Toast

The reason Obama is smacking the auto industry (bye bye Wagoner) and not the financial industry is plain.  Dismantling the bomb derivatives created is not easy and re-engineering the auto industry is by comparison.  So off with their heads in Detroit, because at least we  understand cars. 

But They Said it Couldn't Be Done!

"So, before going any further let me emphasize that no serious danger of a derivatives-induced

financial collapse really exists."  Economics Nobel Laureate Merton H. Miller (University of Chicago) October 17, 1994.  

Good Toxic Assets Primer

Good collection of stories and graphics on Bloomberg giving background on the current financial mess.

What a Difference a Day Makes!

Boy did the markets save Geithner's ass today.  How long they will kiss it remains an open question.

There are two poles to this "toxic trash" debate: those who believe the trash is worthless (Krugman) and those who think it undervalued (Geithner).  I side with Geithner and hope his plan works.  The worthless camp ignores the fact that the "subprime" CDOs  et al. are securitized by real property.  Surely this real property hasn't lost all it's value?   Granted, the underlying assets (homes) have dramatically dropped in value.  But they haven't dropped 100%.  And even in the case of CDOs with foreclosured mortgages  the  CDO owners generally are in the front of the line when it comes to disbursement of foreclosure proceeds.  Furthermore, the default rate in the bundles of mortgages (hundreds even thousands) that make up CDO's  is nowhere near 100%.  That means that CDOs still have some sort of revenue stream; it's just the uncertainty surrounding the future default rate that makes the CDO's  untradeable.     The level of uncertainty surrounding the return on any given CDO prevents investment.  Thus you are left with a CDO that has physical and monetary value but no price.  This is largely a problem of faith, and is not one necesarily rooted in the lack of any value in the securitized assets comprising the CDO.  

What Geithner has that Krugman lacks is faith in the ability of the market to work out the value of the underlying securitized assets.  Krugman thinks that the market cannot work out the value of CDOs even though they are securitized by physical property and revenue streams from current mortgages.  It is impossible for Krugman for there to be a market solution to the market's crash.  For Krugman derivative trading is discredited.  I disagree.  Properly regulated derivatives like CDO's are useful because they ameliorate risk and free up capital.  This crash is like most others, a product of excess and not the result of some innate flaw in derivatives.  No one blames the 1929 crash on innate flaws in the concept of stock shares.  While I don't know if Geithner's plan will pan out, I do think Geithner's right to have faith in capitalism's ability to scavenge itself.  Capitalism is first a predator but second a scavenger. 

Well Said

http://moetkacik.tumblr.com/post/88269730/ugh

Tone Deaf

I work on Wall Street and have gotten pretty jaded at the level of stupidity, arrogance and greed that occurs.  Of course its not unique to Wall Street, Wall Street just has more money than most stupid, greedy, and arrogant communities and individuals.  But the fact that AIG has the balls to sue the U.S. government, its biggest stakeholder, over tax refunds, blows my mind.  How tone deaf can you get?  Wow.

Where are all the AIG Contracts Buried?

When do we get to see the AIG contracts?  As a lawyer I'm really curious as to their terms, who negotiated them, and what the parties knew when they were negotiated.  If they were negotiated when times were flush I'm inclined to be more forgiving, if negotiated when things were going down the crapper then Cuomo's fraudulent conveyance argument might have some bite.  Show me the contracts, I've already seen the money.

Breach

AIG finally broke down and released the names of its counterparties.  Nothing too shocking.  The usual suspects domestic and international.  Still wondering why we're even bothering to keep the middleman alive.  

On another note, every employment contract I've ever seen, and I've seen a few at this point, make bonuses discretionary.  What gives with these AIG contracts?  I'm a big believer in the sanctity of contract, and I think one of the reasons that the dollar has managed to stay relatively strong in this mess is the fact that our Federal Court system is a relatively unbiased forum for settling contract disputes.  Investors know they can enforce their rights in the U.S., which is more than you can say for China or Russia.  But the fact that AIG was allegedly writing contracts for such a large amount of non-discretionary bonuses is suspicious.  When were these contracts written and what did signatories know about the state of AIG's balance sheet when they signed them?  There may be legitimate ways to void these contracts, at least as to the bonuses, that don't tread on the sanctity of contract.  Fraud and public policy comes to mind.  After all, AIG would have gone under and wouldn't have been able to pay these bonuses without taxpayer money.

China to U.S.: Drop Dead

The Chinese Premier is concerned about the safety of U.S. Treasuries?  I don't have time to blog on this right now but want to say one thing.  The last time I checked the U.S. had never in its history defaulted on its bond issues.  As a matter of fact, one of the reasons Hamilton lobbied so hard for the Constitution was in order to establish strong credit for the U.S.  During the period from the ratification of the Constitution and now, China has seen multiple governments that have defaulted on their debt multiple times.  So while I'm happy that China is finally at the capitalist party, and gee they have a nice outfit, I think they've had a little too much to drink and are starting to talk smack that sounds somewhat silly given their track record.

Boy am I Glad That's Over

And lo, the banks were profitable again and money was lent as manna from heaven and the markets sighed deeply and began their weary climb back up.  Would you like to buy a bridge?  I don't believe anything those banks say about their balance sheets right now, they have powerful incentives to lie about it.  I sincerely hope I'm wrong and that we've turned a corner with the economy in terms of the credit crisis but I find much of the optimism surrounding the Dow's recent uptick ill founded.  History is littered with defunct financial institutions that gave rosy projections until their last breath.  As a matter of fact, isn't that what we saw with Lehman and Bear?  Don't believe the hype.

On Edge

For the moment the market has stabilized teetering on the edge.  

I am worried that Obama's economic action team is not up to the task.  Their dithering on toxic assets, the banks and AIG merely puts the solution off to another day.  This has the unpleasant effect of increasing the cost of any future solution.  Treasury is way too tentative, vague, oracular and  shockingly understaffed.    Economists are losing faith.  You know, the ones that told us the free market would set us free. 

And what's this crap about Citigroup making a profit?  Aren't they on taxpayer life support?  What kind of accounting are they doing that they're showing a profit?  Isn't that the kind of accounting that got us into this mess in the first place?

The market surge after the news that Citigroup was projected to be "profitable" in the first quarter displays the desperate psychology of a wounded beast.  Charging wildly in any direction at the slightest provocation.  This beast is far from done.  

Reason for Concern at Treasury

We're going to need a bigger boat.  The fact that our mission critical teams are understaffed right now is scary.  Compare what's going on in terms of staffing at Treasury with what's going on with staffing at State.  Maybe Hillary should have been Treasury Secretary instead.  If this continues like this for much longer we're doomed.  

Econapocalypse

The current econapocalypse has at its root two  intertwined parts, one a first cause and the other its unintended amplifier.  The government must attack both if it wishes to have any hope of halting this catastrophe.  Unfortunately, it currently is doing a dismal job by failing to either breathe life into the securitization markets or expeditiously wiping out the toxic derivatives paralyzing these markets.  And it is simultaneously failing to expeditiously contain the bonfire of credit default swaps copiously sold as insurance on these toxic derivatives of questionable value and the debt predicated on them.

  

The first cause is the meltdown in the subprime market and what it did to the value of securitized derivatives consisting of bundles of mortgages and other hyper inflated assets. There has been a near total collapse of these securitization markets since subprime mortgage defaults began to surge.  Unfortunately these securitization markets are what most major financial institutions had and have large positions in.  Some of these positions were on-balance sheet but also quite often not.  Thus you are seeing large on-balance sheet losses and the market panic caused by the spectre of even more massive off-balance sheet liabilities at many, if not all, major financial institutions.  

 

No one really knows what these toxic derivatives are worth.  Thus this first cause  turns on finding a way to value (price) these derivatives that a gun shy market can trust. No faith in value equals no sale, no matter how many Nobel Prize winning equations you have on your side.  In the meantime in the face of these paralyzed markets the government simply needs to seize the institutions that are illiquid due to their huge unrealized  losses on their derivative holdings. 

 

The second amplifying part of the econapocalypse is the inability of the sellers of insurance (read AIG) upon debt and derivatives  to meet what are essentially margin calls on their positions. As the value of the debt and/or derivatives  AIG was and is insuring plunges, AIG is contractually obligated to post cash collateral to its counterparties based on factors such as the risk of default and loss in value. 

Worse, AIG CDS contracts are the parchment barrier between liquidity and illiquidity for many financial institutions.  If AIG cannot make its contractual payments on these policies many of these institutions will no longer be able to keep their derivative losses off there books, leading to illiquidity and defaults (that AIG insured) and margin calls because of the change in credit risk.  The formerly lucrative CDS echo chamber thus grows into a roar that no one has been able to quell.  The administration's action on this front has been weak and is cause for concern.

   

Someone Please Kill AIG

Good scoop by the WSJ publishing a partial list of AIG CDS counterparties.  They also give a succint and clear description of the magnitude of the CDS problem.  Naturally, the counterparties on the AIG CDS contracts received funneled payments of roughly $50 billion from the federal AIG bailout funds.   It's the usual suspects, including Goldman, B of A, Deustche Bank, Merrill, Barclays etc.  European financial institutions  had large exposures.  The fear of course is that not bailing out AIG on its insurance contract obligations will force all their counterparties to book the losses on their toxic transactions that AIG sold them insurance on.  As long as the counterparties had a good faith belief that AIG would make an insurance payout on their financial transaction they didn't need to book it as a loss.  But those days are over and the government(s) need to force everyone to book their losses, letting the weak die and saving the strongest by whatever means necessary.  Not bailing AIG out when it was about to collapse last fall would probably have been a bad idea, but the time has come to stop propping up this stinking international heap of greed and shortsightedness. 

How much taxpayer money are we going to shovel into this piece of shit insurance company before we take it out back and shoot it?  Really.  The federal government is posting cash collateral to AIG's counterparties?  Why bother with the middleman AIG?   We already pissed away $173 billion dollars into AIG's bottomless pit.   And Citigroup?  A penny stock.   I voted for Obama and all but Krugman is right:  the administration's economic dithering and weak kneed fantasies of private/public cooperation lifting us out of this apocalypse instead of the bullet to the head of nationalization and good old fashioned bankruptcy (and why are they so averse to bankruptcy? all their "too big to fail" policies do is delay it at a higher cost) are fatally naive.  May I eat my words.