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February 20, 2008
SouthAmerica: Reply to Eusdaiki
Let me put some thoughts on paper, and see if I can start connecting the dots.
1) The Financial Times article said: âUS banks borrow $50bn via new Fed facility.â
The use of the Fedâs Term Auction Facility, which allows banks to borrow at relatively attractive rates against a wider range of their assets than previously permitted, saw borrowing of nearly $50bn of one-month funds from the Fed by mid-February.
âThe TAF ... allows the banks to borrow money against all sort of dodgy collateral,â says Christopher Wood, analyst at CLSA. âThe banks are increasingly giving the Fed the garbage collateral nobody else wants to take ... [this] suggests a perilous condition for Americaâs banking system.â
What common sense tells you regarding this government bailout of the major US banks?
That the banks are dumping garbage into the federal governmentâs lap instead of writing off their books that garbage as they probably should have done.
The banks that are taking these loans in exchange of garbage collaterals - their earnings should be adjusted down to reflect the write offs of these bad investments, and the price of their stock also should be adjusted accordingly.
That means the banks have at least another US$ 50 billion dollars that they already know that it is garbage, and they have not written off from their balance sheets.
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2) Here is an important point to keep in mind: Wall Street has created a super-bubble (Derivatives market) in the credit default swap market that the market value amount of the contracts outstanding of about $ 50 trillion US dollars far exceeds the $ 6 trillion of the corporate bonds whose defaults the swaps were created to protect against.
Now going back to what the above NYT article said:
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NYT: âTo the uninitiated trying to understand this complex market, its size might initially seem a comfort, as if there were far more insurance covering the bonds than could ever be needed. But because each contract must be settled between buyer and seller if a default occurs, this imbalance can present a problem.
Typically, settling the agreements has required the delivery of defaulted bonds if the insurance buyer wants to be fully covered. If the insurance contracts exceed the bonds that are available for delivery, problems arise.
For example, when Delphi, the auto parts maker, filed for bankruptcy in October 2005, the credit default swaps on the companyâs debt exceeded the value of underlying bonds tenfold. Buyers of credit insurance scrambled to buy the bonds, driving up their price to around 70 cents on the dollar, a startlingly high value for defaulted debt.
Market participants worked out an auction system where settlements of Delphi contracts could be made even if the bonds could not be physically delivered. This arrangement was done at just over 36 cents on the dollar; so buyers of protection on Delphi who did not have the bonds received $366.25 for every $1,000 in coverage they had bought. Had they been valuing their Delphi insurance coverage at $1,000 per bond, they would have had to write off that position by $633.75 per $1,000 bond.
That is why the valuation of these contracts is of such concern to some participants.
As with other securities that trade privately and by appointment, assigning values to credit default swaps is highly subjective. So some on Wall Street wonder how much of the paper gains generated in these instruments by firms and hedge funds last year will turn out to be illusory when they try to cash them in.â
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As the economy starts descending into a major recession and many corporations starts going bankrupt â the above example of Delphi start multiplying like rabbits inside of the US economy.
Then some people are going to say that the Derivatives Market was able to survive the last major recession in 2001, and I would say, but the only problem is that the credit default swap market has grown 10 fold since the last recession, and if we have a major recession today, that market it will be tested for the first time â the $ 50 trillion US dollars question.
During the last recession in 2001 that market was in the range of $ 2 to $ 3 trillion dollars value compared with the almost $ 50 trillion US dollars in 2008.
I want also to remind the reader that the $ 50 trillion US dollars credit default swap market represents just a little slice of the Derivatives market.
The OTC derivatives market is huge. According to the Bank for International Settlements, the total outstanding notional amount is USD 516 trillion (as of June 2007).
You can check the Bank for International Settlements detail, in their semi-annual OTC derivatives market activity
http://www.bis.org/publ/otc_hy0711.htm
If you want to have a better understanding of the pieces that makes the Derivatives market then you can check the enclosed information regarding Derivatives:
http://en.wikipedia.org/wiki/Derivative_(finance)#_note-afgh
If the US economy starts imploding, and many companies start going bankrupt, the unemployment rate starts going up very fast, the Federal Reserve would keep lowering the Fed Funds rate, and the US dollar would continue its declining trend.
The subprime mess continues getting worse, real estate values keep declining, the credit problems spread to the other areas of the economy, foreclosures keep reaching new records with all the economic ramifications attached to this real estate meltdown.
After the major banks start writing off losses coming from all kind of sides from subprime investments, to credit card operations, and major losses related to all kinds of derivatives operations â it would not take long for the US government to act as the last resort and a number of major banks would be nationalized after they lose all their capital and become insolvent. The US government probably has to merge the carcass of a bunch of US banks and try to salvage what they can.
This clean up process by the US government would cost trillions of US dollars in taxpayers money.
But as this banking meltdown is occurring the stock market also is declining very fast as PANIC sets in and people realize the magnitude of the implosion that is under way.
I hate to think about would be happening to the value of the US dollar as this financial meltdown is going on. At that point when foreigners realize that they need to get out of US assets as soon as possible the herd get spooked and everybody starts running for the exits and we have the biggest international monetary crisis that the world have ever seen.
Most Americans donât realize but over 70 percent of the US dollar currency ever created by the US government is flying around the world, and complete isolated from any US government intervention.
In another words, today the United States is no longer masters of their own currency.
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3) I donât want to get carried away with my thoughts over here, but there are many other things that I could list here to make the case that the first Great Depression of the 21st century is around the corner.
Remember what I have described above would have a major negative impact on banks, insurance companies, pension funds, hedge funds, private equity companies, mutual funds, and so onâ¦.
Things happen very fast today, as never before. Keep in mind about how fast the Soviet Union imploded and went out of business â today an implosion would happen even faster than before because of new technologies. (The Soviet Union imploded before the age of the internet, and today the implosion of a superpower would happen at the speed of light.)
I just heard last Saturday on Bloomberg radio that since October 2007 and up to last Friday global equities on the global stock markets have lost $ 8 trillion dollars in value, and that is just the beginning of that trend.
Today, Lou Dobbs mentioned on his program that by year-end more than 15 million people would be living in houses in the United States where their outstanding mortgages are much higher than the value of their properties, and many people are going to walk away from these properties leaving the banks and mortgage companies to clean this massive mess.
In the meantime the price of oil keeps going up and causing even further distress to an already bad situation.
It is not hard to connect the dots since all these variables that I mentioned above are going on at the same time, and they start feeding on each other creating the Perfect Storm and you have a gigantic implosion of the entire system.
Yes, this new great depression it will affect most countries from around the world, and countries will be affected according to their participation in the global economy.
People who say that it is impossible for us to have another great economic depression like in the 1930âs â these people are delusional and their minds are living in La La Land.
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