their actions would "promote broad acceptance of the use of the facility."

That's "total derivatives".
"Credit Derivatives" are just a small part of the total, between those 4 banks their total is about 4 trillion, against 130 odd trillion. Read the table.
If you want to get scared have a look at interest rate swaps, but these have come through many financial crises, over many years.
The other thing people should understand is that Credit Derivatives are used to manage risk, not to increase it. There's a big difference.

Hmm.. in Carmel, Indiana. Where? Me neither.

On the other hand, the last table shows that the books are quite balanced. Or do I get something wrong here?

Nope - generally the books should be close to balancing. ...

What does 'moneytize' mean?

Nope - generally the books should be close to balancing. Look on the derivatives positions of the investment banks in the same way as you would the accounts of your local bookies and makes a bit more sense. Most of the 'total' derivatives exposure of the banks should just cancel out, since they're selling both sides of the bet but with the odds weighted in such a way that they should be able to skim off a nice profit for themselves. The investment banks are highly regulated and need to keep this balance right to the satisfaction of the regulators. Hedge funds, on the other hand, are not regulated and can just place their entire assets (plus as much as they can borrow) on Accrington Stanley to win the FA cup, if they so wish.

Unfortunately for the investment banks, if all the punters on one side of the bet lose so badly that they go bust and can't pay up, the investment banks are still left owing the punters on the other side of the bet their winnings. That's where the credit default instruments come in - these are essentially bets placed on whether or not a given punter is likely to go bust, in order to alleviate this kind of situation. Unfortunately, nobody really has a clue of how to price credit default bets, so the odds are usually just fiddled to make the books balance to the satisfaction of the regulators...

If you ever wondered why people refer to the financial markets as the world's biggest casino, this might go some way to explaining it.

C J

CREDIT DERIVATIVE MELTDOWN IN PROGRESS

From table 1 on page 23 of 34 in this PDF
http://www.occ.treas.gov/ftp/deriv/dq406.pdf

The biggest derivatives players are ...

Fed bends rules to help two big banks
August 24 2007: 5:09 PM EDT
http://money.cnn.com/2007/08/24/magazines/...dex.htm?cnn=yes

I think a decision to bail out the banks, goes all the way up to the president. I am sure this will be followed up by rate cut's so the positions can be closed.

Bernanke quite obviously is reluctant to. Maybe he really thinks inflation is too high, maybe he just doesn't want to do soemthing that could be interpereted as panicky.

golden_lifeboat golden_lifeboat is offline
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Join Date: Aug 2007
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This is the biggest financial story this month, and that's saying a lot. The way this has been handled leaves me with a feeling of disgust. The Fed kept it under wraps as long as they could, they knew it was explosive. This is exactly the kind of thing Glass-Steagall was passed to prevent, the same thing which caused so many banks to go under in '29/30 - using depositor accounts to prop up losses in the brokerage arm of the bank, or other banks/Funds/specs.

This story was covered in a WSJ blog on Thursday PM but few noticed, then broke big around 3:30 PM Friday with articles on Bloomberg and Yahoo, and then the one everyone noticed on CNN, time stamped at 4:31 PM ,where i saw it. The Fed actually posted the .pdf files after close today, then pulled them, edited and re-posted them, which caused great consternation among those who had just found out about it. Tinfoil hatters thrive on that, but it was a sideshow.

The inherent moral hazard in this action is about 100 miles deep. The Fed gives money to the big banks so they can support hedge funds and other speculators who got over-extended by their own stupid Ponzi schemes!! The taxpayer is bailing out hedge Fund speculators, to keep "liquidity flowing"!!!

Now, I'm not saying the Fed shouldn't take steps to prevent systemic meltdown, we all have bank accounts, credit cards, etc., but this action goes way beyond that - any action they take to bail out players in a "free market" should be even-handed, open and transparent, and this most certainly is not!

The worst thing about it was it was a done deal on Aug 20, so the insiders had 3-4 trading days to position themselves on this before the public knew about it. Just like the action Friday AM 2 weeks ago to crush the Index shorts, which saved, by some estimates, as much as $8B options writers did not have to pay out, after the Fed helped them by releasing news at 7:30 AM, which made black positons red by opening quote fix time. You can read up on that one at Market Ticker too. Which incidentallly, is one of the most brutally honest places on the web for macro analysis, tho the site is mostly focused on stock options trades. It's worth reading the blog every day there, the tone is very realistic/bearish right now.

That the Fed has pulled this kind of stunt twice in 2 weeks tells me the rot runs very, very deep, and they are desperate. CitiBank is in VERY deep trouble, their terms under this deal are looser than the other banks (BoA and Wachovia) which are also known to be involved. By implication, all banks must be in really bad shape! I think this is also tied into the massive SPY Index options position opened in mid-week, as that is a $1.7B bet that the market will tank before OpEx in Sept. Insiders? Sure looks like it!

The implications are mind boggling. Read the analysis on Market Ticker. By Monday this will be all over the blogosphere, but the MSM don't seem to be reacting much yet, though apparently it was mentioned on CNBC Friday evening, I wasn't watching.

The effects on precious metals prices are unknown. I see it as a huge negative for the US$ and the USA in general, but maybe domestic investors will choose to ignore it. I don't think the rest of the world will be as forgiving, the play that the 2 banks in China got on their sub-prime toxic paper issue today suggests they will not like it one bit. If many see it my way, then maybe it is the catalyst needed to launch precious metals skywards.

I find it hard to believe they can sweep this one under the rug, that huge bulge is obvious, but kool-aid drinkers will certainly try. MSM silence will certainly help their cause. If they are succesful, then precious metals will get no joy here. The market action today between 10:30 AM -12:05 PM in gold, and after 11:30 AM in silver, suggests to me that someone with big money was aware of this, and made their move today. If so, Monday could be a great day for precious metals longs.

If you are an American citizen, I suggest you call/write/e-mail your Congressman/Senator and complain loudly about the vast moral hazard, suspect timing, and general shady way this was done. And get all accounts at any banks/brokers down to under deposit insurance limits ASAP!! If you really want to protest, go down to those banks on Monday and close your accounts and take your business elsewhere.

Mechanically, here's how it works. The Fed will only do business directly with banks that maintained good loan practices and are the most credit-worthy. Lenders of various flavors such as investment banks and hedge funds that took on a lot of bad loans can only deal with the banks that deal directly with the Fed. They do not have access to the new and improved discount window on their own. The credit-worthy banks can use the weak creditors' assets as collateral to borrow from the Fed.

For example, a distressed hedge fund can't access the Fed directly but can take the mortgage-backed securities they hold and bring them to a credit-worthy bank that does have access to the Fed. That bank uses the paper as collateral for a one month loan. That's why Bank of America, Wachovia, Citigroup, and JP Morgan all hit up the discount window at the same time, each for the same $500 million amount yesterday, to let hedge funds and others know where to go to put up their asset backed securities and CDOs and other paper as collateral for loans. The banks borrow from the Fed, and the hedge funds borrow from the banks. Hedge funds and others can still fail, but in an orderly way versus a simultaneous dumping of assets into a frozen market. The Fed can turn the discount window knob as need to control the rate of failure, averting the dreaded "break in the chain of payments." DOW 50k or was that 5K?

http://www.tickerforum.org/cgi-ticker/akcs...5001&page=3

So, what happens when the hedge fund goes bust? Who is holding the MBS bag in the end?

this is like a bag with a billion dollar label containing 1 million dollars. As long as it's never opened, its worth 1 billion.

So, the borkers at BAC and C get to hand the bag to their banking brethren, the bank now needs to dump it. The next logical step is for the bank to dump it to the fed or fnm, etc. then, the fed can open it quietly, and fill it up with taxpayer money, and THEN announce it's got 1 billion.

Its an orderly way of absorbing all the toxicity into the tax payer. Meanwhile, all those who got rich stay rich, and when J6P retires, he'll live on dirt and water.

form that point on, lending restrictions will be in full effect so no more unsecured lending (show me your W2s). housing prices will still drop for the time being, but salience will come back to the system.

i think, ultimately from this -- assuming people do not freak out and start withdrawing funds (which if it does happen may be forbidden by the government) -- and that is a large assumption, but utlimately:

RE in bubble areas correct, non-bubble remains largley unchanged. Defaulting loans are passed up through the chain via the proverbial 1 billion bag. REO inventory liquidated at market price (30-60 cents on dollar). Markets thaw as true asset value is backing paper again.

Now, these loans from the Fed are very short-term. However, if the get rolled-over and rolled-over and rolled-over...

So we can have a real meltdown, but no one has to notice and the taxpayer pays for it? Hmmm. Something must give.

Red Flag-Do we need a Glass Steagal Act II?

READ THE ARTICLE FROM Peter Eavis!!!!!!! (Fed bends rules to help two big banks) If you are interested in economics and US financial markets at all, the need to understand the legal frame work and how the banking system operates is essential, as that is at the heart of the whole system. We have cited a small bit from the article

The regulations in question effectively limit a bank’s funding exposure to an affiliate to 10% of the bank’s capital. But the Fed has allowed Citibank and Bank of America to blow through that level. Citigroup and Bank of America are able to lend up to $25 billion apiece under this exemption, according to the Fed. If Citibank used the full amount, “that represents about 30% of Citibank’s total regulatory capital, which is no small exemption,” says Charlie Peabody, banks analyst at Portales Partners.

If we reach back in history, the issue then as today revolves around credit speculation. This was one of the issues behind the 1929 crash. The bi product was the Glass Steagal Act and Banking Act of 1933. The acts separated commercial banks from investment banking. In the late 20’s commercial banks where taking their assets and deposits and underwriting companies only to take them public in the market to sell to investors. As bubbles go, guidelines, relationship and lending practices became lax and greed took control, until the party came crashing down. Under the Act only 10% of a banks capital can be exposed to an affiliate operation. Granted, there where many other variables in the 29′ crash, but this one seems to lend itself, as a reference point, to today’s crisis.

Now the FED has agreed to allow a bank to lend its capital to prop up brokerage service units. The effects area bit far reaching. The main issue we have with the FED’s move is the desire to bail out poor speculation. In the future will institutions still be encouraged to take on risky operations and over lend? (increasing of morale hazard) In short it is a very precarious move. Accordingly, Glass Steagal and Banking Act of 1933 was repealed on November 1999 and replaced with Gramm-Leach-Bliley Act. The act allowed banks to diversify into other services again. We have listed a few cited in the Act; non-bank mortgage lenders, loan brokers, some financial or investment advisers, debt collectors, tax return preparers, banks, and real estate settlement service providers. The Act may have increased the risk banks are exposed to rather than the intended effect of reduced financial exposure through industry diversification. Thus, we have the FED bailing out banks from exposure to Real Estate lending.

The recent move confirms the crisis is far deeper and points to a structural failure in the financial system. At this point it is not a question of if, but when the FED cuts the Fed Funds rate. Accordingly, we are not sure if the shock to the financial system is over and are very worried by the rapid rise in the equity market.

The merger and acquistion flood gates opened. The consolidation reduced diversity in the market place. The big banks accumulated more influence over the market, until ... they began influence the market, and that by text book definition is monopolistic. To help mitigate this, a limit on funding is still supposed to exist between commercial and brokerage operations. But, today's fiscal crisis is so bad, the Fed just bent the rules, proving my point. They can't let the big ones fail, because they too strongly influence the market.

This is so bad, if I wasn't basically 100% in gold anyway, I would do it NOW. And I would withdraw cash from these banks. I sort of expect this to happen.

New York Fed Affirms It Accepts Asset-Backed Paper (Update2)
Officials at the New York Fed, the central bank's liaison will Wall Street, received inquiries from commercial banks in recent days on whether their clients' asset-backed commercial paper could be pledged as collateral at the discount window.

As investors shunned the commercial paper sold by finance companies that held loans such as mortgages, the companies asked banks to buy the securities. The New York Fed's announcement clarifies that its discount window is prepared to accept these asset-backed securities as collateral from banks.