Dec 20 2007
Lost at Sea in the Perfect Financial Storm
“Its like playing in the band on the Titanic…some people think you have a job, the music is playing, its going to be ok. But we’re sinking. The ship is sunk. This will get worse for banks before it gets better.
That’s a direct quote from an old friend who works in the upper end of a billion dollar mortgage business. In response to a comment of mine, that things can’t be going so well when Wall Street is relying on bailouts from China, he said:
If not China to the rescue, then who? Somebody better come and save us…”
Indeed, the sea is stormy and here we are, with more bad news surfacing left and right, while many parties struggle to keep their heads above water. Who shall come and save them?
This week we learned that Morgan Stanley was selling a $5 billion stake to the Chinese government via their “sovereign wealth fund” in a move that coincided with a $9.4 billion charge on subprime related investments in the 4th quarter, taking the total to a whopping $10.8 billion in write-downs. How rare is this turmoil? For Morgan Stanley it is its first quarterly loss in its 72-year history of being ponied up nicely to the Federal Reserve printing press.
Today Bear Stearns joined in the fray, reporting its first quarterly loss in its nearly 80 year history, in a $845 million loss vs. $563 million profit. Bear Stearns had to write down $1.9 billion of its holdings in mortgage related securities.
The total so far is about $40 billion in write downs industry wide, but that figure undoubtedly is going to go a lot higher, with estimates of $250 billion to $500 billion being at risk through this.
Consider what’s happening to the credit / Bond insurers. In no uncertain terms we are witnessing carnage. Sheer carnage.
Yesterday S&P cut ACA Financial Guaranty Corp to Junk — all the way from an A rating down to CCC. As we discussed a few days ago, this comes as no surprise — nor does the fact that MBIA — the world’s largest bond insurer — has copped to massive mortgage exposure, having guaranteed $8.1 billion of the riskiest mortgage securities — including the “CDO squared” variety where the lower grade Mortgage backed Securities were repackaged through the alchemy-till and sliced and diced into tranches highly rated spinoffs. MBIA claims upwards of $30.6 billion of complex mortgage securities in total. Says Morgan Stanley, “We are shocked that management withheld this information for as long as it did.”
Well, HELLO! What do people think this is???
As for ACA, they’re on $1 billion of losses with upwards of $26 billion in lingering guarantees. Look out below.
Meanwhile, Merrill Lynch and Bear Stearns and a few others are in talks to bail out ACA. This is truly becoming a shell game of hiding reality and propping up facades of solvency. We can’t blame them for wanting to support ACA. After all, a collapse there and suddenly guarantees are worthless, causing a whole series of cascading implications. But MBIA is sitting there fresh, next in line and looking none the more capable of supporting these promises.
This brings us to counterparty guarantees and the derivatives markets. From the NY article linked just above:
“The troubles at ACA could also serve as the first real test for credit default swaps, the tradable insurance contracts used by investors to protect, or hedge, against default on bonds. In June, the value of bonds underlying credit default swaps rose to $42.6 trillion, up from just $6.4 trillion at the end of 2004, according to the Bank for International Settlements. “
“The hedge is only as good as the counterparty, or the other party, to the hedge,” said Joseph R. Mason, a finance professor at Drexel University and the Wharton School of the University of Pennsylvania. “This is part and parcel of the financial innovation that has grown very rapidly in recent years.”
Those figures are astoundingly large, and the fiasco now unfolding is precisely the one Warren Buffet (and folks like us) have warned about for years that could conceivably trigger financial Armageddon! After all, if a trade that works so well that it bankrupts your counterparty, well… what actually do you have??!
The implications are astounding as this unfolds. So many values are dependent upon the belief that risk intermediation is still somewhat viable. But what can you say in an environment where S&P kept ACA’s rating at A until yesterday despite the company’s stock failing to meet the requirements of retaining its listing on the New York Stock Exchange?!!?? Hello?!??
This all should make you wonder about how deep in the ratings agencies are. Their ratings have been exposed at entirely worthless on far too many cases, continually a day late and a few billion dollars short. You wonder when the shoe will drop on MBIA’s rating falls from its AAA grace, or when the fan is hit with Ambac and its $546 billion of guarantees!
All of this, as Fortune is reporting, threatens the big banks and the financial system as we know it. For example, the Canadian Imperial Bank of Commerce losses could exceed $3 billion if ACA defaults. “It is not known whether ACA will continue as a viable counterparty to CIBC,” the bank said in a statement.
And we’re not even discussing the carnage of non bank investors. At least they don’t have reserve issues that are implied with capital losses, but the news is no better. A prime example is the crisis swamping U.S. municipalities. What do these losses mean for taxpayers?
Meanwhile, across the pond ECB President Jean-Claude Trichet looks like he’s going to follow in the footsteps of Benji Bernanke and Bank of England Governor Mervyn King in dropping rates. As if the joint agreement among Central Banks hadn’t telegraphed the problem sufficiently already, the cash spigots appear to be opening in order to support all the collapsing financial paper values that were never justified in the first place. So, that said, it is not just the United States economy that is being exposed as one whose been foffing-off overpriced debt in exchange for real tangibles.
No doubt, the day of reckoning is nearing for the fiction of inflation based growth. Currency invented from thin air is nothing. Zero. Yet it has been allowed to serve as a claim to tangible wealth — acting no differently as currency backed by sacrifice, savings, and hard work. In other words, the people of the world have suffered from the delusional of allowing nothing to be traded for something until it formed into system dependent on a Ponzi finance.
Will more liquidity injections solve the problem? Ask yourself, does more heroine save the junkie? Does more poison save the poisoned? The pathogen, readers, cannot be the cure. The money will no doubt flow forth to try to reflate this problem away, but the damage is done. The fraud has been exposed, at least to those paying attention. And more shoes will drop until those either too distracted, too locked into comfort zone thinking, or plainly too dumb to realize finally catch on.
That is what the global economy is coming to terms with. While westerners are distracted with the holidays and the latest reality TV hit, they have no clue that the rising water is no normal tide, but rather a Tsunami of consequences from a 35-year experiment with unbridled credit and currency expansion.
As I finish this post, I learn that the Taj Mahal won’t accept dollars anymore. What does that tell you?
It tells me to plan accordingly. As the saying goes, fortunes are made when there is blood in the streets and the crowd is confused.
