Буду втыкать сюда что найду интересным. И всем того же желаю. Можно даже без обсуждения, просто чтиво.
Thursday, September 18th, 2008
The Real Reason for the Global Financial Crisis…the Story No One’s Talking About
[Part
I of a three-part series looking at how so-called “credit default swap”
derivatives could ignite a worldwide capital markets meltdown.]
By Shah Gilani
Contributing Editor
Are you shell-shocked? Are you wondering what’s really going on in
the market? The truth is probably more frightening than even your worst
fears. And yet, you won’t hear about it anywhere else because “they”
can’t tell you. “They” are the U.S. Federal Reserve and the U.S.
Treasury Department, and they can’t tell you what’s really going on
because there’s nothing they can do about it, except what they’ve been
trying to do - add liquidity.
At the exchange rate yesterday (Wednesday), 35 trillion British Pounds was equivalent to U.S. $62 trillion (hence, the 35 trillion Pound gorilla). According to the International Swaps and Derivatives Association, $62 trillion is the notional value of credit default swaps (CDS) out there, somewhere, in the market.
This isn’t the first time Money Morning has warned readers about the dangers of credit default swaps. And it won’t be the last.
The Genesis of a Derivative Boom
In the mid-1980s, upon arriving in New York from Chicago with an
extensive background trading options and futures (the original
derivatives), I was offered a job at what was then Citicorp [today's
Citigroup Inc. (C)]. The offer was for an entry-level post in the bank’s brand new OTC
(over-the-counter, meaning not exchange traded) swaps and derivatives
group. When I asked what the economic purpose of swaps was, the answer
came back: “To make money for the bank.”
I declined the position.
It used to be that regulators and legislators demanded theoretical,
empirical, and quantitative measures of the efficacy of new tradable
instruments being proposed by exchanges. What is their purpose? How
will they benefit the capital markets and the economy? And, what
safeguards will accompany their introduction?
Not any more. In the early 1990s, in order to hedge their loan risks, J. P. Morgan & Co. [now JPMorgan Chase & Co. (JPM)] bankers devised credit default swaps.
A credit default swap is, essentially, an insurance contract between
a protection buyer and a protection seller covering a corporation’s, or
sovereign’s (the “referenced entity”), specific bond or loan. A
protection buyer pays an upfront amount and yearly premiums to the
protection seller to cover any loss on the face amount of the
referenced bond or loan.
Typically, the insurance is for five years.
Credit default swaps are bilateral contracts, meaning they are
private contracts between two parties. CDSs are subject only to the
collateral and margin agreed to by contract. They are traded
over-the-counter, usually by telephone. They are subject to re-sale to
another party willing to enter into another contract. Most
frighteningly, credit default swaps are subject to “counterparty risk.”
If the party providing the insurance protection - once it has
collected its upfront payment and premiums - doesn’t have the money to
pay the insured buyer in the case of a default event affecting the
referenced bond or loan (think hedge funds), or if the “insurer” goes
bankrupt (Bear Stearns was almost there, and American International Group Inc. (AIG) was almost there) the buyer is not covered - period. The premium payments are gone, as is the insurance against default.
Credit default swaps are not standardized instruments. In fact, they
technically aren’t true securities in the classic sense of the word in
that they’re not transparent, aren’t traded on any exchange, aren’t
subject to present securities laws, and aren’t regulated. They are,
however, at risk - all $62 trillion (the best guess by the ISDA) of
them.
Fundamentally, this kind of derivative serves a real purpose - as a
hedging device. The actual holders, or creditors, of outstanding
corporate or sovereign loans and bonds might seek insurance to
guarantee that the debts they are owed are repaid. That’s the economic
purpose of insurance.
What happened, however, is that risk speculators who wanted exposure
to certain asset classes, various bonds and loans, or security pools
such as residential and commercial mortgage-backed securities
(yes, those same subprime mortgage-backed securities that you’ve been
reading about), but didn’t actually own the underlying credits, now had
a means by which to speculate on them.
If you think XYZ Corp. is in trouble, and won’t be able to pay back
its bondholders, you can speculate by buying, and paying premiums for,
credit default swaps on their bonds, which will pay you the full face
amount of the bonds if they do actually default. If, on the other hand,
you think that XYZ Corp. is doing just fine, and its bonds are as good
as gold, you can offer insurance to a fellow speculator, who holds the
opinion opposite yours. That means you’d essentially be speculating
that the bonds would not default. You’re hoping that you’ll collect,
and keep, all the premiums, and never have to pay off on the insurance.
It’s pure speculation.
Credit default swaps are not unlike me being able to insure your
house, not with you, but with someone else entirely not connected to
your house, so that if your house is washed away in the next hurricane
I get paid its value. I’m speculating on an event. I’m making a bet.
The bad news is that there are even worse bets out there. There are
credit default swaps written on subprime mortgage securities. It’s bad
enough that these subprime mortgage pools that banks, investment banks,
insurance companies, hedge funds and others bought were over-rated and
ended up falling precipitously in value as foreclosures mounted on the
underlying mortgages in the pools.
What’s even worse, however, is that speculators sold and bought
trillions of dollars of insurance that these pools would, or wouldn’t,
default! The sellers of this insurance (AIG is one example) are getting
killed as defaults continue to rise with no end in sight.
And this is only where the story begins.
The Ticking Time Bomb
What is happening in both the stock and credit markets is a direct result of what’s playing out in the CDS market. The Fed could not let Bear Stearns enter bankruptcy
because - and only because - the trillions of dollars of credit default
swaps on its books would be wiped out. All the banks and institutions
that had insurance written by Bear would not be able to say that they
were insured or hedged anymore and they would have to write-down
billions and billions of dollars in losses that they’ve been carrying
at higher values because they could say that they were insured for
those losses.
The counterparty risk that all Bear’s trading partners were exposed
to was so far and wide, and so deep, that if Bear was to enter
bankruptcy it would take years to sort out the risk and losses. That
was an untenable option.
The Fed had to bail out Bear Stearns.
The same thing has just happened to AIG.
Make no mistake about it, there’s nothing wrong with AIG’s insurance
subsidiaries - absolutely nothing. In fact, the Fed just made the best
trade in its history by bailing AIG out and getting equity, warrants
and charging the insurance giant seven points over the benchmark London Interbank Offered Rate (LIBOR) on that $85 billion loan!
What happened to AIG is simple: AIG got greedy. AIG, as of June 30,
had written $441 billion worth of swaps on corporate bonds, and worse,
mortgage-backed securities. As the value of these insured-referenced
entities fell, AIG had massive write-downs and additionally had to post
more collateral. And when its ratings were downgraded on Monday
evening, the company had to post even more collateral, which it didn’t
have.
In short, what happened in one small AIG corporate subsidiary blew apart the largest insurance company in the world.
But there’s more - a lot more. These instruments are causing many of
the massive write-downs at banks, investment banks and insurance
companies. Knowing what all this means for hedge funds, the credit
markets and the stock market is the key to understanding where this
might end and how.
The rest of the story will be illuminated in the next two
installments. Next up: An examination of the AIG collapse, followed by
a look at how bad things could get, and what we can do to fix the
problem at hand. So stay tuned.
